Ratings: Five Growth Stocks to Watch Now

We screen for quality growth.
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The U.S. stock market indices are hitting new highs, at the same time that expectations for growth are declining. Feeling like you were left behind? Wondering where the next growth leg comes from? The way to prosper now is to focus on sustainable growth and think long term. Ratings screen for the week features the Top 40 Fast-Growth Stocks. In today's article we give you five names (but be sure to check back in the future for full results of screens from Ratings).

To make this list, a company has to have a consistent pattern of both sales and operating income growth. The criteria we use are at least 12% top-line growth and consensus earnings-per-share growth expectations of at least 12% for the coming year. In addition, the stock has to score in the top 20th percentile in cash flow, total return to shareholders, capital efficiency, low price volatility and solvency -- the five core factors in our stock ratings model. This helps give us quality growth.

Before proceeding to the names on the list, note that just filtering stocks on a set of financial or technical criteria alone can expose your portfolio to risk. Also remember that past performance is not a guarantee of similar future gains, especially for these highflying stocks.

Fortunately, stock screening can be combined with more automated investment knowledge management systems, such as our nightly 6,000 stock ratings model. The goal is to highlight new investments that have higher probabilities of successful outcomes. As part of its selection process, Ratings stock model looks at more than 60 distinct measures to come up with an overall investment grade and recommendation. For this growth list we focused exclusively on the model's top-rated stocks.

So, what are the results?

The net result is a list of companies with global reach, unique franchises and the potential for future upside momentum. But there are also surprises.

The first surprise is how attractively underpriced these stocks are relative to their growth expectations. It would be natural to expect that most of these stocks have been rewarded for their past performance, and that these are not the cheapest stocks around. Not so. The 40 names on this list have an average 20% earnings growth expectation, based on consensus estimates, and sell at only 17 times forward earnings -- a discount to growth.

Another surprise is that not all have hit their 52-week highs in the last few days. So yes, there are still some laggards here, especially with the less well-known names or those that are misunderstood.

The final surprise is that a wide range of industries and sectors is represented, including everything from information technology to acquisitive utility companies.

Here are the five stocks at the top of the list. In terms of potential appreciation, all our models point to large-cap growth continuing to outperform, so we've ordered them by market cap.

The top spot goes to


(ORCL) - Get Report

, the $95-billion-market-cap software heavyweight. Although the stock has risen 50% over the last 12 months, investors have been somewhat skeptical of the company's ability to continue a double-digit growth trajectory, and this has been demonstrated in greater stock-price volatility.

Fundamentally, the model favors Oracle because of its significant cash balances, great margins and ability to put capital to work wisely in growth-generating acquisitions. The stock hit a new 52-week high Thursday.

Second on the list is

United Technologies

, the leading $62-billion-market-capitalization aerospace and defense company that gained 34% in the last year. The stock has come down with recent easing of Mideast tensions, but the company is likely to continue posting solid gains, as it will benefit from the significant increases to the U.S. defense budget.

Our model gives this company high marks all the way around, but it points to the excess capital the company is retaining as a potential issue. For the near term, the company is executing a $1.5 billion buyback program and has raised its stock dividend by 19%, two moves that will benefit shareholders and boost returns. The company is expected to report earnings Oct. 17.

No. 3


(EXC) - Get Report

shares are up 21% in the last 12 months to a market capitalization of $41 billion. This well-positioned midwestern, mid-Atlantic utility owns one of the largest portfolios of electricity generating capacity with a nationwide reach. Relative to its utility industry peers, EXC has posted well above-average margins and growth, both positives for our stock model. The company is expected to report earnings Oct. 26.

The fourth spot goes to

General Dynamics

(GD) - Get Report

, another aerospace and defense stock that rose 30% during the last year. With a market capitalization of $28 billion, GD is still less than half the size of United Technologies, but it is growing the top and bottom lines at a faster clip and divesting noncore operations. The stock hit a new 52-week high Thursday. Earnings will be released Oct. 18

Our fifth stock is

Johnson Controls

(JCI) - Get Report

, the most misunderstood stock on this screen. This is a classic example of how an objective model will zero in on profit opportunities that individuals miss.

Johnson Controls has a track record of 60 consecutive years of sales increases, 16 consecutive years of earnings increases and 31 consecutive years of dividend increases. JCI generates half of its sales from non-North American clients, it leads in several fast-growing markets, and it possesses technology innovations that can accelerate growth. Management clearly states that it has no problem forecasting double-digit growth over the next few years.

The Ford Drag
JCI feels the pain of Ford's problems.

As the above chart shows, it's been a rough 2006 for JCI. The main culprit has been


(F) - Get Report

. Problems at the automaker have discounted JCI's role as being a major supplier to the global auto industry, with the stock dropping from $90 to $70 in a little more than three months. Although the stock price has bounced back a bit to $75, Johnson Controls' management clearly has to do something to turn this negative perception around and recast it as a diversified growth play.

The company is presenting its strategy review and 2007 outlook to analysts today. Expect to hear more good things from Wall Street as analysts focus on the prospects for the global auto market (yes, it's No. 1 in China), integration of electronics into current auto production, hybrid batteries and integrated controls in non-automobile markets.

For the more aggressive investor who is willing to commit for the longer term, all five of the stocks discussed here also have long-term options (LEAPs) available, which can be used to create various option strategies. (Check out

this article

on LEAPs.)

Rudy Martin is the director of research for Ratings. In keeping with TSC?s Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

In keeping with TSC?s Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Martin cannot provide investment advice or recommendations, he appreciates your feedback;

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