More Growth Stocks Than Before

This spring more than flowers were budding as companies and analysts were not afraid to raise their forecasts. For the first time in a long time positive revisions are outnumbering the negative.

Although the recent exuberance in the market has leveled off, it is still a much better time to be a growth investor than it was a few months ago.

More Good than Bad

At the start of the second quarter, 3 earnings estimates were being cut for every one that was raised. Now, as we near the end of the quarter, we are seeing slightly more positive revisions than negative revisions (1.1 increases for every cut). And though growth opportunities are not exactly falling into our laps, it is quite a bit easier to find growing companies that it was before.

EPS Momentum and Growth

A popular assumption is that growth stocks will have double-digit growth for the next several years. While this is true in many instances, the current economic environment is yielding fewer pure growth stories. There are, however, plenty of stocks with positive earnings estimate momentum - something that should be attractive to growth investors.

In essence, a company whose profit forecasts are being drastically raised by analysts can be considered as a growth stock, regardless of the EPS growth from the prior year. After all, what you are really looking for is better earnings that will, in turn, drive the stock price higher. And while, both EPS momentum and double-digit growth would be fantastic, our current economic climate is making finding both characteristics quite difficult.

Where’s the Growth?

If you let go of certain assumptions, you can avoid a common mistake of dismissing certain industries that have been historically less explosive. Firms that exhibit phenomenal growth rates and/or rising earnings estimates can be found in any sector.

These companies are quite easy to find. I use a stock screener to help me take an objective approach to identify any company meeting my growth requirements, rather than trying to stick one specific industry or another.

Here is an example of a strategy I use to find companies with earnings momentum.

• Zacks Rank = #1 or #2
• Change in Current-Year Consensus > 20%
• PEG Ratio < 1.1

This is just a jumping off point, so feel free to adjust the criteria to fit your style.

Growth Stock Candidates

Ruth’s Hospitality Group, Inc. (RUTH) is a good example of a company that is showing great EPS estimate momentum.

The full-year 2009 consensus estimate is now 32 cents, up from 18 cents a couple of months ago. Projections for next year now average 35 cents, up from 25 cents. It may not be explosive growth, profits should grow roughly 8% in 2010, but the sharp rise in profit forecasts should drive the stock price higher.

Aeropostale, Inc. (ARO) is in a sector that you might be ignoring right now because of worries about consumer spending. If you’re looking for growth, that would be a mistake as full-year estimates are climbing.

The consensus earnings estimate for 2009 is now $2.79, up from $2.22. Estimates for 2010 are now averaging $3.04, up from $2.35.

If these expectations are met, the teen apparel retailer will realize a year-over-year growth rate of 26% and 8.9% for 2009 and 2010, respectively. ARO happens to show characteristics of both EPS estimate momentum and year-over-year growth. Not bad for a retailer in a struggling economy.

American Medical Systems (AMMD) also shows both year-over-year growth and EPS estimate momentum. The company supplies medical devices to physicians specializing in the treatment of disorders.

The consensus estimate for 2009 is now 98 cents, up 17 cents over the past 2 months. Estimates for 2010 are also up 16 cents to $1.11. These numbers equate to year-over-year earnings growth of 40% and 13%, respectively.

Keep an Open Mind

Many of us fall prey to the idea of the “growth” stocks of the late 1990s when anything with “tech” or “.com” was deemed a good choice. We all got a rude awakening a few years later. The moral of the story is not to ignore certain sectors that do have not traditionally produced the sensational growth story. Rather, keep an open mind.

You’ll be surprised what you find.

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