Focusing on a company’s earnings growth can be a good Idea, especially when targeting rising stock prices.
So often, the catalyst behind a well-performing share price is earnings. Investors want to see profits rising or the expectation of bottom-line progress in the near future.
Investing for growth
Dividends, on the other hand, can be less important for growth stocks. One well-reasoned school of thought is that businesses can often employ their spare cash better by reinvesting it back into operations. In that way, the firm may generate even larger earnings later.
It can be wise to fill a long-term portfolio with both types of stock. Some of them can target growing dividend streams and others, expanding earnings.
Recently, I’ve been considering several London-listed growth stocks. For example, international online research data and analytics technology company YouGov looks interesting.
City analysts expect the firm’s earnings to grow in the ballpark of 30% in the current trading year to July 2024 and the same again next year. That’s the kind of double-digit progress I look for in a growth-focused company, so YouGov is a good one to consider.
However, I’m also running the calculator over autonomous cybersecurity artificial intelligence (AI) company Darktrace (LSE: DARK). Once again, analysts are optimistic about earnings and have pencilled in increases of over 40% and nearly 35% for the current trading year and next.
Such business progress is impressive. However, the market looks well up with events. With the share price near 484p (15 March), the forward-looking earnings multiple is a chunky 36 or so for the trading year to June 2025.
A mark of quality?
Now, I wouldn’t allow a full-looking price-to-earnings (P/E) ratio to put me off investing in a company’s shares if I believed the business had decent prospects for growth. In the past, filtering out expensive-looking stocks has kept me away from some of the market’s best performers.
Sometimes a higher rating can be considered a mark of quality. But having said that, a higher valuation does introduce an extra element of risk for shareholders.
Darktrace only needs to fall short of its earnings estimates and the market could be brutal in its re-appraisal of the company’s immediate prospects. Not only might the share price adjust lower to account for smaller anticipated earnings, the P/E itself could decrease.
Combined, those two effects may lead to a dramatic fall for the share price. It’s a scenario seen many times with growth stocks and could lead to a volatile long-term journey for Darktrace shareholders.
One of the ‘problems’ now is that on 7 March the firm issued a stonking set of half-year results with a positive outlook statement and the stock shot higher.
Sometimes, though, moves like that can retrace a bit. So I’d keep Darktrace on close watch for the time being with a view to picking up some of the shares on dips and down-days. My plan would be to hold the stock for the long term as further growth in earnings hopefully unfolds during the coming years.
On balance, I think Darktrace looks like an attractive growth company to consider for March and beyond.
