Stock pickers who favor growing companies but will invest only if they can obtain them at fair prices practice GARP -- growth at a reasonable price -- investing. Paul Szczygiel, manager of DLB Small Company Opportunities fund, practices his own version. He calls it QARP -- quality at a reasonable price. By quality, Szczygiel means he looks beyond simple earnings.
It's just as important to Szczygiel that companies deliver good growth in cash flow (earnings plus depreciation and other non-cash charges.). Plus, he seeks companies with high returns on equity and financially strong companies that have little or no debt.
In addition to financial strength, Szczygiel looks for companies with experienced, shareholder-friendly executives; strong and steady revenue growth; and competitive advantages. He also tries to buy only stocks of companies in attractive, growing industries.
To find companies with the potential to generate earnings growth of at least 15% per year in the future, Szczygiel hunts for companies that have delivered that level of growth over the previous five and ten years. He also tracks down companies whose annual earnings before interest and taxes are at least three times greater than the amount of interest the company pays to service its debt. Szczygiel does further study of companies that pass just one of these four tests.
Next Szczygiel and his analysts read financial documents and news releases and visit company executives. And he searches for companies with catalysts likely to spur growth.
He sells a stock when it becomes overvalued. Szczygiel says he'll often begin to sell a stock when its P/E ratio rises to 50% higher than the company's projected earnings-growth rate. He will sell immediately when a company's executives depart from their long-term strategy.
You can find stocks that could show up on Szczygiel's list of candidates using these criteria:
- Market value: $50 million to $2 billion
- Return on equity: average of 15% or more over the previous five years
- Historical earnings growth: average of 15% or more over the previous five years
- Estimated long-term earnings growth: 15% or more
- Value measure: PEG ratio of 0.67 or less
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