Buy and Sell Stocks

Key Fundamentals: Sales, Margins, Return On Equity

Sales growth, profit margins and return on equity are vitally important in evaluating a company's health. This lesson explains the significance of these financial gauges and how to identify the companies with best numbers.

It All Starts With Sales

Sales figures are a key measure of a company's strength -- or lack of it. Perhaps no other piece of financial information reflects growth better than sales: the money that comes into a company from products sold or services rendered. If a company is run efficiently, sales growth essentially drives earnings growth. Companies basically have two ways to increase earnings. They either increase sales, reduce expenses or ideally do both. Although a well-managed company controls expenses, healthy sales are the main engine for growth.

Nokia Nokia began a 630% jump from March 1998 through December 1999 and continued rising into 2000 after the wireless-phone maker reported sales gains of 9%, 12% and 19% in the three quarters leading up to the big move. Earnings were rising sharply during this period, too.

When you search for the best stocks, you want a company to have strong sales growth to support its earnings growth. Think of sales growth as the foundation under your house: if it is loose, it's not as stable as one with all the structural elements in place. When you see a company increasing its sales, it's telling you its business is drawing larger demand and is structurally sound and prepared to expand and generate the earnings capable of boosting its stock price.

Demand is driven by a number of factors, including larger numbers of customers, customers increasing their purchase volume, introduction of new products, expansion into new markets and the improvement of existing products.

The top-performing companies show consistent double- or triple-digit sales growth. It's even better when the percentage growth rate increases quarter after quarter. Such acceleration is the hallmark of quality growth companies. They reflect a well-managed organization. Take a look at some companies that have done just that:

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Your Stock Buying Checklist — A Review

step-by-step guide to finding stocks with the characteristics that make them market winners. This lesson reviews stock buying concepts presented in this course.  

Investor's Business Daily's Key Buy Rules

#1. Top Fundamentals

Concentrate your buys in the No. 1 company within its particular industry in terms of sales and earnings growth, profit margins, return on equity (ROE) and relative price performance. A leader should have the characteristics shared by the best stocks before they made their major price moves:

• At least a 25% increase in the most recent quarter's earnings per share (EPS) vs. the same period in the year earlier.
• Ideally, accelerating earnings growth in the three most recent quarters.
• At least a 25% increase in annual EPS in each of the past three years.
• The most profitable companies have Earnings Per Share Ratings of at least 80 or 85.
• Sales growth should be up at least 25% in the most recent quarter, or accelerating over the past few quarters, or both.
• The most profitable companies tend to have annual ROE of 17% or higher.
• Pretax and after-tax margins should be improving and near their historic peak.
• Stocks should have Sales+Margins+ROE (SMR™) Ratings of A or B, which means they are in the top 20% or top 40% of stocks, respectively, in terms of sales growth, profit margins and ROE.