How to Select High Profit and Low Risk Stocks

It is commonly believed that highly profitable stocks are less risky than low profit companies because earnings drive share prices. Not so fast my friend. It depends on how one defines high profit and how one defines low risk. In this article we explore how to define high profit and how to define risk. Then we will learn how to find and select high profit and low risk stocks.

Define high profit. There are many ways to define highly profitable; we can use earnings growth rates, profit margins, or total net profits, to name a few. For example, Exxon has quarterly earnings growth of 17%, net profit margins of less than 10%, and net profits of $11 billion. Google has quarterly earnings growth of 30%, net profit margins of 25%, and net profits of $1.3 million. Which company is more profitable? It depends. Most investors focus on earnings growth rates because Wall Street is most concerned with future expectations rather than past profits. For purposes of this article, let's define high profit as a company that has yearly earnings growth of more than 50%.

Define risk. A common definition of risk is beta. Beta measures a stocks movement in relation to the overall market. For example, if the market drops 1% a stock, with a beta of 2 will drop by 2% (riskier than the market). When the market drops by 1% a stock with a beta of .5 will only drop by .5% (less risky than the market). The same principle applies on the up side. Remember, more risk, more return. Not only is beta a good measure of risk, most detailed quote screens display beta, so it is easy to find.
Beta is a figure that is used in most detailed quote screens.

Now that we have our definitions for high profit and low risk, let's search for stocks that meet our criteria. Yahoo! Finance has a Stock screener that is easy to use. Go to Yahoo! Finance Stock Screener to begin our search. A link to Yahoo! Finance Stock Screener is available below in the Resources section of this article.

On the Stock Screener page, scroll down to the section titled, "Share Data." In this section, you will find Beta. Select a beta figure of 0.5 to indicate we want stocks that move less than the overall market. In other words, when the market drops by 1%, stocks with a beta of 0.5 will fall by only 0.5% (less risky than the market). Also, when the market rises by 1%, stocks with a beta of 0.5 will rise by 0.5%. That is the risk/reward trade-off.

To select our high profit stocks, scroll down to the section titled, "Analysts Estimates." In this section, we can screen for companies that have earnings growth estimates of more than 50%. Specifically let's search for companies with 5 year growth rates estimated to be more than 50%. In the item "Est. 5 Yr EPS Growth:" select "Up more than 50%."

Click Find Stocks. When I did this screen on May 28, 2008, I came up with 378 stocks that have a low risk and high expected earnings growth rates. That is a pretty large list.

If that list seems daunting, narrow the screen. Remember how many definitions of "high profit" we discussed. On the Stock Screener page, look for the Profit Margin item. Add a screen for Profit Margins of at least 30%. Now we are looking for stocks with low betas of .5, net profit margins of at least 30% and 5 year estimated earnings growth rates of more than 50%. This list, as of my search on May 28, was 33 companies. Now we're talking; a list I can digest.

Once you have learned to search for high profit, low risk stocks, use the stock screener to fine tune what levels of profit/earnings and risk you can tolerate by changing the variables in the stock screener and studying the stocks on the list for suitable investments. Happy investing!

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