Author: JUAN CARLOS ARANCIBIA
Source
Financial analysts will tell you that the figures behind a company’s earnings are more revealing than the earnings themselves. Other than profits, three financial numbers matter most in selecting the best stocks.
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That’s sales growth, profit margins and return on equity. IBD’s research shows strong numbers in those three areas help separate the winning stocks from the rest. That’s why IBD created the Sales+Margins+Return on Equity (SMR) Rating. In a single letter grade, the rating immediately tells investors how a company stacks up in those important factors.
The SMR Rating assigns an A to E grade. An A represents the top 20% of companies in terms of the three factors in the rating. You should prefer stocks with A or B ratings, and use it in combination with other ratings when researching stocks.
Specifically, the rating crunches IBD’s database and calculates how each company performed in terms of sales growth over the past three quarters. It then measures pretax profit margins, after-tax margins and return on equity.
Sales Growth, Margins, Return On Equity
Sales growth and after-tax margins are computed using quarterly figures; return on equity and pretax margins are from annual reports. The SMR Rating improves when the growth rate in any of those gauges is accelerating.
While companies can fudge sales, it is a number less likely to be manipulated than earnings. Pretax and after-tax margins — profits per each dollar of sales — are another way to measure the quality of earnings. Return on equity generally measures the dollars in profit vs. equity invested into a company. As such, it is a useful way to gauge financial execution and select the best stocks. The SMR Rating is part of the Composite Rating, IBD’s catchall rating.
Selecting The Best Stocks: Exceptions
Some companies have no SMR Rating because they lack one or more of these financials. For example, companies that have posted losses cannot have any amount of profit margins. These cases are noted as “N/A” in IBD’s research tools. Keep in mind that turnaround companies will lag in their SMR Ratings but many eventually succeed as market leaders.
The SMR Rating can be found in Investors.com’s stock quotes, IBD Stock Checkup, IBD Weekly’s research tables and IBD’s premium charting and research service, MarketSmith.
This article was originally published April 23, 2020.
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The post After Earnings, These Three Financials Matter Most In Picking Great Stocks appeared first on Investor’s Business Daily.