Earnings are the most important factor that identifies successful stocks, decades of IBD research confirms. This key fundamental metric moves stocks during earnings seasons and even after.
Earnings per share is a simple calculation in which you divide a company's net income by the number of shares outstanding. EPS growth rates of at least 25% in the most recent quarter or two show that the company has a strong demand for its products or services. Studies show that's the minimum increase you should look for in a successful stock.
The annual earnings growth is also important. Look for at least a 25% increase in annual EPS in the most recent fiscal year.
That's a lot of numbers to sort through. But Investor's Business Daily's Earnings Per Share Rating calculates both earnings growth and growth stability over the three most recent years. The two most recent quarters have a greater weighting than earlier ones.
The results are put on a rating between 1 and 99, with 99 being the best.
Picking stocks with an EPS Rating of 80 or higher is advisable. If earnings have been accelerating in recent quarters, that is even better.
Earnings estimates for the current quarter and later also indicate whether the company is on a growth path. But they are not part of the EPS Rating.
How To Invest: Putting This Rating To Use
But a lower EPS Rating does not always lead to poor performance. In some cases, a company is turning itself around and will show poor EPS Ratings until the profits get back to respectable levels.
The EPS Rating is just one — although important — indicator of a company's strength. Besides, a growing market for a product could boost a stock even when the company has a lower EPS Rating or even is realizing losses. In these cases, sales growth should be impressive.
Biotech companies developing drugs are great examples of growth stocks that can net big gains even when they are losing money. Also recent new issues may have a lower EPS Rating because those companies tend to be startups.
EPS Ratings will change with time. That's not just because the latest earnings release will have a bigger impact on the rating, but also because companies can reduce the number of shares outstanding through buybacks, which will increase the earnings per share.
The EPS Rating is found on IBD Stock Checkup, IBD MarketSurge, stock research tables and other research tools.
How To Invest: Putting It Together
Using the EPS Rating with other IBD Ratings such as the Composite Rating and Relative Strength Rating increases the chances of picking winning stocks. IBD also recommends looking at stocks funds are buying. The Accumulation/Distribution Rating is ideal for that.
Once you have analyzed the ratings and other important factors, you can decide to buy the stock when it tops a proper buy point.
The market conditions may not always favor buying, however. In his book, "How to Make Money in Stocks," IBD founder William O'Neil observed that "in the late stage of a bull market, some or even many leaders that have had long runs may top out even though their earnings are up 100%."
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