This is the high tide of earnings season, and I have to confess how excited I am. Ten of my Emerging Growth stocks reported earnings today including one of my favorites, Transcend Services (TRCR). As I've come to expect, their earnings report was outstanding--profits jumped more than fivefold and the stock popped 20%.
Now that's what Emerging Growth investing is all about.
Earnings season is basically Judgment Day for every stock. Trust me, corporate executives like to talk a good game during the quarter, but now is when companies have to show the goods. Or in many cases, explain the bads.
Earnings season is all about finding stock "poppers" like Transcend. These are stocks that vault up 10%, 20%, 30% or more on the day of their earnings announcement, and often continue to rally as institutional investors scramble to buy more shares. Apple (AAPL), another Emerging Growth favorite, just reported stellar earnings and the stock is up 20% for the month.
Let me explain what stock poppers are and how I go about finding them in my Emerging Growth service.
As a general rule of thumb, a stock's price/earnings multiple should be the same as its earnings growth rate. So if a stock is projected to have earnings of $2 a share and it's growing at 10% a year, the share price should be around $20 a share.
I have nothing against a stock like that. It's perfectly fine and most investors are satisfied with owning it, but at the end of the day it's not for me.
At Emerging Growth, we've able to beat the market by over three-to-one--not for a year or two--but for over two decades. Since 1985, my Emerging Growth Buy List is up over 5,500%, and the reason we've been so successful is because we haven't settled on nice little 10% growers.
Instead, my system locks-in stock poppers. So let's say that when our little 10% grower reports earnings, it's not $2.00 a share. No, they beat the Street and report earnings of $2.04 a share. Well, that changes everything!
The stock's valuation changes on two levels. This is very important to understand but it's how poppers...pop. The shares don't just become worth 10 times $2.04, or $20.40, a share. Remember the growth rate has changed as well, so they're worth a higher multiple times a higher earnings base.
What we're talking about is a new growth rate of 12%, so it's 12 times the revised earnings of $2.04. The stock is now fully valued at $24.48 a share. In theory, the stock immediately adjusts, or pops, from $20 to $24.48. That's a 22.4% pop. Many times, this happens in a few minutes, or even seconds. Traders will panic and swarm over the shares hoping not to be the last on board. It's like tossing a Christmas goose into a pool full of piranhas. (Or a pool full of traders!)
I've seen this happen countless times, and it's how successful investors are able to beat the averages. Once you understand how a seemingly small earnings surprise can translate into a huge share gain, you see the importance of our Emerging Growth strategy. In fact, tracking earnings surprises is one of the foundations of how we beat the market.
In my new book, The Little Book That Makes You Rich: A Proven Market-Beating Formula for Growth Investing, I describe in full detail how my team and I go about finding stock poppers. In addition to earnings surprises, we look at factors like earnings revisions, sales growth, expanding operating margin and free cash flow. All of these variables come down to earnings season and finding a stock with good news to report.
The next likely contender to reach stock popper status is Manitowoc (MTW). Based in Manitowoc, Wisconsin, the company is a major crane operator and the growing world economy has made their business hot. The company reports next Wednesday, and Wall Street expects earnings of 63 cents a share.
I won't make an earnings prediction, but I will say I wouldn't at all be surprised to see MTW easily top 63 cents a share. Consider that during last year's third quarter, the company demolished Wall Street's estimate. The Street was expecting 37 cents a share; Manitowoc delivered 41 cents a share. The stock soared 13% that day and it continued to climb another 9% before the end of the year. I currently rate Manitowoc a strong buy for all types of investors up to $52 a share.
