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Screening for Rule #1 Businesses
Having read “The Standard and Poor’s Guide to Selecting Stocks“, I am ready to define my stock criteria.
After having looked at the various investment styles within the book, Rule #1 investors definitely resemble the screens for growth at a reasonable price (GARP). After all, a Rule #1 investor is looking for a company with good, consistent growth rates that is selling at a discount.
Rule #1 investors use 5 metrics to determine whether a moat exists:
- Return on Investment Capital
- Earnings per Share growth rate
- Sales growth rate
- Equity growth rate
- Cash Flow growth rate
In using these metrics, we look at the 10-year average, the 5-year average and the 1-year rates. These should all be greater than 10% and preferably increasing. That is the easy part of the screen. After all, I was able to choose 3 out 4 businesses randomly that met these requirements!
The hard part is determining whether the stock is cheap or expensive. The book states that
The single best ratio for screening for GARP stocks is the PEG ratio.
Interesting. So what is the PEG ratio? You calculate the PEG ratio by dividing a stock’s price/earnings ratio by its growth rate. The book suggests that you use the forward P/E ratio and the expected earnings growth.Ā Once we have this ratio, we would be looking for a PEG ratio of less than 1.0. That implies that the company’s growth rate is greater than its P/E ratio.
One other ratio to look at when screening for GARP stocks is the debt/equity ratio. This ratio helps determine whether or not the business earned its high growth rates by using lots of leverage.
With this information, it is time to start playing with some stock screeners!
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- Rule #1 Screen Results
- Importance of Stock Screeners
- New Rule #1 Screen
- Dividend Screening - The Easy Way
- Dividend Screening Results
[…] Screening for Rule #1 Businesses […]
May 3rd, 2007 at 10:01 pm[…] Jungle has Screening for Rule #1 Businesses. Having read “The Standard and Poor’s Guide to Selecting Stocks”, I am ready to […]
May 8th, 2007 at 10:11 amGreat post - what tool did you use to build the screen?
September 12th, 2007 at 11:40 am