Interactive Investor

10 growth stock stars still on the up

24th May 2017 13:53

Stockopedia from interactive investor

Scouring the stockmarket for cheaply priced value shares is a strategy with rich heritage and a popular following among investors. But not everyone wants to spend their days digging around for opportunities among distressed stocks and 50/50 recovery plays.

Investors like William O'Neil, Philip Fisher, Jim Slater and Peter Lynch earned reputations as spirited adventurers in search of explosive growth stocks. They did it by either ignoring valuation completely, or paying a little extra for shares with the promise of exciting growth.

With London's main indices breaking out to new highs in 2017, growth stocks - and growth stock strategies in general - have been some of the big winners. So it's worth exploring how these approaches work and how they find the market's fastest-moving companies.

Fast and persistent earnings growth

A company's historic profitability and the expectation that its earnings will keep growing is a crucial factor in any growth investing strategy. Back in the 1930s, the 'father of growth investing', US asset manager T. Rowe Price, put earnings growth at the centre of his strategy. He looked for a long-term rising trend in earnings per share (EPS) and used forecasts to predict whether earnings would keep growing.

US investor William O'Neil uses a similar approach in his trademarked CAN-SLIM strategy, which also looks for accelerating EPS and sales growth trends.

Growth at a reasonable price

Value investors have lots of measures at hand when it comes to valuing shares. But growth investors tend to be more cautious about using ratios like price-to-earnings (PE) when analysing stocks.

Philip Fisher, who was a big influence on Warren Buffett, aimed to buy stocks that offered growth at a reasonable price (otherwise known as GARP). He looked for a track record of consistent sales growth as one of his leading indicators. Unlike many value investors, Fisher was content to keep holding shares even when they became fully or over-valued in the market.

One of the best-known measures of the relationship between value and growth is one made famous by investors like Peter Lynch and Jim Slater. Using the price-earnings growth factor, or PEG, they measured the trade-off between a stock's price, its earnings and its expected growth rate.

Both men worked out the PEG slightly differently, but with the common aim of buying growth at an acceptable price. A PEG of less than 1 indicates that a company is growing EPS faster than its PE ratio, and can be a pointer to cheap growth stocks.

Positive price trend

Peter Lynch is well known for his desire to find 'tenbaggers' - those stocks that could literally make him ten times his original investment. But to do that, those stocks need to be consistently breaking new price highs, which means that tracking relative strength against the market is vital for growth investors.

Slater's approach uses positive price performance as a sign that investors are beginning to notice a company's potential. It looks for high relative strength in the previous one-month and 12 month periods compared with the market.

A similar approach is used by O'Neil who uses relative strength to find the very best price performers in strong sectors.

Screening for growth

Growth strategies have been very successful so far in 2017. One of the most impressive is modelled on the rules suggested by Bill O'Neil's highly-respected CAN-SLIM strategy.

In essence, the method looks for historical and forecast earnings growth in profitable companies with prices that are breaking out. Over the past year, a strategy loosely modelled on some of these ideas has generated a 43.9% return.

O'Neil worries less about buying stocks on the cheap, but he sells them quickly if there is a meaningful breakdown in their price momentum. Here are some of the companies that currently pass these types of rules:

NameMkt Cap £mEPS Growth % Qtr on QtrForecast EPS Growth %Return on Equity %% 50-day Moving AverageSector
Boohoo.com2,13116.223.1299Consumer Cyclicals
Swallowfield64.933.366.516.711Consumer Defensives
Fever-Tree Drinks1,95092.116.235.67.6Consumer Defensives
Best Of Best40.225.816.953.84.5Consumer Cyclicals
NMC Health4,2881730.7199.5Healthcare
MD Medical Investments619.630.335.117.63.4Healthcare
JD Sports Fashion4,340119.214.441.27.4Consumer Cyclicals
CVS852.462.5199.616.112.8Healthcare
Caretech Holdings301.8117.93.01165.4Healthcare
Mortgage Advice Bureau238.742.99.289210.3Financials

A glance at the charts of these shares reveals some of the fastest-moving shares in the market. Fashion retailer Boohoo.com, tonic water business Fever-Tree Drinks and JD Sports & Fashion have all produced stunning returns in recent years. Other shares here that match the profile of classic high-growth companies include the competitions business Best of the Best, veterinary group CVS, and care services firm Caretech.

Growth companies have been some of the big winners in the bullish market conditions that have propelled prices since last summer. Often, the stand out features of these fast-paced shares is their rapid earnings growth, profitability and accelerating price momentum. The catch is that they can come crashing down if they dare to dash investor expectations.

So, having a strategy for both buying and selling these stocks is a good discipline for anyone tempted to invest in what are some of the most exciting parts of the market.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.