A = Annual Earnings Increases; Look for Meaningful Growth

If you want to own part of a business in your home town, do you
choose a steadily growing, successful concern or one that is unsuccess-
ful, not growing and highly cyclical?

Most of you would prefer a business that is showing profitable growth.
That's exactly what you should look for in common stocks. Each
year's annual earnings per share for the last five years should show an
increase over the prior year's earnings. You might accept one year
being down in the last five as long as the following year's earnings
quickly recover and move back to new high ground.

It is possible that a stock could earn $4 a share one year, $5 the next
year, $6 the next, and the following year¡X$2. If the next annual earn-
ings statement were $2.50 versus the prior year's $2 (+ 25%), that would
not be a good report. The only reason it may seem attractive is that the
previous year ($2) was so depressed any improvement would look good.
In any case, the profit recovery is slow and is still substantially below the
company's peak earnings of $6:

Select Stocks with 25% to
50% Annual Growth Rates

Owning common stock is just the same as being a part owner in a busi-
ness. And who wants to own part of an establishment showing no growth?
The annual compounded growth rate of earnings in the superior firms
you hand pick for purchasing stock in should be from 25% to 50%, or
even 100% or more, per year over the last 4 or 5 years.

Between 1970 and 1982, the average annual compounded earnings
growth rate of all outstanding performing stocks at their early emerging
stage was 24%. The median, or most common, growth rate was 21% per
year, and three out of four of the prominent winners revealed at least
some positive annual growth rate over the five years preceding the giant
increase in the value of the stock. One out of four were turnarounds.
A typical successful yearly earnings per share growth progression for a
company's latest five-year period might look something like $.70, $1.15,
$1.85, $2.80, $4.

The earnings estimate for the next year should also be up a healthy
percentage; the greater the percentage, the better. However, remember
estimates are opinions. Opinions may be wrong whereas actual reported
earnings are facts that are ordinarily more dependable.

What Is a Normal Stock
Market Cycle?

Most bull (up) market cycles last two to four years and are followed by a
recession or bear (down) market and eventually another bull market in
common stocks.

In the beginning phase of a new bull market, growth stocks are usual-
ly the first sector to lead the market and make new price highs. Heavy
basic industry groups such as steel, chemical, paper, rubber, and
machinery are commonly more laggard followers.

Young growth stocks will usually dominate for at least two bull market
cycles. Then the emphasis may change for the next cycle, or a short
period, to turnaround or cyclical stocks or newly improved sectors of
the market, such as consumer growth stocks, over-the-counter growth
issues, or defense stocks that sat on the sidelines in the previous cycle.
Last year's bloody bums become next year's heroes. Chrysler and
Ford were two such spirited turnaround plays in 1982. Cyclical and
turnaround opportunities led in the market waves of 1953¡X1955,
1963-1965, arid 1974-1975. Papers, aluminums, autos, chemicals, and
plastics returned to the fore in 1987. Yet, even in these periods, there
were some pretty dramatic young growth stocks available. Basic industry
stocks in the United States frequently represent older, more inefficient
industries, some of which are no longer internationally competitive and
growing. This is perhaps not the area of America's future excellence.
Cyclical stocks' price moves tend to be more short-lived when they do
occur, and these stocks are much more apt to suddenly falter and
encounter disappointing quarterly earnings reports. Even in the stretch
where you decide to buy strong turnaround situations, the annual com-
pounded growth rate could, in many cases, be 5% to 10%.

Requiring a company to show two consecutive quarters of sharp earn-
ings recovery should put the earnings for the latest twelve months into,
or very near, new high ground. If the 12 months earnings line is shown
on a chart, the sharper the upswing the better. This will make it possi-
ble in many cases for even the "old dog" about-face stock to show some
annual growth rate for the prior five-year time period. Sometimes one
quarter of earnings turnaround will suffice if the earnings upswing is so
dramatic that it puts the 12 months ended earnings line into new highs.

Check the Stability of a
Company's Five-Year
Earnings Record

While the percentage rate of increase in earnings is most important, an
additional factor of value, which we helped pioneer in the measure-
ment and use of, is the stability and consistency of the past five years'
earnings. We display the number differently than most statisticians do.
Our stability measurements are expressed on a scale from 1 to 99.
The lower the figure, the more stable the past earnings record. The fig-
ures are ca^ulated by plotting quarterly earnings for the last five years
and fitting a trend line around the plot points to determine the degree
of deviation from the basic earnings trend.

