Introduction
Buying is the fun and easy part. It’s really not that hard to find stocks that are going up and simply “jump on the bus.” I guess the art for the investor, as opposed to the trader, is finding stocks that have the greatest potential to go up for as long as possible.
Buying is a two step process for me. The first step is identifying a universe of companies that I want to own. The second step is trying to determine the best time to buy those companies. In this article, I focus of the first step – What to buy?
On this site, I have two model portfolios. The aim of the Quality Model Portfolio is to find those stocks that have the greatest potential to go up for as long as possible. The aim of the Growth Model Portfolio is to find the stocks that are likely to go up the most in the near term. The magic happens, when a stock from the Growth Model Portfolio graduates to the Quality Model Portfolio. Even better if it can feature on both.
The stocks in these two portfolio’s provide an answer to the first step of my process. They provide the “What to buy?”
Growth Stock Criteria
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- Upward Share Price Trend
- Current Revenue per share growth
- Current Earnings Before Tax per share growth
- Operating Cash Flow per share growth
- Outlook for continued Revenue Growth
- Outlook for continued Earnings Growth in the form of EBITDA.
Once these stocks have been identified, it’s a matter of sorting those that are growing the fastest.
The churn in this portfolio is greater than in the Quality Model Portfolio because there are more stocks here that haven’t yet built a history of performance. They may be just getting started or are turnaround stories. Companies in this portfolio simply have more false starts. However, those that can maintain their growth trajectories, even for just a year or two, can provide significant upside in a short amount of time. Those that can sustain it for even longer have the greatest potential to become future market leaders.
An example of a stock that met my Growth Criteria early on was Tuas ASX:TUA. In April 2023, I took a position at around $1.50. Today they remain in the Growth Portfolio and have also graduated to Quality Portfolio. The stock is $5.30 at the time of writing.
Quality Growth Stock Criteria
- The criteria are similar to the Growth Stock Criteria, with the addition of some other requirements:
- Low Debt
- A history of very high Revenue per share growth consistency OR a history of very high Earnings per share growth consistency
- More than a Single Analyst covering the stock, providing the forward projections I use in my analysis
- Operating Cash Flow positivity
- Profitable on a Pre-Tax Earnings basis
Once again, stocks that meet the criteria are then sorted according to their earnings potential.
Where’s Valuation?
As a growth and momentum investor, I do not factor valuation into my criteria. This may surprise or not appeal to many, given that we’ve all been told to buy stocks when they’re cheap and sell when they become expensive. I’m not saying that approach is wrong, but I’ve found it very difficult to execute.
I’ve always been pretty good at the “buying cheap” part of the equation. The challenge has been in selling when a stock appears expensive, which has cost me more than I’d like to admit. A good example is selling Pro Medicus when it was under $40. At the time, it looked expensive, and now with the share price around ~$180, it looks even more expensive. I also mentioned Tuas earlier. With a price-to-sales ratio of 17 times and no after-tax profits, it looks very expensive. The old me would have sold long ago. Today, I continue to hold, though I’ve trimmed my position once or twice to maintain proper portfolio balance.
Now, I let the market determine valuation, not a formula or opinion. I trust the market to signal when Pro Medicus or Tuas becomes too expensive, which will happen when their prices drop enough to trigger my trailing stop-loss. This shift has allowed me to hold onto my winners much longer, addressing one of the biggest weaknesses I identified in my strategy before becoming a full-time investor in 2021. For more on this, refer to “When to Sell.”
Company Dashboard For Quick Reference
The criteria described above are displayed on the Company Dashboards that I use when creating my Company Reports. The dashboard has been developed to speed up the process of identifying whether a stock is a good candidate for investment. If I see eight ticks, I will proceed to look more closely. If I don’t see eight but maybe just six or seven, I can quickly identify which areas the company may be lacking in and assess whether it is still worth keeping an eye on them for the future. A company that only has a few ticks can easily be disregarded and time and effort can be directed elsewhere. A stock in a downtrend (i.e. the black price line is heading down and in the dark red zone) can easily be avoided until the market suggests it’s worth looking at. One clear goal of my approach is to not be stuck in falling stocks.
Disclaimer: This information is provided purely for educational purposes. It takes no account of an individual’s personal financial circumstances and hence can in no way constitute financial advice. The above data may be subject to errors or inconsistencies for which the author takes no liability. It is imperative that all investors do their own research or if they need advice, seek it from a qualified financial adviser.
What to buy?