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RS And EPS Ratings Are Tools, Not Stand-Alone Buying Signals

You know that the very best stocks tend to boast the very best EPS and RS ratings.

But these gauges are valuable tools, not stock-pickers. Learning the right way to use them will bolster your portfolio's returns.

First, let's talk about what we're talking about.

The is an IBD proprietary gauge that compares a company's profit record (quarterly and annual, with more weighting on recent results) with those of all other publicly traded companies. It's listed in the stock research tables, Stock Checkup and many other IBD features.

They're ranked daily. The Rating runs from 1 (worst) to 99 (the best). A stock with an of 88 owns a profit record better than 88% of all other publicly traded companies.

The Relative Price Strength (RS) Rating measures a stock's 12-month price performance with those of all other publicly traded stocks. The RS rating also runs from 1 to 99, worst to best.

Well, you might ask, "Why shouldn't you just buy the EPS and RS 99s and sit back and count the money?" Come on, if it were that easy, my idiot brother-in-law could do it.

These ratings are crucial parts to the puzzle, yet they aren't the whole story. Remember, stocks can end stellar runs and top out with the very best of ratings.

Rather, the EPS and RS ratings should be used in tandem with your other research.

Ask: How is the market? If the broad market is correcting, you won't be buying anything anyway. But if the market is in a confirmed uptrend and acting healthy, you should always have a well-honed watch list. Corrections don't least forever.

Ask: How is the base? Is it sound and healthy? There are plenty of stocks in flawed bases that nevertheless show fabulous ratings. How? These are just numbers. You have to go in and see if the base is tight, if accumulation is strong, if price-volume action is right.

Ask: Are you buying correctly? Lots of people lost money in stocks like Dell (DELL) and Starbucks (SBUX), even in their salad days. Leaderboard, the chart analyses in every IBD 50 and Big Cap 20 chart, and Daily Stock Analysis on Investors.com can help you buy and sell right.

Look at Chinese search-engine king Baidu (BIDU). The stock peaked on July 26, 2011. Its ratings could hardly have been better: a 99 EPS and 94 RS as of IBD's July 27 edition. Yet Baidu fell from 165.96 to 100.95 in nine weeks.

If you didn't look too closely you wouldn't have seen any problems. Like what? Earnings growth had slowed to 87% — an admittedly fabulous pace, but not quite the triple-digit gains seen the prior six quarters. And with a market share of 80%, Baidu would have been vulnerable at the appearance of a serious challenger — like its new rival, Qihoo 360 Technology (QIHU).