Seek Stocks Showing Huge Current Earnings Increases
In our models of the 600 best-performing stocks from 1952 to 2001, three
out of four showed earnings increases averaging more than 70% in the lat-
est publicly reported quarter before they began their major advances. Those
that did not show solid current quarterly earnings increases did so in the
very next quarter, with an average earnings increase of 90%!
Priceline.com was showing earnings up “only” 34% in the June quarter of
2006, when its stock began a move from $30 to $140. But its earnings accel-
erated, rising 53%, 107%, and 126%, in the quarters that followed.
From 1910 to 1950, most of the very best performers showed earnings
gains ranging from 40% to 400% before their big price moves.
So, if the best stocks had profit increases of this magnitude before they
advanced rapidly in price, why should you settle for anything less? You may
find that only 2% of all stocks listed on Nasdaq or the New York Stock
Exchange will show earnings gains of this size. But remember: you’re looking
for stocks that are exceptional, not lackluster. Don’t worry; they’re out there.
As with any search, however, there can be traps and pitfalls along the
way, and you need to know how to avoid them.
The earnings per share (EPS) number you want to focus on is calculated
by dividing a company’s total after-tax profits by the number of common
shares outstanding. This percentage change in EPS is the single most
important element in stock selection today. The greater the percentage
increase, the better.
And yet during the Internet boom of the wild late 1990s, some people
bought stocks based on nothing more than big stories of profits and riches
to come, as most Internet and dot-com companies had shown only deficits
to date. Given that companies such as AOL and Yahoo! were actually show-
ing earnings, risking your hard-earned money in other, unproven stocks was
simply not necessary.
AOL and Yahoo! were the real leaders at that time. When the inevitable
market correction (downturn) hit, lower-grade, more speculative companies
with no earnings rapidly suffered the largest declines. You don’t need that
added risk.
I am continually amazed at how some professional money managers, let
alone individual investors, buy common stocks when the current reported
quarter’s earnings are flat (no change) or down. There is absolutely no good
reason for a stock to go anywhere in a big, sustainable way if its current earn-
ings are poor.
Even profit gains of 5% to 10% are insufficient to fuel a major price
movement in a stock. Besides, a company showing an increase of as little as
8% or 10% is more likely to suddenly report lower or slower earnings the
next quarter.
Unlike some institutional investors such as mutual funds, banks, and
insurance companies, which have billions under management and which
may be restricted by the size of their funds, individual investors have the
luxury of investing in only the very best stocks in each bull cycle. While
some companies with no earnings (like Amazon.com and Priceline.com)
had big moves in their stocks in 1998–1999, most investors in that time
period would have been better off buying stocks like America Online and
Charles Schwab, both of which had strong earnings.
Following the CAN SLIM strategy’s emphasis on earnings ensures that
an investor will always be led to the strongest stocks in any market cycle,
regardless of any temporary, highly speculative “bubbles” or euphoria. Of
course, you don’t buy on earnings growth alone. Several other factors, which
we’ll cover in the chapters that follow, are almost as important. It’s just that
EPS is the most important.
Watch Out for Misleading Earnings Reports
Have you ever read a corporation’s quarterly earnings report that went like
this:
We had a terrible first three months. Prospects for our company are turning
down because of inefficiencies at the home office. Our competition just
came out with a better product, which will adversely affect our sales. Fur-
thermore, we are losing our shirt on the new Midwestern operation, which
was a real blunder on management’s part.
No way! Here’s what you see instead:
Greatshakes Corporation reports record sales of $7.2 million versus $6 mil-
lion (+20%) for the quarter ended March 31.
If you’re a Greatshakes stockholder, this sounds like wonderful news. You
certainly aren’t going to be disappointed. After all, you believe that this is a
fine company (if you didn’t, you wouldn’t have invested in it in the first
place), and the report confirms your thinking.
But is this “record-breaking” sales announcement a good report? Let’s sup-
pose the company also had record earnings of $2.10 per share, up 5% from
the $2.00 per share reported for the same quarter a year ago. Is it even better
now? The question you have to ask is, why were sales up 20% but earnings
ahead only 5%? What does this say about the company’s profit margins?
Most investors are impressed with what they read, and companies love to
put their best foot forward in their press releases and TV appearances.
However, even though this company’s sales grew 20% to an all-time high, it
didn’t mean much for the company’s profits. The key question for the win-
ning investor must always be:
How much are the current quarter’s earnings per share up
(in percentage terms) from the same quarter the year before?
Let’s say your company discloses that sales climbed 10% and net income
advanced 12%. Sound good? Not necessarily. You shouldn’t be concerned
with the company’s total net income. You don’t own the whole organization;
you own shares in it. Over the last 12 months, the company might have
issued additional shares or “diluted” the common stock in other ways. So
while net income may be up 12%, earnings per share—your main focus as
an investor—may have edged up only 5% or 6%.
You must be able to see through slanted presentations. Don’t let the use
of words like sales and net income divert your attention from the truly vital
facts like current quarterly earnings. To further clarify this point:
You should always compare a company’s earnings per share to the same
quarter a year earlier, not to the prior quarter, to avoid any distortion
resulting from seasonality. In other words, you don’t compare the
December quarter’s earnings per share to the prior September quarter’s
earnings per share. Rather, compare the December quarter to the
December quarter of the previous year for a more accurate evaluation.
