How I Spot Profitable Growth Stocks To Buy
How To Pick Best Profitable Nigerian Growth Stocks – Learn How I Pick Fast Growing Undervalued Companies At Cheapest Price Per Share
I get so excited when I discover new stock market investment topics that will help you invest well, find good stocks to buy and become a profitable Nigerian stock trader. Today, I will be sharing interesting secrets to finding true growth stocks that will appreciate.
Let’s spend some time to find the perfect answer to this typical question, would you rather buy a stock that is selling for N5 or invest in a bigger company’s share at N500 per unit? A better way to explain this: if you have N10,000,000 to invest in stock, would you invest in Nestle stock that is already at a very high price of N1,300 per share or choose Diamond bank that is selling at just N3 per share? When I asked this question a few weeks back, the majority of the answers favoured Diamond bank shares because it’s cheaper at N3. Well, that isn’t the right way to advise a beginner on how to pick his first stock.
I had been in a situation like this, where I decided on buying stocks that were selling at a high price or go for a stock that was cheap since quantity matters too. The truth is, a stock is not considered cheap because the price per share is low neither is it expensive because it has risen too high, you need to focus on a simple metric called growth rate before picking the best stocks to buy. Nestle share price increased from N20 to N500 at some point and a lot of investors felt it was too high at that level, the same share broke through that level to hit N1000 and now at N1,300, my big question is do you still think the share is already high? Before I help you find an answer to that using my personal check, there is a number you need to understand or else, you might be misdirected if the price of the stock is the only factor you watch out for before investing. The number is the projected growth rate of a stock based the fundamentals. Smart investors were not putting more money into Nestle stocks because they were fools, they knew the company was a growth stock with great fundamentals. This is how you should think when investing in a company.
Good companies have common positive metrics before they start rising faster than their peers, you need to spot these secrets features because of one fact: they uncover companies that had shown resilience in the midst of difficult operating environments, posted impressive profit figures and recorded outstanding appreciation in share prices.
This is what I called growth stocks. A lot of investors think growth stocks are stocks that have been growing their share price, no! they are not, growth stocks are stocks that are growing sales and profit faster and at some, smart investors expect the price to reflect the actual value of the company. You can find more details on how I value Nigerian stocks before buying again. If you had thought of growth stocks as one with fast-growing price, look at Nigerian Breweries, the stock which as of this writing hasn’t posted good result but trading at approximately 31 times its earnings; price is growing faster than the profit which is a time bomb. A closer look at the chart trend reveals that institutional investors are gradually dumping the shares as it underperformed the NSE index in 2017 and already down on a look at the year to date performance.
When a stock price is growing fast and posting stead weekly gain, don’t just rush into it and get trapped, look at all the criteria that make a company stock to be referred to as a growth stock before waiting for the perfect time to buy.
How to spot growth stocks.
Here are important checks you should do before picking growth stocks:
A true growth stock can’t thrive in a sector that is not supported by government policy, for instance, the CBN micro credit policy aimed at boosting agricultural outputs will no doubt help Agric-business access finance to scale up faster. This is a typical example of how growth stocks can emerge from policies and initiatives. We saw how the CBN’s Investors’ and Exporters’ Window provided FX liquidity, stabilized the exchange rate and reduced material input cost that were initially high due to the high cost of access forex from the alternative market.Such policy should drive consumer goods stocks that rely on imported materials as the cost of sales will likely reduce, and help improve profit figures.
You can subscribe to business dailies, follow top blogs for the latest news that could drive sectoral growth.
This is the starting point of every growth stock pick, make sure the stock you analyse has a consistent sales growth history of at least 10-20% in the last 3-5 years. When you compare their sales revenue with the overall industry figure, it will help you check percentage market share a company currently occupies; portrays market leader and brand loyalty.
Also, good sales figure don’t come from extraordinary or one-time business transactions but from their real line of business – operating activities.
If cost is rising faster than sales, this is a clear red flag that something is wrong. True growth companies keep their operating cost under control, they have a high level of operational efficiency and can utilise available resources to produce greater results and impressive numbers. The best way to measure this is what we call “cost to sales/income” ratio, a measure of how much is incurred to produce 1 naira sales, the lower the better. I love to look at this metrics on quarter to quarter basis.
Avoid stocks that are intentionally cutting cost to manipulate profits, you will such stock when sales growth is stagnant.
Lower debt and increasing return on equity.
