Over the years, I have met several private investors who were consistently trying to buy companies which were very clearly heading downhill. The rationale is that the share price is low, and the firm will bounce back and become profitable.
Needless to say, this is not often the case, and it’s more common than not for the losing firm to deteriorate even further before it goes bust. With this in mind, I like to bet on winners.
When you’re thinking about where to focus, consider the megastars of the world, such as Cisco and Walmart. These companies often experience very strong growth in earnings per share (EPS), usually one to two quarters before their stocks start to rally. Looking across many winners, EPS growth will on average be 70 per cent year-on-year.
As the EPS ratio will be influenced by cost cutting measures, you also need to observe the growth in revenues to see if there is higher demand for the company’s products or not. A higher EPS should go hand in hand with higher revenues.
Alejandro Zambrano is an economist and market analyst with FXCM UK.