In our models of the 600 best-performing stocks from 1952 to 2001, three
out of four showed earnings increases averaging more than 70% in the lat-
est publicly reported quarter before they began their major advances. Those
that did not show solid current quarterly earnings increases did so in the
very next quarter, with an average earnings increase of 90%!
Priceline.com was showing earnings up “only” 34% in the June quarter of
2006, when its stock began a move from $30 to $140. But its earnings accel-
erated, rising 53%, 107%, and 126%, in the quarters that followed.
From 1910 to 1950, most of the very best performers showed earnings
gains ranging from 40% to 400% before their big price moves.
So, if the best stocks had profit increases of this magnitude before they
advanced rapidly in price, why should you settle for anything less? You may
find that only 2% of all stocks listed on Nasdaq or the New York Stock
Exchange will show earnings gains of this size. But remember: you’re looking
for stocks that are exceptional, not lackluster. Don’t worry; they’re out there.
As with any search, however, there can be traps and pitfalls along the
way, and you need to know how to avoid them.
The earnings per share (EPS) number you want to focus on is calculated
by dividing a company’s total after-tax profits by the number of common
shares outstanding. This percentage change in EPS is the single most
important element in stock selection today. The greater the percentage
increase, the better.
And yet during the Internet boom of the wild late 1990s, some people
bought stocks based on nothing more than big stories of profits and riches
to come, as most Internet and dot-com companies had shown only deficits
to date. Given that companies such as AOL and Yahoo! were actually show-
ing earnings, risking your hard-earned money in other, unproven stocks was
simply not necessary.
AOL and Yahoo! were the real leaders at that time. When the inevitable
market correction (downturn) hit, lower-grade, more speculative companies
with no earnings rapidly suffered the largest declines. You don’t need that
added risk.
I am continually amazed at how some professional money managers, let
alone individual investors, buy common stocks when the current reported
quarter’s earnings are flat (no change) or down. There is absolutely no good
reason for a stock to go anywhere in a big, sustainable way if its current earn-
ings are poor.
Even profit gains of 5% to 10% are insufficient to fuel a major price
movement in a stock. Besides, a company showing an increase of as little as
8% or 10% is more likely to suddenly report lower or slower earnings the
next quarter.
Unlike some institutional investors such as mutual funds, banks, and
insurance companies, which have billions under management and which
may be restricted by the size of their funds, individual investors have the
luxury of investing in only the very best stocks in each bull cycle. While
some companies with no earnings (like Amazon.com and Priceline.com)
had big moves in their stocks in 1998–1999, most investors in that time
period would have been better off buying stocks like America Online and
Charles Schwab, both of which had strong earnings.
Following the CAN SLIM strategy’s emphasis on earnings ensures that
an investor will always be led to the strongest stocks in any market cycle,
regardless of any temporary, highly speculative “bubbles” or euphoria. Of
course, you don’t buy on earnings growth alone. Several other factors, which
we’ll cover in the chapters that follow, are almost as important. It’s just that
EPS is the most important.
Watch Out for Misleading Earnings Reports
Have you ever read a corporation’s quarterly earnings report that went like
this:
We had a terrible first three months. Prospects for our company are turning
down because of inefficiencies at the home office. Our competition just
came out with a better product, which will adversely affect our sales. Fur-
thermore, we are losing our shirt on the new Midwestern operation, which
was a real blunder on management’s part.
No way! Here’s what you see instead:
Greatshakes Corporation reports record sales of $7.2 million versus $6 mil-
lion (+20%) for the quarter ended March 31.
If you’re a Greatshakes stockholder, this sounds like wonderful news. You
certainly aren’t going to be disappointed. After all, you believe that this is a
fine company (if you didn’t, you wouldn’t have invested in it in the first
place), and the report confirms your thinking.
But is this “record-breaking” sales announcement a good report? Let’s sup-
pose the company also had record earnings of $2.10 per share, up 5% from
the $2.00 per share reported for the same quarter a year ago. Is it even better
now? The question you have to ask is, why were sales up 20% but earnings
ahead only 5%? What does this say about the company’s profit margins?
Most investors are impressed with what they read, and companies love to
put their best foot forward in their press releases and TV appearances.
However, even though this company’s sales grew 20% to an all-time high, it
didn’t mean much for the company’s profits. The key question for the win-
ning investor must always be:
How much are the current quarter’s earnings per share up
(in percentage terms) from the same quarter the year before?
Let’s say your company discloses that sales climbed 10% and net income
advanced 12%. Sound good? Not necessarily. You shouldn’t be concerned
with the company’s total net income. You don’t own the whole organization;
you own shares in it. Over the last 12 months, the company might have
issued additional shares or “diluted” the common stock in other ways. So
while net income may be up 12%, earnings per share—your main focus as
an investor—may have edged up only 5% or 6%.
You must be able to see through slanted presentations. Don’t let the use
of words like sales and net income divert your attention from the truly vital
facts like current quarterly earnings. To further clarify this point:
You should always compare a company’s earnings per share to the same
quarter a year earlier, not to the prior quarter, to avoid any distortion
resulting from seasonality. In other words, you don’t compare the
December quarter’s earnings per share to the prior September quarter’s
earnings per share. Rather, compare the December quarter to the
December quarter of the previous year for a more accurate evaluation.
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