Analyst's Toolkit: Bristol-Myers Measures Up

Analyst's Toolkit is a weekly feature that assesses stocks, bonds and funds by using measures that can give different perspectives on valuation. Come back every Wednesday for fresh insights into analyzing securities.

Investors ideally ought to pick stocks that will rise faster than others and the market as a whole.

Incredibly, some investors buy shares of companies with no growth at all. And others find it hard to determine growth prospects in the first place. What's more, expectations of future growth make the task even more difficult.

To do so, many investors focus on earnings growth or return on equity. While important, those factors are backward looking. A method known as sustainable growth can help provide insight into future growth.

Only companies in the same industry are comparable. Pharmaceutical firms, for instance, tend to have substantially higher growth rates than those in industries that don't generate as much cash to fund their operations.

The theory behind the calculation of sustainable growth is that a company's growth is fueled by net income that flows from the income statement to the balance sheet as retained earnings. Dividends are an impediment, as they don't land on the balance sheet.

As a result, sustainable growth is a calculation of return on equity multiplied by the so-called plowback ratio. That is, earnings per share minus the dividend paid over the earnings per share. That calculation determines the percentage of the earnings that a company is reinvesting in itself rather than paying out to shareholders.