Growth. It is what “Mr. Market” loves.
What else to explain how Amazon (AMZN) can trade at traditionally nose-bleed valuations for over 15 years? Or how Netflix (NFLX) can be a market darling at an unheard of P/E ratio of 238 times earnings! Or how Tesla (TSLA), a company with tremendous financial risk, a gauntlet of competition, and unprofitable operations and outlook, can continue to trade at 8.4 times sales?
Not all growth comes at such a price, though. Many rapidly growing companies are actually priced *under* market averages. These are one group to look for.
But also, growth isn’t always immediately obvious. Today, I want to walk over 5 different ways that companies can grow earnings. Several of them are obvious, a few of them are sometimes overlooked, but they all can be utilized to grow the all important earnings per share number. And growing earnings per share, ultimately, is what grows the stock price.
#1: Grow Revenue
Duh, right?
The only way to truly “grow” a company is to grow its revenue. Precisely, a company has to grow its revenue profitably.
The really huge gains from Magic Formula® and other value investing techniques come from identifying undervalued stocks that can continue to grow revenues at rates exceeding expectations, then riding those stocks for years.
There are several MF stocks that are growing by increasing revenues rapidly. Perhaps the best two examples are Apple (AAPL) and Gilead (GILD) – two stocks valued far below the market averages that are growing sales far ABOVE the average company.
#2: Grow Profit Margins
Even with flat revenue contribution, a company can grow its earnings by becoming more efficient and delivering better profit margins.
This is what companies are trying to do when you hear the term “restructuring” and my favorite, “right-sizing”. Many larger firms with many lines of business will also seek to divest lower margin (or money losing) businesses to raise the corporate average.
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