Growth is good. Increasing earnings growth, even better. However, to really identify when a stock is poised to break out, it helps to know when that increase in earnings growth represents an improvement from the company’s prior rate of earnings growth, better known as accelerating earnings growth.
A quick way to gauge earnings strength is by using IBD’s Earnings Per Share Rating, commonly called the EPS Rating, which takes a company’s two most recent year-over-year changes in quarterly earnings, and profit of the past three to five years, then compares those results with all the thousands of stocks in IBD’s database.
Ratings Can Reflect Accelerating Earnings
The strongest possible rating is a 99 — meaning earnings are growing faster than 99% of all other companies. Leading stocks typically carry EPS Ratings of 85 or better. EPS Ratings can also be found at IBD’s Stock Quotes page, as well as Stock Checkup and the IBD Smart NYSE and Nasdaq Tables.
But to drill deeper, you need to find out whether or not that increase represents an increase from the company’s prior rate of growth. Take, for example, SciPlay (SCPL), a stock in the IBD 50 in September 2020. The small-cap video game maker appeared poised to break out of a cup base.
A quick look at IBD’s Stock Checkup for SciPlay at the time showed things like a Composite Rating of 99 and an EPS change of 200% over last year’s second quarter. Also, SciPlay had four straight quarters of earnings acceleration. And it posted a positive earnings surprise of 8% in the latest quarter. All were good signs for the stock.
Although not visible in the Checkup, SciPlay’s earnings growth accelerated from 29% in the third quarter of 2019 to 36% in Q4, 73% in Q1 and 200% in Q2. The higher rate of growth in each successive quarter is a classic example of accelerating growth. What if the next quarter’s EPS growth is expected to slow down? That still doesn’t take away the most important fact — that acceleration took place.
A company that has accelerating earnings and accelerating sales growth is especially noteworthy. You can argue that SciPlay’s 1% sales decline in Q4 followed by a flat Q1 and 40% increase in Q2 was an acceleration trend. SciPlay’s breakout failed in October, despite the accelerating growth.
Accelerating Sales Also Key
In fact, accelerating sales can make up for cases when revenue growth lags the 25% minimum in CAN SLIM investing.
Now, back to our tutorial of how to use accelerating growth to help identify stocks with potential upside. Other ways of tracking a stock’s earnings are looking at how many analysts have raised their estimates for the company in recent months. Additionally, the percentage by which previous quarterly earnings reports have beaten estimates.
The flip side of this is looking at earnings deceleration. “If a company that has been growing at a quarterly rate of 50% suddenly reports gains of only 15%, that might spell trouble, and you may want to avoid that company,” writes IBD founder William O’Neil in his bestselling book, “How to Make Money in Stocks.”
This article was originally published Sept. 25, 2020, and has been updated.
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