Growth stocks with good stability of earnings tend to show a stability
figure below 20 or 25. Equities with a stability rating over 30 are more
cyclical and a little less dependable in their growth. All other things
being equal, you may want to choose the security showing a greater
degree of consistency and stability in past earnings growth.
Earnings stability numbers are usually shown immediately after a
company's five-year growth rate, although most analysts and investment
services do not bother to make the calculation.

If you primarily restrict your selections to ventures with proven
growth records, you avoid the hundreds of investments having erratic
earnings histories or a cyclical recovery in profits that may top out as
they approach earnings peaks of the prior cycle.

How to Weed Out the Losers
in a Group

When you investigate a specific industry group, using the five-year
growth criteria will also help you weed out 80% of the stocks in an
industry. This is because the majority of companies in an industry have
lackluster growth rates or no growth.

When Xerox was having its super performance of 700% growth from
March 1963 to June 1966, its earnings growth rate averaged 32% per
year. Wal-Mart Stores, a discount retailer, sported an annual growth
rate from 1977 to 1990 of 43% and boomed in price an incredible
11,200%. Cisco Systems growth rate in October 1990 was an enormous
257% per year and Microsoft's was 99% in October 1986, both before
their long advances.

The fact that an investment possesses a good five-year growth record
doesn't necessarily cause it to be labeled a growth stock. Ironically, in
fact, some companies called growth stocks are producing a substantially
slower rate of growth than they did in several earlier market eras. These
should usually be. avoided. Their record is more like a fully matured or
nearly senile growth stock. Older and larger organizations frequently
show slow growth.

New Cycles Create New
Leaders

Each soaring new cycle in the stock market will catapult fresh leader-
ship stocks to the attention of the market, some of which will begin to
be called growth stocks. The growth record in itself, however, is only a
starting point for would-be victorious investors, and it should be the
first of many earnings measurements you should check.
For example, companies with outstanding five-year growth records of
30% per year but whose current earnings in the last two quarters have
slowed significantly to + 15% and + 10% should be avoided in most
instances.

Insist on Both Annual and
Current Quarterly Earnings
Being Excellent

We prefer to see current quarterly earnings accelerating or at least main-
taining the trend of several past quarters. A standout stock needs a
sound growth record during recent years but also needs a strong current
earnings record in the last few quarters. It is the unique combination of
these two critical factors, rather than one or the other being outstanding,
that creates a superb stock, or at least one that has a higher chance of
true success.

Investor's Business Daily provides a relative earnings ranking (based
on the latest five-year annual earnings record and recent quarterly earn-
ings reports) for all common stocks shown in the daily NYSE, AMEX,
and OTC stock price quotation tables.

More than 6000 stocks are compared against each other and ranked on
a scale from 1 to 99. An 80 earnings per share rank means a company's
current and five-year historical earnings record outclassed 80% of all
other companies.

The earnings record of a corporation is the most critical, fundamental
factor available for selecting potential winning stocks.

Are Price-Earning Ratios
Important?

Now that we've discussed the indispensable importance of a stock's cur-
rent quarterly earnings record and annual earnings increases in the last
five years, you may be wondering about a stock's price-to-earnings
(P/E) ratio. How important is it in selecting stocks? Prepare yourself for
a bubble-bursting surprise.

P/E ratios have been used for years by analysts as their basic measure-
ment tool in deciding if a stock is undervalued (has a low P/E) and
should be bought or is overvalued (has a high P/E) and should be sold.
Factual analysis of each cycle's winning stocks shows that P/E ratios
have very little to do with whether a stock should be bought or not. A
stock's P/E ratio is not normally an important cause of the most suc-
cessful stock moves.

Our model book studies proved the percentage increase in earnings
per share was substantially more crucial than the P/E ratio as a cause of
impressive stock performance.

During the 33 years from 1953 through 1985 the average P/E for the
best performing stocks at their early emerging stage was 20 (the Dow
Jones Industrial's P/E at the same time averaged 15). While advancing,
these stocks expanded their P/Es to approximately 45 (125% expansion
of P/E ratio).

..to be continued..

(Excerpt from 'How To Make Money from Stocks')