Stock Exchange Growth: Growth Stocks Examined

Looking at stock exchange growth, what are growth stocks? There seem to be as many answers to that question as there are investment analysts and stockbrokers. Here is one o£ the more quotable definitions, offered by the Valley National Bank in Phoenix, Arizona:

If a stock yields 5 per cent it can't be any good. If it yields 2 per cent, it must be hedge against inflation since there is no other reason to buy it. And if it yields 1 per cent, it is a 'growth situation' meaning that no one can figure out what it is worth.

Evidently, the market doesn't care what the Valley National Bank says. It has gone right on shrinking that 1 per cent yield for many of the supergrowth issues.

We are not concerned here, however, with such supergrowth stocks, but with more earth-bound ones—stocks which should be easier to identify than their stratospheric sisters.

To be a growth stock, according to prevalent Wall Street thinking, a stock should show a record of doubling sales and earnings in about five years.

Why five? Because two or three years is too short to be indicative o£ future trends. Nowadays, many companies whose stock is going on sale to the public disclose a record of only one to two years to show how excellent their growth record has been. This representation could be highly misleading, since the rate of growth for most companies tends to be the greatest, percentagewise, in the first few years of their corporate existence.

Companies usually start out rapidly, then slow down and eventually halt. When looking at stock exchange growth, to mistake their initial rate of growth as an indication of future trends is to dangerously overestimate them.

Using the Profit Margin as a Yardstick

Perhaps the surest measurement of corporate growth is profit margin. A widening profit margin always means better cost control, lower production cost and other positive management features which are classic characteristics of a growth company.

Some see a salient growth feature in the plowback of a greater portion of earnings in the business instead of paying them out in dividends. A higher percentage of earnings thus retained does not, however, necessarily mean growth.

Genuine growth companies are the ones that are able to advance their selling prices in line with rising production costs. While inflation means higher costs, wages and taxes, it does not necessarily mean higher prices for manufactured articles. Unlike the seller's market of the immediate postwar years, overcapacity and price competition have forced many companies to forego price increases even in the face of ever rising manufacturing expenses. For several years now, for example, the prices of lead and zinc have been falling while the cost of production has been climbing.

Airplane and air transport companies are other examples of such shrinking profit margins. The changing fortunes of the airplane makers versus all manufacturing are shown in the following contrasting profit margins: 1957—17 vs. 9.8 per cent; 1958—13 vs. 10.7 per cent; 1959 third quarter—6.8 vs. 9.6 per cent.

As for air transport concerns, their profit margins have been seriously threatened by high wages-to-sales ratios. A major portion of their receipts goes to labor forces, and their profit margins quickly narrow when revenues slide off.

So, you see, other things being equal, investors should definitely prefer companies with a low wages-to-sales ratio over those which have high ones. Belonging to the former industry groups are tobacco, oil, food and distilling, whose labor cost absorbs only about 10 to 15 per cent of sales. In the latter groups are such industries as auto parts, steel and electrical products.

The general trend of profit margins for American industries has been down for more than a decade. According to a recent report by First National City Bank of New York on 1,944 manufacturing companies, their net income as a percentage of sales was 5.8 per cent in 1959, which was below the twelve-year (1947—58) average of 6.3 per cent. So be sure to get info situations that show the greatest resistance to the general declining trend in profit margin. To be classified as "growth," companies should consistently show at least 10 per cent profit after taxes and substantial research expenditures.

It is also wise to remember that when looking at stock exchange growth in a real situation, a company will be able to finance its expansion largely through funds generated by its own operations instead of resorting to frequent borrowing or selling stocks, which would dilute stockholders' equity.

Now, let's discuss those clues to growth which the statistics don't reveal.

What the Statistics Don't Tell You

One of the most far-reaching changes in the concept of growth stock evaluation has been the recent emphasis on the inexplicit or intangible. There was a time when a potential investor could find everything he had to know about a company in its balance sheet. Today, however, security analysts speak of management caliber, quality of research and other intangibles which are not measurable in dollars and cents.

Take Geophysics Corporation of American as an example. The company "went public" in 1960 at $14 per share. This was a pretty high price according to any traditional standard, since the offering price meant 87 times the l6¢ per share the company earned in the fiscal year ended September 30, 1960. However, the stock reached the 50 level by April 1, 1961.

Of course, you couldn't find anything in Geophysics' balance sheet or earnings statement to account for this hefty market quotation. Its attraction lay somewhere else. For one thing, it is backed by the fabulous Laurance S. Rockefeller and the equally fabulous Itek Corporation. The fact that Mr. Rockefeller is Geophysics' largest individual stockholder made some "venture" investors more willing to pay $50 per share; it seemed immaterial to them that Mr. Rockefeller had paid only $2.62. The stock was $21 on March 30, 1962!

In these days even professional security analysts looking at stock exchange growth feel helpless in evaluating companies like Geophysics. Surely, for instance, it would be an intelligent guess at best as to the value added by Laurance Rockefeller's backing.

How to Appraise Management Caliber

Another factor which has carried increasing weight with the market in evaluating equities is management caliber. And for a good reason too!

That's why investment companies have paid increasing attention to "on the spot" evaluations of managements of companies in which they are interested. For instance, on a trip to Chicago in July 1961, an analyst visited not only Max Swiren, president and board chairman of MSL Industries, but also Arnold Meyer and Norman Sackheim, presidents of MSL's Universal Screw division and Heads & Threads division respectively.

It is only through such personal contacts that you will be able to get first-hand information to appraise management performance and companies' facilities. MSL is in a good position to acquire other companies because of its good cash position in addition to its large tax loss carry forward running out in 1962.

The latest MSL action was an agreement to acquire Miami Industries which was in line with MSL's industrial development program. It was described as "another sound enterprise with an established earnings record in the metal working industry."

Despite the "inexplicit" nature of management caliber, you can gain a good insight into it from a careful study of the company's income accounts and balance sheets. Although the picture these statistics provide is only partial, financial reports are still a valid reflection of how judiciously the management employs the stockholders' money and hence what that stock's future stock market growth will be.

Research Caliber

In addition to backing and management caliber, another major inexplicit which has weighed heavily with the market in evaluating growth equities is research caliber. This is particularly true of companies operating in scientific and technological fields.

The willingness of investors to place a relatively high valuation on research-minded companies is understandable. For one thing, organizations willing and able to devote large sums to research have generally come out on top over their less research-conscious competitors. For another, the changing international scene is such that the United States has lost its unique position as the world's undisputable leader in science and technology. The very survival of the nation will depend upon America's ability to stay ahead of Russia both in fundamental research and applied science.

American outlays for research were virtually doubled in the period between 1953 and 1959. All signs point to a continued increase in the nation's research bill, with the government paying about 60 per cent and industry the rest.

More and more investors have come to realize the importance of a company's research program as a vital corporate function. Some analysts even go so far as to measure the degree of a company's growth solely in terms of its research outlays as a percentage of sales.

While undoubtedly the extent of a company's research effort could be used as a vital standard of measurement, it is certainly not the sole determinant of corporate growth. Research can be fruitless too and, in many cases, even damaging, especially to small-sized firms with their research outlays disproportionately heavy in relation to sales or income. For such companies, failure of a vital research project could spell disaster.

By and large, however, industries and companies that have devoted a sizeable proportion of their sales to research usually come out with favorable results and are, therefore, generally accorded a "growth" rating. Research leaders in chemicals, drugs, science and electronics are outstanding examples of companies that always command a premium in terms of statistical values compared with more prosaic stocks. When considering stock market growth for various stocks you will consequently consider these a boon.

Are You Ready To Move Onto The Next Lesson? Click Here...