I’ll use Impath, the cancer diagnostic service provider, to demonstrate how to fill out the growth stock scorecard.

Step 1. Analysts’ Ratings & Forecasts

Good growth candidates often have relatively weak, but not too weak sentiment scores, combined with strong earnings growth prospects. The scorecard rewards firms with sentiment scores in the minus two to plus two range, and penalizes those with scores below minus two (too weak) and above eight (too strong). It penalizes companies with forecast annual earnings growth below 15 percent. Negative earnings forecast trends (forecast for the same period has declined from 90 days ago), or a history of negative earnings surprises (reported earnings below forecast) spell trouble and disqualify growth candidates. Impath’s zero value Sentiment Index earned it one point. Its 41 percent year-over-year forecast earnings growth was well above the minimum, so Impath was not penalized. Impath’s earnings forecasts were trending up, and it did not show a persistent history of negative earnings surprises, so it was not disqualified by those tests.

Step 2. Valuation

Promising growth candidates are often richly valued, but unrealistic valuations signal high risk. This test rewards stocks priced below their expected year-over-year earnings growth rate, but penalizes those priced for more than 40 percent annual earnings growth, regardless of the analysts’ forecasts. Impath’s share price reflected implied growth slightly below its forecast 30 percent earnings growth, and thus earned one point.

Step 3. Target Price

This test rewards firms trading within or below their calculated target buy range. However, since growth stocks often trade for extended periods above values dictated by their fundamentals, it doesn't penalize those trading above the target buy range until they move up into the sell target range.

Impath earned one point because it was trading within its target price buy range.

Step 4. Industry Analysis

You’ll find your best growth candidates in fast growing, concentrated industries. Consequently, this test rewards firms in industries growth faster than 20 percent and penalizes those in industries growing less than 15 percent annually. Firms in concentrated industries earn another point, but since most industries don’t fit that description, firms in fragmented industries aren’t penalized.

I forecast Impath’s industry growth at 15 percent, so it did not earn a point for industry growth. Also, it participated in a fragmented industry, so it didn’t earn a point in that category either.

Step 5. Business Plan

Transfer the business plan score computed during your analysis to the scorecard. Impath’s business plan score was two, losing points for lack of market and product diversification, and for depending on acquisitions for much of its growth.

Step 6. Management Quality

Growth and value investors alike will benefit by picking firms with quality management. The scorecard rewards companies with key executive and board quality that you graded as very good or excellent. Points are not deducted for poor management. I had rated Impath’s management as excellent, so it earned one point.

Since clean accounting and reasonable stabile earnings growth are the norm, firms that have those qualities aren’t rewarded, but those that don’t are penalized.

I rated Impath’s accounting as clean, and its earnings growth stability as good, so it wasn’t penalized.

Step 7. Financial Health

Failing the appropriate financial health test disqualifies a candidate. Impath qualified for the busted cash burners test and passed.

Step 8. Profitability

Strong sales growth and profit margins are hallmarks of promising growth candidates. The sales growth test rewards firms with growth exceeding 25 percent and penalizes those growing slower than 15 percent. Similarly, the return on assets test rewards firms with ROA above 14 percent and penalizes those with ROA below 6 percent. Deteriorating operating margins warn of future problems. Significant margin declines disqualify candidates. By the same token, persistent cash burners are riskier investments than cash generators, and are also disqualified. Impath’s 50 percent plus year-over-year sales growth earned it a point in that category, but was penalized for its below-par 5 percent ROA. Impath’s operating margins were on the rise, and it was not a persistent cash burner, so it was not disqualified on those counts.

Step 9. Red Flags

Red flags signal slowing growth, a disaster for a growth company’s shareholders. The discovery of any red flags disqualifies a growth candidate. Yellow flags pointing to longer-term problems signify added risk but are not necessarily disqualifying factors. The scorecard penalizes a firm for each of the two potential yellow flags found. Impath’s analysis found no red or yellow flags.

Step 10. Ownership

Mutual funds and other institutional buyers usually load up on growth stocks. Lack of institutional ownership signals that these tunedin buyers don’t think that they can make money owning your candidate. The institutional ownership test disqualifies growth candidates showing less than 30 percent institutional ownership.

Very high insider ownership may be a tip-off that big shareholders are waiting for an opportunity to unload at least a portion of their holdings, an event likely to pressure the share price. This test penalizes firms with more than 55 percent insider ownership.

Step 11. Price Chart

Growth stocks should be moving up in price, not down. However stocks well into strong uptrends are riskier than stocks that have just begun their move. This test penalizes firms with share prices trading below their 200-day moving average (downtrend), or more than 50 percent above their 200-day MA (moved up too fast).

Impath, trading 60 percent above its MA, was penalized one point.

Summary Impath scored a respectable five points. Participating in a relatively slow growing and fragmented industry held down its total. Further, its slow industry growth rate impelled Impath to pursue a growth by acquisition strategy, further reducing its score.