A true growth doesn’t channel the bulk of its earnings to finance expenses or debt servicing as they have a lower debt figure compared to their equity. Such company reports increasing return on equity above 15% year on year and can pay dividend to shareholders. As of this writing, the CBN has just released a dividend payout policy that restricts certain banks, that have a high non-performing loan and below the required capital adequacy ratio (CAR) , not to pay dividend above a certain threshold. Of all the banks listed, only 4 banks can pay dividend without restriction as they have a lower cost of risks and higher CAR.
This is a perfect example of what you should look at when picking the perfect growth stocks, the lower the debt issued, the lower the interest expense, also known as finance cost and the higher the profit attributable to shareholders and dividend payout.
The cash flow from operating activities is growing inline with or faster than the profit after tax.
It is not all the figure declared as profit are available in the bank as cash. A company may declare N10 billion Naira profit after tax but when you check their bank account, the only figure you see is N2billion, what does it mean? they are not able to convert profit to physical cash and as such might not pay dividend. This is a sign that something is wrong.
The cash flow statement is a very important financial statement you shouldn’t ignore: a company can manipulate a lot of stuff to show you big figures but at the end, it the actual cash generated from operating activities that matter.
When I check the historical cash flow trend of growth stocks, I love to see a growth percentage that is close to or greater than the net income growth or EPS growth in the same period.
For instance, if a company reports a profit after tax of N10 billion in 2017 against N5 billion PAT in 2016, that’s like 100% growth, the cash flow from operating activities in the same period should grow by at least 50%, 100% or even more.
The next check on cash flow is, what percentage of the profit declared is available as cash? using the first example, if I have N2billion available as cash when I declared N10 billion, then I have 20% cash conversion ratio. This ratio will help you see the ability of the company to raise more cash to finance growth without borrowing more.
Earnings Per Share
This is the profit attributable to shareholders in a company, besides, it is the key metrics all investors watch out for as it tells whether a company will pay a dividend or not. Most dividend payouts come from the profit after tax.
EPS is also a major factor I use to estimate the intrinsic value of a company; I divide the figure by the average yield on the 10-year FGN bond. This is the metrics I used to confirm my buy signal on Zenith bank’s stock when the bank released a Q3 EPS of N4, the estimated share price I arrived at was N38 but the stock traded at N22, presenting over 60% potential upside.
Is it all stocks that trade below estimate value are great stocks? No, do your background check to be sure that it’s only sell-offs attributed to profit taking and not a fundamental issue. What should I do when a stock trades above it’s estimated value based on its most recent EPS figure?
Know the PEG ratio (price-earnings to growth rate).
This is a very important metrics that helps you uncover the potential of a stock. Every stock has a price-earnings ratio, a number that tells investors’ perception about a stock and the premium they are willing to pay to own that stock. Stocks with high price-earnings ratio indicates that expectations are high while a lower number tells the reverse. What if there is a way to check how fast the company is growing, compare the result with what investors’ expectation of sentiments, would you take advantage of the gap discovered and inject more cash into the stock? Here is price-earnings to growth, the light metrics that does the magic for you.
With PEG, you can easily tell whether a stock is growing faster than what investors really think or slowly which could eventually give you an idea of a future trend.
An easier way to calculate PEG ratio is to find out
- the price-earnings multiple of a stock by dividing the share price by the current EPS figure
- the average EPS growth in the last 3 years and use it as the projected growth rate.
- divided the price-earnings multiple by EPSS growth rate.
Stocks with PEG less than 1 means that it is highly undervalued and above 1 indicates an overvalued stock. Proper care should be taken when projecting the EPS growth rate of a company to avoid over-estimating or under-estimating the figure. I love to use a modest EPS growth range of 15%, 20% and 25% to estimate a stock intrinsic value at various growth levels; this had helped me discovered what a stock’s value was in worst case scenarios.
Share Price Growth
When I talk about fast-growing stocks, I really do not think a stock actually qualifies to be called growth stock if the share price hasn’t performed well in the last 3 years. A modest minimum price appreciation of 50% growth in 3 years and last year is what I use to screen for top performing stocks because if all the metrics I have shared above are actually present, the performance should reflect investor’s perception or sentiments. So, before you conclude that the stock you are about to buy is a true growth stock, check how the stock had performed in previous years for better decision or else, you might miss out a key reason institutional investors or big market movers are not buying the stock.
Please read my guide on the perfect time to buy your next stock so you don’t jump into a good stock at the wrong time.
Did you find this guide on how to pick best profitable Nigerian growth stocks interesting? Please share your ideas and opinion.