Outside the Box: The Importance of Sales Growth

When evaluating a particular stock on a fundamental basis, it is important to focus attention on sales growth, or revenue growth. This is especially true when focusing on growth stocks because sales growth indicates if the underlying is actually growing. A genuine representation of a company’s growth is if they are indeed selling significantly more this year versus the prior year.

Sales growth is a top-line item and it is very difficult for a company to massage or manage this particular figure on the income statement. Basically, without the presence of big increases in quarter-over-quarter and year-over-year sales growth, it is extremely difficult for a company to demonstrate big growth.

Companies generate growth by providing a product or service that has a very high demand, and that more of it gets sold for each and every quarter. Another way that rapid sales growth can occur is when the supply/demand imbalance prompts steady price increases. In this scenario, prices and demand increase but the costs running the business do not go up that much. This has certainly been the case with most of the oil companies recently as the commodity that they sell has steadily climbed without much increase in their costs.

Historically, fast-growing revenues have been a key factor in most of the huge winners in the stock market. Companies that demonstrate lasting growth in sales are more often than not going to produce returns that are not dependent on the overall market or economy. They are basically immune from what is currently taking place in the market or the general economy.

In fact, when a growth stock starts to experience slowing sales growth, it’s a key sign to start looking to sell the stock and move on to another opportunity. Many great companies can find it tough at times to keep up great sales growth. This is certainly the case for such big names like Microsoft and Intel, which basically could no longer exceed their prior successes in terms of sales growth.

These two companies were the “poster kids” for growth stocks in the nineties. However, in time they came to dominate their particular industries, and now there are just not that many new customers out in the marketplace to purchase their respective products and services. Intel and Microsoft now rely on product upgrades and add-ons in an attempt to grow sales, but obviously not at the rate they experienced in the 1990s.   

Declining sales growth is a big red flag for growth stocks. Remember, sales growth measures the percentage change in a company’s sales for one quarter versus the same quarter in the prior year. It is a very important variable when selecting growth stocks.

Happy Trading.

Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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