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8 Ways to Uncover the Best Growth Stocks

With the market at record highs, and a lot of “what ifs” regarding the year ahead, it’s worth taking a moment to think critically about what investments we should buy and hold over the coming year.

The high-level checklist I use below to find winning growth stocks is not complicated, nor is it perfect. But it serves its purpose, which is to work as a first line of defense as I screen stocks. Let’s get into each line item in the checklist:

1. Find Big Ideas That are Part of Big Trends
There are a zillion trends out there that seem attractive. But it’s the really big and durable trends that you need exposure to when enacting a buy and hold strategy to build long-term wealth. Current examples include cloud computing, personalized health care, data security and clean energy. Really big trends are so big there are many ways to play them. That translates into lots of stocks, which means investors can buy several to play different angles of the trend and retain the freedom to make an occasional mistake without doing outsized damage to their portfolio.

2. Look for Revenue Growth Above 20%
Growth is a must-have for a young company, especially these days, and the more the better. Beyond the obvious that revenue growth shows demand for products and solutions, growth companies are sure to raise capital through equity raises and convertible debt offerings to fuel even more growth. This can become a self-fulling prophecy in which a higher share price allows more capital raises with less dilution. The key is that the pace of that growth needs to be enough to overcome the dilutive impact of such capital raises and keep investor confidence high.

3. Look for Earnings Growth Above 20%
It should also go without saying that EPS growth is necessary. Attractive early-stage growth stocks don’t need to be profitable. But they do need to be trending meaningfully in the right direction, even if there is the occasional quarter (or year) where EPS growth is down due to investments, acquisitions, pandemics or other short-term reasons. Earnings growth that’s faster than revenue growth is a plus as it shows the business has leverage to increase profitability as it gains scale.

4. Seek a Strong Chart (But Not Too Strong)
This seems like an obvious statement, but I still get tons of emails from subscribers wondering if an ailing stock is a “deal.” No! Sure, there are always examples of a banged-up stock that pops on an earnings report, new initiative or takeover. But what are the chances you can identify these opportunities with any regularity? Life doesn’t need to be that difficult, and enacting an investing strategy focused on turnaround stocks is a very different game than the one I play. Buying on a pullback or a dip when the longer-term trendlines are still up is fine. But don’t try to be a hero. The same is true on the flipside. While there are examples when buying on strength makes sense, “strength” is a relative term. A stock that’s gone parabolic and appears detached from the public information supporting the directional change requires that investors dig quite a bit deeper to make sure they understand the risks, and potential opportunity, of buying on such strength.

5. Invest in Companies with Good Business Models
Big Trends and Big Ideas are great. But a company is only going to start gushing cash if management has developed and implemented a rational business model to seize the opportunity. The hard part for investors is that understanding a company’s business model takes time, and not all have the time or attention span to do that work. This is where an advisory service can be helpful so investors can focus on the opportunities and not do so much homework.

6. Look for Repeatable Positive Events and Catalysts
Pick any stock and you can figure out at least one potential reason for it to go up (and down). But management teams running early-stage growth stocks can’t build sustainable growth around one potential growth catalyst. They need several, and they need a constant supply of fresh ideas that they can execute on within a reasonable time frame. Examples include new products that resonate with the market and help drive deeper, more profitable relationships with customers. Also, pay attention to acquisitions that make sense, are aligned with the business model, are integrated relatively smoothly and represent a more efficient way to acquire technology and talent than building from within.

7. Try Not to Sell Too Early
It’s incredibly hard to hold on to stocks for the long term. That’s especially true when talking about early-stage growth stocks because a lot of them go through meaningful corrections, then take off again. That’s why it’s so important to focus on everything I’ve just said, from big trends to business model, to durability and scarcity premium. No single thing defines a great early-stage growth stock; it’s the sum total of many smaller things that matters, and which will give you the confidence to stick with it.

8. Have Your Own Opinion AND Seek Help
Investors are responsible for their own actions. You can read research reports from the best numbers guy or strategic thinker out there. But it’s your cash and your future. Be a skeptic, understand that even the best companies in the world are less than perfect. Your opinion of a stock’s potential is what brings the entire stock selection process full circle.

At the same time, most of us need help to find winning growth stocks, vetting them, and following along as a company matures. For those that are able, paying a few bucks to work with somebody that has a stock selection process that resonates and kicks out intriguing opportunities can be well worth it.