Most bull (up) market cycles last two to four years and are followed by a recession or bear (down) market and eventually another bull market in common stocks. See Bulls vs Bears for more information.
In the beginning phase of a new bull market, growth stocks are usually the first sector to lead the market and make new price highs. Heavy basic industry groups such as steel, chemical, paper, rubber, and machinery are commonly more laggard followers. Young growth stocks will usually dominate for at least two bull market cycles. Then the emphasis may change for the next cycle, or a short period, to turnaround or cyclical stocks or newly improved sectors of the market, such as consumer growth stocks, over-the-counter growth issues, or defense stocks that sat on the sidelines in the previous cycle.
Last year’s bloody bums become next year’s heroes. Chrysler and Ford were two such spirited turnaround plays in 1982. Cyclical and turnaround opportunities led in the market waves of 1953-1955, 1963-1965, arid 1974-1975. Papers, aluminums, autos, chemicals, and plastics returned to the fore in 1987. Yet, even in these periods, there were some pretty dramatic young growth stocks available. Basic industry stocks in the United States frequently represent older, more inefficient industries, some of which are no longer internationally competitive and growing. This is perhaps not the area of America’s future excellence.
Cyclical stocks’ price moves tend to be more short-lived when they do occur, and these stocks are much more apt to suddenly falter and encounter disappointing quarterly earnings reports. Even in the stretch where you decide to buy strong turnaround situations, the annual compounded growth rate could, in many cases, be 5% to 10%.
Requiring a company to show two consecutive quarters of sharp earnings recovery should put the earnings for the latest twelve months into, or very near, new high ground. If the 12 months earnings line is shown on a chart, the sharper the upswing the better. This will make it possible in many cases for even the “old dog” about-face stock to show some annual growth rate for the prior five-year time period. Sometimes one quarter of earnings turnaround will suffice if the earnings upswing is so dramatic that it puts the 12 months ended earnings line into new highs.
How to Weed Out the Losers in a Group
When you investigate a specific industry group, using the five-year growth criteria will also help you weed out 80% of the stocks in an industry. This is because the majority of companies in an industry have lackluster growth rates or no growth at all.
When Xerox was having its super performance of 700% growth from March 1963 to June 1966, its earnings growth rate averaged 32% per year. Wal-Mart Stores, a discount retailer, sported an annual growth rate from 1977 to 1990 of 43% and boomed in price an incredible 11,200%. Cisco Systems growth rate in October 1990 was an enormous 257% per year and Microsoft’s was 99% in October 1986, both before their long advances.
The fact that an investment possesses a good five-year growth record doesn’t necessarily cause it to be labeled a growth stock. Ironically, in fact, some companies called growth stocks are producing a substantially slower rate of growth than they did in several earlier market eras. These should usually be avoided. Their record is more like a fully matured or nearly senile growth stock. Older and larger organizations frequently show slow growth.