William Baldwin joined Forbes Magazine in 1980 and served for 11 years as its editor. An Enrolled Agent since 1979, he finds many of his stories at the intersection of taxation and portfolio management.
Some companies have delivered an exponential growth in their earnings per share over the past decade. A curve-fitting measure identifies them.on a growth stock? How big a premium do you have to pay to get that stock? How reliable is the earnings growth? These questions are answered by a statistical analysis of 22,000 earnings numbers.
Highlights of what comes out of the survey are in the four tables below. The roster of fast-growing earners includes familiar names like Amazon, Netflix and Nvidia. There are some others that would be discussed alongside the Magnificent Seven if only they were larger in market capitalization: Fortinet, in cybersecurity, Arista Networks, in data networks, and Veeva Systems, which massages data for the life sciences industry. With few exceptions, you have to pay a steep price to get in on this kind of growth. By way of comparison, the S&P 500 index trades at 26 times its forecast earnings. However, those index earnings incorporate all the negative numbers for money losers. Exclude them and the market’s forward multiple is more like 20. To make that list of fast growers a company has to enjoy above-average predictability in earnings. Our second table has a higher hurdle for constancy of growth: All these land in the top decile of the universe in predictability of the earnings progression. Measuring growth is a tricky business. A naïve approach assumes an arithmetic progression, such as $1 a share this year, $1.20 next and then $1.40 and then $1.60. But this is not how the world works. An economic series, whether GDP or the revenue Fair Isaac gets from its credit scores, ought to grow exponentially. A 20% growth rate in earnings per share would mean $1, $1.20, $1.44, $1.73. But what do you do with a loss year? Tesla went from a loss of 32 cents a share five years ago to a gain of 21 cents the next year. No percentage can be assigned to this improvement. The analysis behind these growth rate calculations finesses the problem with losses by looking only at positive earnings and only at long-term trends. It starts with 1,860 U.S.-traded companies with market values over $1 billion. The review goes back ten years and includes a consensus forecast for the current fiscal year . Excluded from consideration: Any outfit that doesn’t have at least 10 of the 12 target years in positive territory. That rules out companies that went public after 2015 and companies that have too many loss years . All four of these market darlings may prove to be terrific growth companies, but they haven’t proven themselves yet. The 10 out of 12 minimum eliminates 39% of the stock market. For each of the remaining 1,137 names, the analysis presented here measures the steepness of the exponential curve that best fits a company’s EPS record. The predictability grades are based on the goodness of fit, with penalties for missing years. Those grades are awarded on the curve, with the top quartile scored “Very High” or “High” in predictability and the bottom quartile “Low” or “Very Low.” Investors yearn for growth rates that are both high and predictable. Indeed, if favorites like Nvidia and Fair Isaac can keep up their pace for a decade or two, their steep multiples would be entirely justified. But no law dictates that growth lasts forever. Half a century ago, IBM was a favorite. Its earnings growth was good and, possibly with help from well-timed shifts between sales and rentals of its mainframes , impressively smooth. Now IBM stands out on a list of disappointments. Concluding here is a list of companies with seemingly bad but very uneven records. They might deliver a surprise. That is, they might elevate themselves from bad to mediocre. The source of the earnings history data used here is FactSet and of the forward P/Es is YCharts. The evaluation of trends is by Forbes.
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