Analyzing growth is not enough. It's also important to assess management's efficiency and effectiveness to be confident in its ability to sustain that growth.
Profit Margin
Profit margins—the percent of every dollar of sales the company gets to keep after paying its expenses—can show you how efficiently management spends expense dollars. Steady profit margins, for companies that are turning in good results and are likely operating at or near peak efficiency, or increasing margins, where management is responding to a need for improvement, are signs of good management.
A declining trend in profit margins is the result of rising expenses compared with sales, and would suggest that management was not "minding the store" as well as perhaps it should.
Experienced investors may be able to identify some scenarios where declining profit margins are okay; but the beginning investor should definitely shy away from companies with decreasing margins.
Return on Equity
A second though less important indicator is the Return on Equity (ROE).
Return on Equity—the percent of profit the company makes for every dollar of its shareholders' investment—is based on longer-term decisions whose results will actually show up later in the profit margins. ROE can serve as a caution flag if it differs substantially from earnings growth. Trends aren't necessarily meaningful?especially if earnings have been growing at greater than a sustainable rate.
To see how these values are calculated, review the Worksheet for the stock.