|  James W. Oberweis is President of Oberweis Securities, Inc. Senior Vice-President of Oberweis Asset Management, Inc. and Portfolio Manager of the Oberweis Mid-Cap Portfolio. The Oberweis Funds specialize in rapidly growing companies in the micro-cap, small-cap, and mid-cap asset classes. Mr. Oberweis edits The Oberweis Report advisory letter which was ranked by Hulbert Financial Digest as the #2 performing investment advisory letter for the 10 year period ended 12/31/2000. Investing in very fast growing companies -
Look for consistent, rapid growth in sales - preferably internally generated and 30% or greater. If you are looking for stocks with great investment potential, we recommend beginning with the most successful companies. If consumers or corporate purchasing agents are buying 40%, 50%, or 100% more of a company's products each year, then the company is a super-success in the marketplace . Whether they produce hamburgers, computers or widgets, one of the best indications of the success of their products is the rate at which sales are growing. Surprisingly, the industry in which a company operates should not be a critical factor. In fact, companies able to grow at rapid rates in industries with average growth rates are sometimes the best prospects. This indicates to us that the company clearly is doing something better than its competitors . We prefer internally generated growth rather than growth through acquisitions. -
Look for similar consistent growth in pre-tax income and earnings per share. Similar consistent rapid growth in earnings is also required. A corollary is that the company must have earnings. It is frequently possible to increase sales in the short run by significantly cutting prices. But if such price reductions diminish or eliminate profit margins, such growth may not be in the long-term best interests of the shareholders. Be wary of companies and sectors experiencing rapid growth, but where that growth is not feeding through to increased earnings, as we saw with airline companies in the 1960s and internet companies in the late 1990s. While you may miss some opportunities in the short run, investing in companies with increasing annual profits will increase the probability of owning long- term successful businesses. We have seen far too many times the promise of future earnings fail to materialize. -
Look at net income, of course, but pre-tax income is also very important. If profit growth is resulting primarily from lower tax rates, such growth is not sustainable. There must also be similar growth in earnings per share. It is always possible for a company to increase its earnings by selling more shares and using the proceeds to pay off debt or even investing in T-bills. From the shareholders' point of view, this only makes sense if earnings per share are enhanced over the long run. -
Buy stocks whose P/E ratios are not greater than half of the company's rate of growth. Once you have identified a list of companies that meet the revenue and earnings growth minimums you must still make a value judgment. Is the current price reasonable in relation to the company's growth prospects? Are there even more attractive investment opportunities? Which is a better buy - a company selling at 20 times earnings growing at 30% per year or a company selling at 30 times earnings growing at 60% per year? Many investors - institutional as well as individual - would assume the first stock is a better value since it is selling at a lower price/earnings (P/E) ratio. All else being equal, I would argue that the second is more attractive since it is selling at a lower ratio of P/E to growth rate. -
Look for companies with products or services that offer the opportunity for substantial future growth. Looking forward also requires you to make a value judgment concerning a company's products or services. Was its recent growth due to a temporary or a sustained increase in demand for its products? For example, exceptionally low interest rates over the past several years have led to an increase in demand for construction and substantial profit increases for construction- related firms. However, are construction companies experiencing this growth due to solid, long-term increasing demand for their products? Probably not. When interest rates reverse course, you can bet your last dollar that demand for construction will slow as well. A further desirable characteristic is that the product of service offered by the company should be capable of substantial future growth without attracting too many competitors, too quickly. -
Pay particular attention to recent trends in quarterly sales and earnings. Look for companies whose rate of growth is expanding. This (and the following rule) focus on the most recent quarterly results - perhaps the most important numbers when evaluating a company's direction - and how the market values the company in relation to its sales. Investors should focus not on the year-over-year earnings gain but rather on the consecutive quarterly increase for non-seasonal, non-cyclical companies. In other words, if a company reports 1995 Q2 EPS of $.15 vs. $.10 a year ago, that report sounds great - a 50% increase. But if the first quarter was $.16 vs. $.08, then the second quarter was actually $.15 vs. $.16 in the prior quarter, indicating a slowing in the company's growth sequentially. For seasonal companies, such as retailers, compare a company's latest quarter year-over-year growth rate with the prior quarter's growth rate, rather than comparing absolute numbers. The ideal situation is a company whose earnings and revenues grew at 25% or 30% last year, are growing 35% or 40% this year, and are accelerating towards 45% or 50% for next year. In these rare situations, the stock frequently rises not only because of the earnings growth but also due to multiple expansion - the PE becomes larger as investors begin to recognize the company's faster growth rate. Obviously such situations are wonderful for investors. -
Watch for a reasonable price-to-sales ratio based on the company's growth prospects and profit margins. A price/sales ratio of 2 means that the total market value of the company is twice its annual sales. Companies with fast growth and/or high profit margins should have a higher P/S ratio than companies with a lower growth rate or lower margins. When a company's P/S ratio exceeds 5, either the company must have excellent growth prospects or very attractive profit margins or the stock may be overpriced. A P/S below 1 may indicate modest growth prospects, lower margins, or an undervalued stock. These two guidelines help determine whether a stock is an attractive buy at any particular time. -
Carefully review the company's balance sheet. Try to understand why and how the company is growing so fast. Sometimes unusual items may be discovered , such as a huge increase in receivables or inventories, unrelated to the sales increase. Pay particular attention to footnotes in order to identify unusual items, which may indicate future problems. Don't be afraid of leveraged companies. Leverage tells us how a company is financed, not whether a business is successful. A successful, growing business can be financed primarily through equity, debt, or any combination thereof. In the case of a very successful company, some leverage may be a positive rather than a negative factor, but note that this leverage does increase the risk level. -
Believe the tape! A final check is relative strength. If a company shows consistent rapid growth in both earnings and revenues, has attractive P/E and P/S ratios, strong recent trends, and a product or service which offers excellent future growth prospects, yet its stock is underperforming the market, don't buy it. If everything looks good fundamentally, the stock should be rising faster than the market. An easy way to check its relative performance over the last 12 months is to look at its relative strength. The number tells us how a particular stock is performing compared to the market. If everything looks strong fundamentally for a particular stock, but it has a low relative strength, something may be wrong. Your analysis may be missing something or insiders may know something you don't. Generally it's best under such circumstances to wait awhile before buying the stock. If the fundamentals are as strong as you believe, the relative strength should begin to improve and you can buy the stock then, even though you may miss the first few points of a move. But frequently by waiting you may learn more and find you have avoided a disaster. For this reason, no matter how good a company looks on paper, if its stock is declining in a steady or rising market, don't buy it. -
Diversify. Finally, it's especially important when investing in emerging growth companies to follow the Golden Rule of Investing - Diversify, diversify, diversify. If you follow these guidelines over long periods of time, at least 5 to 10 years, I believe you will be able to achieve above average investment results. www.oberweis.net |
