Apple’s share price exceeded $500 this week, giving it the largest market cap of any U.S. company.

Apple (Nasdaq: AAPL) so successfully sells computers, phones and other electronic gadgets that recently announced fourth-quarter profits soared 118% on a 73% increase in revenue. This is unheard of for a $475-billion company.

To put this in perspective, earnings at the companies in the S&P 500 stock index are on track to post a 6.6% year-on-year rise for the fourth quarter. Yet once Apple’s earnings are factored out, the expected fourth-quarter gain shrivels to just 2.8%. This so skews results that many Wall Street analysts are now stripping Apple from the index before weighing valuations and making forecasts.

Of course, it’s just a matter of time before Apple’s torrid growth begins to wane. It’s not possible for $500-billion companies to keep growing at the rate of $5-billion companies… or even $50-billion companies.

So the key is to search for the next Apple. But how do you find it?

Fortunately, the factors that make a great-performing stock are well known and have been intensively studied by academics and researchers. We know the key characteristics that top-performing stocks generally possess before making their parabolic moves up.

Here are just a few:

1. Double-digit sales growth. You can only grow the bottom line for so long by cutting costs. Every business needs to have healthy top-line growth before it can generate robust and sustainable long-term earnings growth. Note that sales at Apple jumped 73% last quarter.
2. At least 25% quarterly earnings growth. In an economy as weak as this one, most companies can’t meet these first two hurdles. But, again, Apple is seeing earnings growth at more than four times this rate.
3. A return on equity of 17% or more. Return on equity – an excellent measure of management’s efficiency with capital – is calculated by dividing earnings per share by book value per share. (This is one of Warren Buffett’s key metrics, too.) Note that Apple’s return on equity is a whopping 46%.
4. New products and services. Apple is the king of innovation, regularly bringing out not just new versions of products but entirely new products: iPods, iTunes, iPhones and iPads.
5. High-quality management. Never forget that every company is essentially a team of people. And just as every great sports franchise needs a highly qualified coach, so does each company require a visionary leader. Apple’s co-founder and former CEO Steve Jobs was one of the greats. Now that he’s gone, it will be interesting to see how the new management performs.
6. Institutional support. The vast majority of shares traded on the major exchanges are mutual funds, hedge funds, pension plans and endowments. You want to own the same stocks the institutions are buying. And, indeed, institutions own more than 70% of Apple’s outstanding shares.

These are some of the key criteria that companies need to meet to generate superior long-term returns for shareholders.

We may not see another company in our lifetimes that transforms the business landscape the way Apple has. But there are plenty of great innovators out there, including Amazon (Nasdaq: AMZN), Google (Nasdaq: GOOG), Genentech, eBay (Nasdaq: EBAY), Costco (Nasdaq: COST) and Intuitive Surgical (Nasdaq: ISRG).

These companies – and others like them – are likely to be among the best-performing stocks in the years ahead.

Good Investing,

Alexander Green

by Alexander Green, Chief Investment Strategist
Monday, July 19, 2010: Issue #1304

I’ve often said that my stock-picking approach can be boiled down to this mantra:

Share prices follow earnings.

I challenge you to look back through history and find even a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along.

By the same token, try to find a company whose earnings were flat or declining year after year and the shares kept rising. It doesn’t happen, even in a roaring bull market.

But is growth in earnings per share all you really need? Could it be that simple?

Of course not.

Any company can increase its earnings for a while merely by cutting expenses. But eventually, a firm reaches a point where it can’t cut costs further without damaging the underlying business. (Obviously, if you reach the point where you’re selling off key infrastructure or laying off top people to boost short-term profits, you’re hurting the company’s long-term prospects.)

There are other important factors as well and I can illustrate a few of them by pointing to a near-perfect growth stock…

Want to See If a Company is Growing? Look to These Three Crucial Factors

In order to see robust bottom-line growth, you need to see substantial top-line growth. In other words, sales have to rise, too.

And Apple, Inc. (Nasdaq: AAPL) is doing just that.

• Sales & Earnings: The company is selling boatloads of iPods, iMacs, iPhones and iPads. In many instances, it’s been unable to keep up with demand. In the most recent quarter, sales jumped 49%. That enabled earnings to soar 90%.
• Profit Margins: This is another important factor. If competitors can come in and easily underprice you, your business is vulnerable.

But Apple is well-protected with its iron-clad patents on the Mac operating system and many of the key features of its bestselling products. So it’s no surprise that operating margins top 29%. Or that Apple is up 63% over the last 52 weeks, even after the recent market dip.

Over time, Apple has brought down the price of most of its products, but not because competitors were forcing them down. Management did it because they wanted to broaden the potential market for Apple’s products. That’s key.

• Return on Equity: This key metric is calculated by dividing earnings per share by book value (or net assets) per share.

Why is this important? Because it tells you how efficiently management is deploying the firm’s capital. Warren Buffett – who puts a great deal of emphasis on ROE – says anything above 17% is good. Apple’s return on equity is twice that.

Happy Customers… Happy Shareholders

Apple has done plenty of other things right, too. It’s a consistent innovator and is a world-class marketer. (Its products are so cool, customers find themselves lusting over things they don’t even need.) And it’s done a good job of keeping a lid on costs.

The end result? Earnings per share have boomed over the last decade. And while the broad market has gone nowhere, shares of Apple are up several-fold.

It’s a classic story of a company that keeps its customers coming back because it makes them happy. And the resulting increase in earnings keeps shareholders delighted, too.

Good investing,

Alexander Green