Forget traditional valuation methods, writes Stockopedia's Ben Hobson, this strategy is a winner.
One of the standout themes in the stock market over the past decade has been the success of strategies that focus on fast growth and momentum. In bullish conditions, investors have gravitated to firms with rapidly growing profits. And while these stocks have often looked expensive, the momentum in their prices has been relentless.
Growth strategies are popular among traders and investors who are looking for quick price moves - but they can also be fearsome. Unlike value strategies, which rely on a gradual correction of market mispricing, growth strategies can be much more sensitive to market sentiment. So they need careful handling.
Some of the masters of this kind of investing are the likes of Mark Minervini and William O'Neil. Both of these Armerican trading gurus have made careers out of buying stocks where earnings momentum and price momentum are both rising fast
O'Neil's 1994 book How to Make Money in Stocks is an investment classic that followed years of research into the background of some of the best performing shares of all time. Its appeal lies in the excitement of finding companies that are seeing their profits increase but are yet to see their share prices reflect it.
The popularity of this approach meant that O'Neil, a stockbroker by trade, could build a mini empire for what he called the 'CAN SLIM' strategy, which is driven by his online news and research portal, Investor’s Business Daily.
CAN SLIM represents the seven factors that O'Neil looks for in a stock. His strategy blends conventional 'growth' measures such as Current and Annual earnings growth and New product innovation with ‘technical’ indicators like the Supply and demand for shares, whether it's the Leader in its specific sector, whether it has Institutional support allied with overall bullish Market strength.
Importantly, O'Neil tends to disregard valuation measures like price-to-earnings ratios when it comes to analysing shares. His studies of the market found that it was actually those companies that looked very expensive based on these measures that went on to be some of the greatest winners.
For that reason, the strategy also carries a potentially high degree of risk, which is why he also insists on setting strict eight percent stop-losses on entry points, which limits the financial damage that can be done if the price does fall.
A pre-costs strategy based loosely on CAN SLIM rules tracked by Stockopedia has easily beaten the FTSE All Share over the past three years. But it's important to note that when market sentiment comes under pressure - as it did last October - growth strategies like this can fall sharply.
Source: Stockoepdia Past performance is not a guide to future performance
Here are some of the stocks that currently share the characteristics of what O'Neil looks for in his CAN SLIM strategy:
|Name||Mkt Cap £m||EPS Gwth % Q on Q||EPS Gwth %||EPS Gwth % Forecast 1y||1 Year Relative Strength||% vs. 52w High|
|Churchill China (LSE:CHH)||175.2||92.2||27.6||6.03||55.3||-4.5|
|Judges Scientific (LSE:JDG)||221.4||58.2||76||22.7||52.9||-2.5|
|Elektron Technology (LSE:EKT)||94.9||147||106.5||41.8||32||-3.8|
|EKF Diagnostics (LSE:EKF)||163.5||374||195.3||40.4||22.9||-9.3|
|Liontrust Asset Management (LSE:LIO)||399.7||68.1||27.5||56.2||21.3||-2.5|
One of the interesting features of this strategy is that it finds stocks from all areas of the market. Just in terms of size, this list ranges from the mega-cap information and analytics group RELX (LSE:REL) to the small-cap operations management business Elektron Technology (LSE:EKT). All of them are trading close to their 52-week high prices, which means that these are some of the fastest moving stocks in the market.
Leading the list is the ceramics group Churchill China (LSE:CHH), which recently raised its full-year earnings expectations - which is a classic hallmark of this strategy. Other fast moving and fast growing stocks include the digital services group Kainos Group (LSE:KNOS), scientific instruments business, Judges Scientific (LSE:JDG), and promotional products specialist, 4imprint (LSE:FOUR).
In summary, O'Neil's focus on a blend of earnings growth and price strength has played well in the bullish market conditions of recent years. But it's still a strategy that calls on investors to keep a close watch over the companies it picks up. Sudden changes in sentiment can see these kinds of shares fall sharply. But as a guide, this kind of approach can be a useful pointer to stocks that are growing fast and starting to capture the imagination of the market.
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