Every now and then, I take issue with something I read from Investor's Business Daily. Back in late 2004, for example, I disagreed with some of its "top 10 investing mistakes." I wrote about this, and IBD countered with some responses, which I also covered. Then I recently ran across another IBD list: "10 Highest-Rated Stocks."
Here are the stocks IBD offered:
(NASDAQ:JOYG), a mining-equipment maker.
(NYSE:TS), a Luxembourg-based steel-pipe producer.
(NASDAQ:TRAD), an electronic securities broker.
(NASDAQ:ABAX), a maker of portable blood-analysis equipment.
(NASDAQ:GILD), a biotechnology enterprise.
(NASDAQ:CTRN), an urban apparel retailer.
(NASDAQ:PTRY), a convenience-store operator.
- TIM Participacoes, a Brazilian wireless-system provider.
(NYSE:WDC), a maker of computer peripheral products.
(NASDAQ:CRDN), a maker of body-armor products.
So what criteria led to this list? Well, they all feature strong recent earnings-per-share (EPS) growth. IBD used a screen to select them, factoring in the stock's price relative to its 52-week high, EPS growth rates, and its "Relative Price Strength Rating," which measures a stock's price performance over the past 12 months.
The report noted, "When searching for a top stock, earnings growth should always play an important role in the decision-making process. Specifically, look for companies showing robust quarterly increases in earnings and sales growth. It's even better when growth is accelerating."
I can't completely dismiss IBD and its stock-picking. Its "IBD 100" list has performed quite well, trouncing the S&P 500 both in the past year and since its inception. And the list above isn't meant to be a buy list, but rather a watch list.
Still, some of IBD's words above make me wince a bit. I have some reservations about IBD's approach, which is extremely quantitative and mechanical. Running screens and crunching numbers can work for some folks, but I prefer to look beyond the numbers. Here's why:
- Placing a lot of importance on earnings, especially earnings per share, is problematic. Companies can manipulate their earnings (also known as "net income") in many perfectly acceptable ways. It's sounder to look at cash from operations, or free cash flow, to get a more dependable idea of the firm's progress.
- Per-share numbers, in theory, can go up just because of share buybacks, reflecting no operational success. If you have 100 shares, your earnings are divided by 100 to get EPS. If you buy back 40 shares, your earnings are divided by 60 instead of 100, and the resulting amount will automatically be higher.
- The attention paid to the stock's price also troubles me. Although some rapidly growing stocks will continue their swift rise, others may run out of steam. Some stocks that have surged ahead may have become overpriced and are due for a retreat.
Also, I think there are some qualitative measures that no screen will catch -- first and foremost, quality of management. Fool co-founders David and Tom Gardner agree -- they've made quality of management a core component of their recommended companies in the Motley Fool Stock Advisor newsletter service. David in particular looks for what he terms "visionary leaders" when recommending companies.
A list like IBD's is far from useless; it can be informative to a curious investor. For example, IBD noted that TradeStation "recently reported a 40% jump in daily average revenue trades (DARTs) to 48,767." If an electronic platform for day traders and others is experiencing such an increase, it suggests that speculation in the market may be increasing. (Bill Mann reviewed TradeStation back in 2004.)
It's usually a bad idea to invest blindly from any list, but lists can offer you ideas to investigate more closely. If Ceradyne interests you, for example, you might look into it further. I found that my colleague Seth Jayson shared some positive thoughts about the firm back in October. He looked at much more than just its earnings and stock price, of course, noting rising profit margins among other positive signs.
In the final analysis, the IBD list seems to deliver only half of the goods, looking only at the quantitative picture. That can work for some people, but it can also fail many others. (Heck, some Nobel laureates lost their shirts, billions of dollars' worth, in a high-profile implosion of a quantitative system.)
More where that came from
I've found that the IBD list -- and others like it -- can be a sound start on the path toward market-beating investments. But if I didn't have time for intensive research into a potential investment, and I were still interested in recommendations of quickly-growing firms, I'd look elsewhere. One resource that has long impressed me is David and Tom's Stock Advisor service, which you can try for free. It has also depressed me, since it features many recommendations I wish I'd bought. I know I'm far from unbiased on the matter, but it's hard to quibble with the newsletter's results. Over roughly four years, David and Tom have lapped the market, averaging returns of 45% and 73%, respectively, against the S&P 500's 21%.)
Better still, the brothers aren't making their selections solely from stock screens. They back up each recommendation with research, and they let you know when they advise selling out of a position, and why. A free trial of the service will give you access to past issues and a chance to review every single recommendation and its subsequent performance. You've got nothing to lose by checking it out.
No matter what list you're going by, if you're looking through quantitative metrics of potential investments, remember to also look for qualitative measures like management and corporate culture. Here's to big profits in your future!
Selena Maranjian 's favorite discussion boards include Book Club, Eclectic Library, Television Banter , and Card & Board Games. She owns shares of no company mentioned in this article. For more about Selena, view her bio and her profile. You might also be interested in these books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . The Motley Fool is Fools writing for Fools.