Earnings growth is a crucial characteristic that defines winning stocks. But there's something to be said for stable earnings performance, too.
"Explosive earnings have accompanied big stock moves throughout the stock market's history in America," IBD founder William O'Neil wrote in "How to Make Money in Stocks." The book details the results of decades of market research.
The percentage change in year-over-year earnings per share, he noted, is "the single most important element in stock selection today."
In the same investing classic, O'Neil said that another important factor in stock selection is stability and consistency of earnings over the past three years. A company with steady and strong growth is preferable to one in which growth is erratic, or a flash the pan.
"All other things being equal, you may want to look for stocks showing a greater degree of sustainability, consistency and stability in past earnings growth," O'Neil said.
Earnings Stability And Earnings Growth
To wit, IBD offers the Earnings Stability reading. This is a calculation of earnings in comparison with all stocks in our database. Specifically, it is expressed as a percentage from one standard deviation of the variability around the trend line fitted through 3 to 5 years of earnings' history.
The score is in a range from 1 to 99. Lower numbers represent more stable earnings performance. Look for growth stocks with stability scores below 20 or 25. Ratings above 30 tend to be less dependable in terms of their growth.
It is not part of the EPS Rating, which measures profit performance with a greater weight on the most recent quarters.
So, in an ideal situation, a company has a steady and accelerating pattern of solid growth over multiple quarters, something like 25%, 35%, 45% and 55% gains.
Good income stocks should have low earnings stability.
Fastenal, for example, posted EPS gains of 11%, 18% and 27% in the three quarters through Q1 of 2022. Its Earnings Stability was 5 in May of 2022.
Keep in mind the calculation doesn't necessarily favor acceleration. Paychex, also with a 5 stability score at the time, reported EPS gains of 18%, 41%, 25% and 20% from Q3 of 2021 to Q1 of 2022. Its EPS Rating was a below-stellar 73.
You can find the Earnings Stability number in the IBD MarketSmith research tool. It appears in the data block with each stock's weekly chart.
This article was originally published May 6, 2022, and has been updated.
