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I’ll use Impath, the cancer diagnostic service provider, to demonstrate
how to fill out the growth stock scorecard.
Step 1. Analysts’ Ratings & Forecasts
Good growth candidates often have relatively weak, but not too
weak sentiment scores, combined with strong earnings growth prospects.
The scorecard rewards firms with sentiment scores in the minus
two to plus two range, and penalizes those with scores below minus two
(too weak) and above eight (too strong). It penalizes companies with
forecast annual earnings growth below 15 percent. Negative earnings
forecast trends (forecast for the same period has declined from 90 days
ago), or a history of negative earnings surprises (reported earnings below
forecast) spell trouble and disqualify growth candidates.
Impath’s zero value Sentiment Index earned it one point. Its 41
percent year-over-year forecast earnings growth was well above the
minimum, so Impath was not penalized. Impath’s earnings forecasts
were trending up, and it did not show a persistent history of negative
earnings surprises, so it was not disqualified by those tests.
Step 2. Valuation
Promising growth candidates are often richly valued, but unrealistic
valuations signal high risk. This test rewards stocks priced below
their expected year-over-year earnings growth rate, but penalizes those
priced for more than 40 percent annual earnings growth, regardless of
the analysts’ forecasts.
Impath’s share price reflected implied growth slightly below its
forecast 30 percent earnings growth, and thus earned one point.
Step 3. Target Price
This test rewards firms trading within or below their calculated
target buy range. However, since growth stocks often trade for extended
periods above values dictated by their fundamentals, it doesn't penalize
those trading above the target buy range until they move up into the sell
target range.
Impath earned one point because it was trading within its target
price buy range.
Step 4. Industry Analysis
You’ll find your best growth candidates in fast growing, concentrated
industries. Consequently, this test rewards firms in industries
growth faster than 20 percent and penalizes those in industries growing
less than 15 percent annually. Firms in concentrated industries earn another
point, but since most industries don’t fit that description, firms in
fragmented industries aren’t penalized.
I forecast Impath’s industry growth at 15 percent, so it did not
earn a point for industry growth. Also, it participated in a fragmented industry,
so it didn’t earn a point in that category either.
Step 5. Business Plan
Transfer the business plan score computed during your analysis
to the scorecard. Impath’s business plan score was two, losing points for
lack of market and product diversification, and for depending on acquisitions
for much of its growth.
Step 6. Management Quality
Growth and value investors alike will benefit by picking firms
with quality management. The scorecard rewards companies with key
executive and board quality that you graded as very good or excellent.
Points are not deducted for poor management. I had rated Impath’s management
as excellent, so it earned one point.
Since clean accounting and reasonable stabile earnings growth
are the norm, firms that have those qualities aren’t rewarded, but those
that don’t are penalized.
I rated Impath’s accounting as clean, and its earnings growth stability
as good, so it wasn’t penalized.
Step 7. Financial Health
Failing the appropriate financial health test disqualifies a candidate.
Impath qualified for the busted cash burners test and passed.
Step 8. Profitability
Strong sales growth and profit margins are hallmarks of promising
growth candidates. The sales growth test rewards firms with growth
exceeding 25 percent and penalizes those growing slower than 15 percent.
Similarly, the return on assets test rewards firms with ROA above
14 percent and penalizes those with ROA below 6 percent.
Deteriorating operating margins warn of future problems. Significant
margin declines disqualify candidates. By the same token, persistent cash burners are riskier investments than cash generators, and are
also disqualified.
Impath’s 50 percent plus year-over-year sales growth earned it a
point in that category, but was penalized for its below-par 5 percent ROA.
Impath’s operating margins were on the rise, and it was not a
persistent cash burner, so it was not disqualified on those counts.
Step 9. Red Flags
Red flags signal slowing growth, a disaster for a growth company’s
shareholders. The discovery of any red flags disqualifies a growth
candidate. Yellow flags pointing to longer-term problems signify added
risk but are not necessarily disqualifying factors. The scorecard penalizes
a firm for each of the two potential yellow flags found.
Impath’s analysis found no red or yellow flags.
Step 10. Ownership
Mutual funds and other institutional buyers usually load up on
growth stocks. Lack of institutional ownership signals that these tunedin
buyers don’t think that they can make money owning your candidate.
The institutional ownership test disqualifies growth candidates showing
less than 30 percent institutional ownership.
Very high insider ownership may be a tip-off that big shareholders
are waiting for an opportunity to unload at least a portion of their
holdings, an event likely to pressure the share price. This test penalizes
firms with more than 55 percent insider ownership.
Step 11. Price Chart
Growth stocks should be moving up in price, not down. However
stocks well into strong uptrends are riskier than stocks that have just
begun their move. This test penalizes firms with share prices trading below
their 200-day moving average (downtrend), or more than 50 percent
above their 200-day MA (moved up too fast).
Impath, trading 60 percent above its MA, was penalized one
point.
Summary
Impath scored a respectable five points. Participating in a relatively
slow growing and fragmented industry held down its total. Further,
its slow industry growth rate impelled Impath to pursue a growth
by acquisition strategy, further reducing its score. | 
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