A healthy business with steady sales growth is the key to survival in today’s fast changing and highly competitive business environment. However, when it comes to picking stocks, investors often fail to consider sales growth as a dependable metric. This might be because of investors’ preconceived notion that a company’s stock price is typically sensitive to its earnings momentum.
Nevertheless, it’s worth keeping in mind that in cases when companies incur a loss, albeit transitorily, they are valued on their revenues, as top-line growth (or decline) is usually an indicator of a company’s future earnings performance.
Further, a company can improve earnings by resorting to cost control measures while maintaining stable revenues. However, a sustainable bottom-line growth invariably requires superior revenues.
Hence, the Price-to-Sales (P/S) ratio can turn out to be an appropriate metric for stock valuation. Notably, this metric’s importance further lies in the fact that management has limited opportunities to manipulate revenues unlike earnings.
While sales growth provides investors an insight into product demand and pricing power, it doesn’t indicate whether the company is operating efficiently. A huge sales number does not necessarily convert into profits.
Therefore, a consideration of a company’s cash position along with its sales number can be a more dependable strategy. Substantial cash in hand and a steady cash flow give a company more flexibility with respect to business decisions and investments.
A Strategy to Bet On
A careful selection of stocks considering certain factors should help investors to not only build wealth but beat the market as well.
In order to shortlist stocks that have impressive sales growth along with a high cash balance, we added 5-Year Historical Sales Growth (%) greater than X-Industry and Cash Flow greater than $500 million as our primary screening parameters.
However, sales growth and cash strength are not the absolute criteria for selecting stocks. So, we added a few other factors to arrive at a winning strategy.
Price-to-Sales (P/S) Ratio less than X-Industry: This metric measures the value placed on each dollar of a company’s revenues. The lower the ratio, the better it is for picking a stock since the investor is paying less for each unit of sales.
% Change F1 Sales Estimate Revisions (4 Weeks) greater than X-Industry: Northward estimate revision has often been observed to trigger an increase in the stock price.
Operating Margin (Average Last 5 years) greater than 5%: Operating margin measures how much every dollar of a company's sales translates into profits. A high ratio indicates that the company has good cost control and sales are increasing faster than costs, an optimal situation for the company.
Return on Equity (ROE) greater than 5%: This metric will ensure that sales growth is being translated into profits and the company is not hoarding cash. High ROE means the company is spending wisely and is in all likelihood profitable.
Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or #2 (Buy) stocks are known to outperform irrespective of the market environment.
Here are 5 of the 13 stocks that made it through the screen:
Equinix, Inc. (EQIX - Free Report) , a California-based interconnection and data center company, has a long-term expected EPS (earnings per share) growth rate of 20.0%. The company carries a Zacks Rank #2.
LPL Financial Holdings Inc. (LPLA - Free Report) , operating in the investment brokerage space, currently has a long-term expected EPS growth rate of 15%. This Massachusetts-based company holds a Zacks Rank #2.
Laboratory Corp. of America Holdings (LH - Free Report) is a leading healthcare diagnostics company, providing clinical laboratory services and drug development support. This Burlington, NC-based company currently has a long-term expected EPS growth rate of 10.2% and carries a Zacks Rank #2.
Two Harbors Investment Corp. (TWO - Free Report) is a New York-based real estate investment trust (REIT) that is engaged in investing, financing, and managing residential mortgage-backed securities. The company has a long-term expected EPS growth rate of 4.8% with a Zacks Rank #2.
Trinity Industries Inc. (TRN - Free Report) is a Texas-based company engaged in providing products and services to the energy, transportation, chemical, and construction sectors in the U.S. and worldwide. The company has a long-term expected EPS growth rate of 10.0% with a Zacks Rank #1.
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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.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance
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