Peter Lynch, a former fund manager at Fidelity Investments in the US and author of investment books like One Up On Wall Street, once wrote that for every five stocks you have, usually one goes up strongly, one goes down and the other three go sideways.
We should always look for value, but growth at a reasonable price is a winning strategy also. Looking at mid and large-cap stocks, there are some that have the potential to double their earnings per share in as little as three years.
To double earnings in three years, a company would need compounded annual earnings per share growth of 24% or more. We get this number by using the “rule of 72”. Divide 72 by the number of years you want to double your money in (3) and the answer is the percentage you will need. 72 / 3 = 24.
What companies can increase their EPS like that over the next three years? No one can predict the future, but here are two companies that may have the potential to hit that high mark of growth.
REA Group Limited (ASX: REA), the owner of property listings website realestate.com.au, has a history of strong earnings per share growth. After the GFC, the company’s earnings more than doubled in the past three years. In the first half of FY2014, earnings per share were up 37% over the previous corresponding period, keeping up its strong pace. It is expanding overseas and moving to take more market share in Australia as well.
Oil Search Ltd (ASX: OSH) doesn’t have as strong an earnings growth history as REA Group, but the market is expecting the oil and gas producer to have a step-change upwards in earnings.
The PNG LNG project, of which it is a joint owner, is starting to deliver LNG exports this month and the company estimates its production output will increase four times when it reaches full capacity. On top of that, it thinks that it can double production beyond the 2015 level by adding at least two more LNG processing plants within 5-7 years after that.
Both companies have high price/earnings ratios and if they falter in delivering high growth, their share prices can get punished by investors. However, to get that potentially high earnings growth, a premium is required.