Stock Picking 101 : Lesson 4 : Small Cap Growth

Stock Picking 101 : Lesson 4 : Small Cap Growth

Given the market volatility over the last week, I’m sure you may be ready to throw in the towel as far as speculation is concerned. This volatility is exactly the reason I created the “Stock Picking 101” series here on mycomputerninja.com. I got tired of trying to read up on “Tuesday’s Hot 5” or “Wednesday’s Big Losers” which were actually Tuesday’s Hot 5, and decided to find metrics with which I can use to find my own “hot 5”. Some well known and generally sound investing methods have already been covered here, and if you are interested, I encourage you to take a look at the investing category for a review of what we have previously covered. As I have mentioned before, all the stock picking methods explained in “Stock Picking 101” come from a set of preset screens included with the Yahoo.com free stock screener.

Today’s new lesson will cover a method of finding stocks in companies expected to exhibit uncharacteristic high growth in the foreseeable future. In particular, I am going to cover the criteria used to pick small market capitalization growth stocks. Stocks that fall into this category follow these metrics:

  • Market Capitalization of $250 million to $1 billion dollars
  • Price/Earnings growth ratio of less than or equal to 1.0
  • Earnings growth for the last 5 years greater than or equal to 25

Market capitalization has already been covered extensively here at mycomputerninja.com, but if you would like to read up anyway, take a look at Lesson 2 and Lesson 3 for a refresher.

Price/Earnings to Growth ratio is the first new metric in this set of criteria. The metric itself is comprised of 2 separate metrics, one being forward price to earnings ratio, and the other being earnings per share growth estimates. Forward price to earnings ratio is the projected price of a share divided by the earnings per share of the stock. The growth portion of the metric is actually the annual earnings per share growth estimate of the stock. In order to calculate the P/E to growth ratio, divide P/E by the annual earnings per share estimate to arrive at the value that we will use to compare different stock’s potential for growth. In the case of this criteria, the P/E to growth ratio should be equal to or less than 1.0.

It is important to note that, as with many metrics, the potential for manipulation exists. In the case of the Price/Earnings to growth ratio, both numbers could be considered untrustworthy. These values generally come from predicted earnings per share reports submitted by the company itself, so it is easy to see that insider manipulation can effect the quality of the number being reported.

Trailing year earnings growth is the final metric that this set of criteria looks at to determine the growth potential of a company. Trailing growth is a look at the previous years net income, with emphasis on the delta year over year. If the company exhibits net earnings growth equal to or greater than 25% for the trailing 5 years, then the stock has met this requirement. This metric relies on hard data, so it is easier to trust than the P/E to growth ratio, but a wise speculator must always remember that trailing growth is no indication of future growth.

A quick glance at mycomputerninja.com’s favorite whipping boy, Google, reveals that the only criteria it does not meet for this set of metrics is the small cap part. Google, being worth $160 billion, is firmly entrenched in the large cap growth sector, which we will cover in the next “Stock Picking 101” lesson.

The admin of this site and author of this post, Jon Steege, is not a financial analyst or a stock broker. He is a Computer Scientist with a knack for data analysis. He does not own Google stock, but wishes he did. As always, a friendly reminder to buy smart, but buy at your own risk.



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