What is a growth company?

It is always a painful question, what is a "growth company" as opposed to a company that has just had a good year or two?

1. Great growth companies have the ability to increase EPS at an above-average rate year after year.

2. Most growth companies are found in the 'new world' sectors of Support Services, Pharmaceuticals, Healthcare, Media, Electronic & Electrical Equipment, Breweries, Pubs & Restaurants and General Retailers.

3. Almost all companies are cyclical to some extent. However, companies in highly cyclical industries rarely become great growth companies.

4. A competitive advantage, such as a strong business franchise, patent or brand name, is often the main characteristic of great growth companies.

5. A company's capacity to clone an activity like a shop, restaurant, nursing home or indoor tennis facility, and open more of them throughout the country (and possibly internationally) can result in exceptional EPS growth.

6. Calibre of management is a crucial factor in deciding whether or not to buy a growth share, but it is very difficult to judge, so start with the arithmetic.

7. Try to find companies that are increasing EPS by at least 15% per annum. In a difficult year, a minor setback can be ignored, but 15% is the right average level to aim for - it will double EPS every five years.

8. Slater has a number of criteria that must be met before he'll justify calling a stock a growth stock:

   • A company is a growth company only if it has four years of consecutive EPS growth, whether historic or forecast, or a combination of the two.

   • Each of the past five year's results must have been profitable. None may show a loss.

   • Where four periods of growth follow a previous setback, it must have achieved, or be expected to achieve, its highest normalised EPS in the latest period out of the last six.

   • All real estate companies are eliminated, as these are asset situations rather than growth companies.

   • There must be broker forecasts. (Company must not be so obscure that even the brokers haven't heard of it).

   • Companies in the highly cyclical Building & Construction and Building Materials & Merchants sectors and those in the Vehicle Distribution sub-sector are still required to meet the normal growth criteria. In addition, however, they are required not to have incurred a loss or suffered an EPS reversal in any of the last five years of reported results. This last criterion eliminates most of the companies in those sectors, but leaves the few that are arguably genuine growth companies.

9. Only growth companies are awarded a PEG factor.

Competitive advantage

The competitive advantage of a company is what makes it a true growth stock. There are a number of factors that give a company a competitive advantage:

1. Top class brand names. ie Coca Cola, Gillette, Sony.

2. Patents or copyrights. ie record companies and movie producers, drug companies.

3. Legal monopolies (subject to regulation). Utilities can be a very good investment, television stations, news papers - lots of media companies have a sort of monopoly as they are the only established and respectable institution in their particular niche.

4. Industry dominance. Once a company gets a head start it can be very difficult to dislodge. ie Microsoft, Disney.

5. Established position in a niche market. If a company specialises in something as exotic as high performance safety equipment for a technical/ engineering project like Oil and Gas production, a single company can come to dominate the production of gas pressure relief valves or special sensors. As they are a product that is often absolutely needed by the specialised customers that buy them, but the market is not big enough to warrant another competitor going in to start designing, making and marketing their own version, the widget maker can often charge whatever he likes, knowing the customers will pay. Having a few patents also helps here.