Do Growth Stocks Earn More? by Bargain Value

 

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In last few articles we checked: P/S, P/BV and ROCE indicators. Now it’s time for a growth one. Today we will take a look at operating profit (EBIT) dynamic. It is said that stocks with high EBIT growth, outperforms these with low (or even negative). Let’s check if it’s true.

The methodology will be the same as always, so for more info you can find the exact description in article with first test.

As always we will divide stocks into 10 group. Group nr. 1 has the top 10% of stocks according to EBIT dynamic rank (extremly high growers). Group nr. 10 has the bottom 10% of stocks (profits are decreseng extremly fast).

The exact formula to count EBIT dynamic will be:

A = sum of EBIT from last two semesters (1+2).

B = sum of EBIT from two semesters set back by 6 months (2+3).

EBIT dynamic = A / abs(A) – 1

These are the annual profits for each group:

Growth Stocks

for the easier interpretation here is annual profit over base for each group as a column chart:

Growth Stocks

As we can see there is quite good trend in data, which means that groups with high EBIT dynamics (1-3) allowed us to earn more than others. The border somewhere near EBIT dynamic = 10%.

What is more, groups with very poor EBIT dynamic (8-10) performed considerably worse than average. The border for these groups is somwhere near EBIT dynamics = -10%.

If we take a look at distribution of peal stocks, we will find that these can be found at both sides of distribution:

Growth Stocks

It means that pearls can be found either as fast developing companies (EBIT dynamic > 18%) or as companies after breakdown (EBIT dynamic < -30%). If we take a look at distribution of bad stocks, it looks almost the same.

Growth Stocks

It means that the side of distribution increases the probability of meeting stocks with high volatility (either in good and bad direction). If we sum up those charts, we get the overview of the situation.

Growth Stocks

All bars are very small, what means that the distribution of stocks according to EBIT dynamics is not giving us an edge.

However if we check how often each folio performs better than market…

Growth Stocks

… it looks like the higher EBIT dynamic is, the more often folio performs better than market.

We can get to similar conclusions after seeing the worst drawdown of each folio in comparison with market.

Growth Stocks

Stocks with low dynamic (EBIT dynamic < -30%) fall easier during bear market. However the trend is undefined within folios 1-7, so the stocks with higher dEBIT dynamic won’t help us to reduce the loses during bear market.

To sum up, EBIT dynamics gives some edge. Folios with higher EBIT dynamic earned more than market. They beat the market systematically which increases the validity of an edge. However, stocks with high EBIT dynamic won’t allow us to find more risk free pearls and won’t help us during bear market, so the conclusion is that EBIT dynamic should be used as indicator to find good investments but it shouldn’t be the main indicator in investing system.