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6 Points to Help You Find the Next Big Growth Stock

Growth stocks – companies whose businesses have been growing at an above-average pace – can make for great investments.

But at the same time, they can be risky too if their future business performance ends up a disappointment. Growth stocks often carry high valuations; that coupled with business results which are not up to mark can make for a powerful one-two punch on the downside.

This thus makes the proper selection of growth stocks important and it is where Philip Fisher comes in.

A successful money manager and the lesser-known mentor of billionaire investor Warren Buffett, Fisher had a knack for picking out growth stocks and he had detailed his thought processes in that field in his classic investment book, Common Stocks and Uncommon Profits. Incidentally, it was the first ever investment book to rank on the New York Times’ best-seller list.

In his book, Fisher had laid out 15 characteristics (all posed as questions) investors needed to look out for in a share.

One of Fisher’s main investigative techniques to fill in the blanks for the 15 characteristics was termed as “scuttlebutt” and it consists of him digging into the details of a company through conversations with company insiders, industry experts, customers, suppliers, and competitors.

For individual investors, it’s likely that most would not have the connections nor the time to ferret out the details needed to answer all 15 questions. But, there are still six of those 15 which individual investors can answer with relative ease through publicly available information.

Let’s get started using Raffles Medical Group Ltd (SGX: R01) as an example.

For some backdrop, the healthcare services provider runs more than 100 multi-disciplinary clinics across Singapore and four medical centres in Hong Kong and Shanghai. The company’s flagship though, is the tertiary hospital, Raffles Hospital, which opened its doors more than 12 years ago in 2002.

Characteristic No.1: Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?

Over the past three years between 2011 and 2013, Raffles Medical saw its revenue increase by 11.8% annually on average. In the first nine months of 2014, the company’s revenue grew by 8.5% compared to a year ago.

The firm’s core business is the provision of healthcare services. As that won’t go out of style anytime soon, it’s hard to see patient-demand fall for Raffles Medical over the next several years at least.

Characteristic No.2: Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

The company’s currently in the process of building an extension to Raffles Hospital which would see the hospital’s current floor area of 300,000 square feet expand by nearly three-quarters.

In addition, Raffles Medical’s also constructing a 5-storey, 65,000 sq ft commercial building at Holland Village. The company has earmarked 9,000 sq ft of space in the project for the “expansion of medical and specialist services to cater to both local and expatriate patients.”

These are signs that Raffles Medical’s not resting on its laurels and is looking for ways to grow its business.

Characteristic No.5: Does the company have a worthwhile profit margin?

Period Net income margin
Year 2011 18.5%
Year 2012 18.2%
Year 2013 24.9%
12 months ended 30 September 2014 24.5%

Source: S&P Capital IQ

The table above shows Raffles Medical’s profit margins over the past three years – those are some healthy margins.

Characteristic No.11: Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

Healthcare is often termed as a defensive industry which can perform well in both good times and as everyone still would still need doctors regardless of how badly the economy is doing.

But, that doesn’t mean that it is easy at all to run a healthcare business. This is obvious when we compare the net profit margins of Raffles Medical with that of its industry peers which include Pacific Healthcare Holdings Ltd (SGX: P47), Singapore Medical Group Ltd (SGX: 5OT), and Health Management International Ltd. (SGX: 588).

Net profit margins for Raffles Medical, Pacific Healthcare, Singapore Medical, and Health Management

Source: S&P Capital IQ

As you can see, Raffles Medical has managed to maintain a steady profit margin in each year between 2006 and 2013 even as its industry peers were struggling to even generate a profit.

Characteristic No.12: Does the company have a short-range or long-range outlook in regard to profits?

In 2001, Raffles Medical was willing to sit on losses as it incurred costs for the ramp-up of Raffles Hospital. This is a sign that the company has a multi-year outlook as it’s not afraid to suffer short-term pain for massive long-term gains.

The following comments given by Dr. Loo Choon Yong in Raffles Medical’s December 2014 press release regarding the groundbreaking ceremony for Raffles Hospital’s extension is also telling (emphasis mine):

“We hope to meet the increasingly sophisticated healthcare needs of Singaporeans and foreign patients, in terms of quality of care and service. Our patients will experience an enhanced level of coordinated and integrated care by our multi-disciplinary team of staff specialists in a campus setting. This expansion will offer Raffles Hospital a 10-year runway that will benefit patients in new ways.

Dr. Loo’s the co-founder and current executive chairman of Raffles Medical.

Characteristic No.13: In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

Fisher included this characteristic because he was wary of firms that needed to raise cash through the sale of new shares to fund growth. The issuance of new shares is a dilutive act which may stunt the per-share growth of a company. And for investors, what’s of utmost importance is the change in a firm’s per-share figures.

As for Raffles Medical, it currently has S$124.5 million in cash with just S$5.6 million in borrowings. In addition, the firm has generated an average operating cash flow of S$68 million per year between 2011 and 2013.

What this means is the company has plenty of cash-resources to fund its growth and likely wouldn’t require the injection of additional capital through dilutive means.

A Fool’s take

So there you have it, six useful points from Fisher which you can easily use to help you find the next big growth stock.

At this point though, it’d be good to highlight that none of the above is meant to say that Raffles Medical is a good investment. That’s because there’s the matter of the company’s valuation to consider amongst other important things – even the fastest-growing business can be a disappointing investment if bought at too high a price.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical Group.