Why Does Toolkit 6 Project 0% EPS Growth for a Company?
Posted by: Doug Gerlach 11/19/2010 4:08:44 PM

The default judgment function we deployed in Toolkit 6 makes quick work of completing a preliminary stock study. But sometimes the program doesn't project any future growth for what at first glance are growth stocks. Why does this happen?

A Toolkit 6 user recently wrote to me and asked about the program's default judgment growth rate projections for two very established companies: Johnson & Johnson and Amgen, Inc. Toolkit 6 projects future growth of sales and EPS at 0% for both of these companies, yet both have positive 10-year growth for both sales and earnings.

Let's take a closer look at both companies. JNJ's 10-year average annual sales growth rate is 9.4%, with annual EPS growth of 12.9%. AMGN has annual sales growth of 19.2% over the past decade, with EPS growth of 20.0%. Those are quite respectable for large companies the size of Johnson & Johnson and Amgen. So how does Toolkit 6 justify no future growth?

Here are the sales and earnings histories for the past decade for both companies, first for JNJ:

JNJ

and then for AMGN:

AMGN

It's apparent from the Visual Analysis graphs that both companies have had persistent EPS growth over the past 10 years.

If you look at the sales growth from 2008 to 2009, though, you'll see a different story. Both companies saw sales decline in sales for that period. And so Toolkit 6 refuses to project any future growth for those businesses.

Toolkit 6 is really just following the rules that BetterInvesting members have been taught all along: that earnings can't grow over the long-term if sales don't grow, and if a company hasn't grown EPS and sales consistently in the past, what makes you think they can in the future?

Of course, just because Toolkit 6 is unconvinced that these two companies won't see growth in the future doesn't mean that you can't override the default judgment. In fact, that's what we expect users to do if their research shows that past results are somewhat anomalous and are unlikely to recur. Your stock studies are only as good as the work that you do to evaluate a company's quality and growth potential.

One final observation: If you take a look at the Historical Growth Rate graph from the Visual Analysis screen (it's the icon labeled "Hist. Growth" on the toolbar), you will see the change in the rates of growth over the past 10 years. For JNJ, the graph looks like this:

JNJ

And for AMGN, the graph looks like this:

AMGn

This graphs and tables indicate that the growth of sales and earnings for both companies has been consistently slowing down over the past 10 years. Except for Amgen's uptick in EPS growth in 2009, both companies have been growing more and more slowly until they reached the point where sales actually started to shrink.The question that investors have to answer -- as Toolkit 6 demonstrates -- is whether or not the path to future growth is clear enough to warrant investing at this time. That's the key to applying judgment to any stock investing decision.

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