Tuesday, June 20th, 2006
Don’t give up on growth
For many growth investors high EPS growth forecasts are an important part of their method. So it can be a bit disturbing when a big growth money manager, AllianceBerstein, comes out with research saying high forecasts can actually harm performance.
In a white paper Alliance outlines how it found that companies expected to be the best growers ended up underperforming due to mean reversion. Basically it’s extremely hard for companies to keep growing above average. So investors being true to growth and picking stocks because they were going to expand rapidly are being punished. Alliance dubbed this the ‘growth investor’s paradox’.
Maybe this is obvious; the market should have discounted in the high growth rates. But before everyone runs out to buy another Buffett book, Alliance argues that this doesn’t mean growth is redundant. Instead of growth forecasts, investors should invest in stocks that produce consistent earnings surprises. It argues that analysts are biased towards underestimating growth.
Alliance’s research found that there were effective predictors of earnings surprises and hence outperformance:
1. Earnings growth that’s accelerating at an increasing rate
2. Stock price momentum
3. Positive relative earnings growth, and
4. Rising returns on equity (ROE) and rising free-cash flow margins
As many will recognise, these factors are at the heart of William O’Neil’s CANSLIM and Richard Driehuas’ aggressive growth strategy.
This entry was posted on Tuesday, June 20th, 2006 at 7:40 pm and is filed under Aggressive Growth, Breakout trading, Other growth gurus, Richard Driehaus. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
