It All Comes Down to Earnings Growth

And it's about time.

Is this the beginning of the rally that doesn't look back? We'll have to just wait and see.

But one thing is certain – lots of stocks have been going up.

Some deservedly so. Others, not so much.

The saying "a rising tide raises all ships" most definitely applies here.

But when the tide goes down, not all stocks will stay afloat.

So today I'm screening for growth stocks.

And not just any kind of growth stocks.

Stocks with growth rates that are too low aren't really growth stocks at all and don't perform that well.

But stocks with crazy high growth rates don't test that well either. And in my testing, I've found that very high growth rates perform almost as bad as poor growth rates.

A good place to start is to look for growth rates that are aggressive, but also realistic.

Looking at the S&P 500, the average growth rate for the next 12 months is barely positive. But the average 5-Year Historical Growth Rate is roughly 6.5%.

So looking for stocks with a doubling of that growth rate for the current year is aggressive, given the current environment, but pretty reasonable in and of itself.

By using the free screener on Zacks.com, you can get started on this right away.

As the screenshot below shows, just by adding in a price filter of >= $5 and a one year projected growth rate of >= 13%, stocks in the S&P 500 were narrowed down from 500 companies to only 61.

As for how to make sure their growth rates aren't 'too high'; I like to look at their valuations as well.

One ratio in particular that I like is the PEG ratio.

The PEG ratio is interesting when used with growth stocks because it takes into account the growth rate.

The calculation is simply:

P/E ratio divided by its future growth rate = PEG

Basically, it shows how much you're paying for each unit of growth.

A value of 1 means the P/E is in line with the growth rate. Above 1, the P/E is higher than the growth rate. Below 1, the P/E is lower than the growth rate. And in general, a lower PEG is considered better as it shows value. In other words, it isn't too 'expensive' in comparison to its earnings potential and hasn't been bid up too much.

Adding a PEG ratio of

And you don't have to stop there.

You can even take it a step further by using the screener in the Research Wizard, and adding in other items such as stocks with growth rates better than their industry. Or companies with sequentially higher earnings, quarter after quarter after quarter. And then backtest it all to see how it works.

Here are 5 stocks from this week's screen with market-beating growth rates and low PEG ratios.

ADM - Snapshot Report Archer Daniels Midland Company
DTV - Analyst Report The Directv Group, Inc.
HCBK - Analyst Report Hudson City Bancorp, Inc.
MYL - Analyst Report Mylan, Inc.
PRU - Snapshot Report Prudential Financial, Inc.

Get the rest of the stocks on this list and search for all the others that aren’t on the S&P. There are hundreds of solid stocks with outsized earnings waiting to be discovered. And there’s no time to waste. Sign up now for your free trial to the Research Wizard and put your 2009 plans into action today!

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.