Education: Aggressive Growth Investing

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Earnings Estimates Primer

Aggressive Growth investing can be extremely exciting and profitable. This is the realm of the most innovative, cutting-edge companies in the world. Get on board the right one and you could be netting a “Ten Bagger” or more. Just ask anybody who got in early on longtime growth favorites like Microsoft, Amgen and Dell. But guess wrong and you’ll lose money in a hurry. The key to successful Aggressive Growth investing is to monitor their earnings estimate revisions, which is the best gauge as to the current health and future prospects of the stocks you follow.

Importance of Earnings Estimate Revisions

Aggressive Growth companies are generally predicted to have future earnings growth of 20-30%+ per year. Earnings growth is an extension of earnings estimate revisions for it is saying; What is the company predicted to earn in the future?

If earnings estimates are rolling higher for a stock, then the market is saying “The future is brighter than we previously expected…Full Steam Ahead!”

If earnings estimates begin to decline, then the market is indicating “Maybe things aren’t so rosy…perhaps this stock is worth less than we thought.”

You have to realize that Aggressive Growth stocks are often priced for perfection, which results in dangerously high PE multiples. Once investors believe that future prospects are diminishing, then the stock will start to decline and the PE will contract. Sometimes that is akin to a slow leak in a tire. Other times it is a blow out and the stock will crash immediately. Either way, your best indicator to its future prospects is earnings estimate revisions.

To longtime Zacks customers, you already know that “earnings estimate revisions are the most powerful force impacting stock prices”. And the best way to harness this phenomenon is through the Zacks Rank.

Can Disaster Be Avoided?

The beauty of investing with earnings estimates as your guide is that we often get early warning signals that future prospects are on the decline. This allows us to sell off our positions to lock in profits and avoid a devastating implosion of the shares. There is no better historical example of this then the chain of events surrounding WorldCom in 2000.

Even with the market faltering in early 2000, the future for WCOM looked as bright as ever. However on June 30, 2000 the Zacks Rank slipped to 4 (Sell) due to some negative earnings estimate revisions. Any follower of the Zacks philosophy would have seen this as a clear signal to start selling off their position in WCOM at a price of $45.88. Here are the events that followed:

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• July 14, 2000: 2 weeks after our first signal and the stock has actually risen to $49.19. Clearly most investors are ignoring the writing on the wall. But gladly followers of the Zacks Rank can sell off in a stable pricing environment.

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• July 28, 2000: Shares have been declining steadily for 2 weeks and now stand at $36.56. Yet the bulk of investors held onto these shares and suffered further declines.

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• August 8, 2000: Stock falls to Zacks Rank of 5 (Strong Sell) and now shares only $29.94, but still infinitely higher than it will be in the future.

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• August 10, 2001: A year later and shares floundering at $13.66. Zacks Rank is 4, yet too many stubborn investors “waiting until they get back to breakeven”.

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• May 17, 2002: Shares now at a painfully low $1.35.

The Zacks Rank pointed out the failings of WorldCom at the earliest possible stage. It clearly signaled that future prospects would not pan out as previously expected. The natural consequence of these events is a decline in the share price. Obviously those that heeded the warnings of the Zacks Rank did much better selling their shares in immediately at $45. And those that held until the bitter end were taught a very expensive lesson.