Interactive Investor

11 eye-catching growth shares that won't cost investors the earth

23rd May 2018 13:58

Ben Hobson from Stockopedia

When it comes to investing in growth stocks, there are two types of investor. There are those relaxed about paying high prices for the promise of rapid growth. And there are those who hate the idea of overpaying and think a reasonable valuation as essential.

Over the past three years, Fevertree Drinks has been a good example of what it means to pay an eye-wateringly high price for growth. The high-end mixer and soft drinks business floated at the end of 2014. But its shares have never looked cheap against standard valuation ratios. With a current price/earnings (PE) ratio of 73, it has the kind of rating that gives value investors nightmares.

Yet many of the investors who bought Fevertree stock over the past couple of years will tell you that they didn't overpay at all. Fevertree has been a consistent over-achiever, smashing analyst growth forecasts at almost every turn. Its share price has soared as a result - paying off for the growth investors who were prepared to bet that Fevertree could (and can) keep delivering.

Sadly, however, stunning success stories like Fevertree don't come around very often. When they do, the powerful momentum that builds in their share prices can leave investors prone to sudden crashes if (and when) the growth slows down. This is precisely why many growth investors take valuation seriously.

Growth at a better price

Growth at a reasonable price (GARP) investing was made famous by a fund manager called Peter Lynch. He produced stunning returns while running the Magellan fund for Fidelity Investments (he later wrote One Up on Wall Street). In the years that followed, the late Jim Slater introduced a similar growth approach to the British investing masses in his book, The Zulu Principle.

In essence, GARP strategies look to balance a track record of earnings growth with a moderate valuation in stocks that are usually good quality and may already have caught the attention of the market.

At Stockopedia, a screen that models these factors is currently the top performing strategy over the past five years. In lab conditions (where the portfolio is rebalanced quarterly and costs are excluded), it has generated a remarkable 250% return over that period. It also leads the performance tables over the past year, with a 22.1% gain.

Source: Stockopedia                           Past performance is not a guide to future performance

So how can you build your own GARP screen? The answer is that different investors - from Jim Slater to Robbie Burns - all have their own preferred GARP metrics. But Stockopedia's GARP screen uses ten main inputs that combine to look for a track record of double-digit growth, reasonable valuation and strong quality and momentum. Here's a general idea about what they look for:

● Market Cap greater than £200 million

● Double-digit earnings per share (EPS) compound annual growth rate (CAGR) over 3 and 5 years

● Below average PE ratio, and definitely below 20x

● EPS should be positive and Return on Capital Employed (ROCE) should be in double figures

● Net margin should be greater than it was a year ago

● Positive relative price strength over the past year

Here are some of the companies that currently pass these rules:

NameMkt Cap £mEPS 3y CAGR %PE RatioROCE %Relative Price Strength 1ySector
Griffin Mining263209.38.7632.3176.6Materials
CMC Markets528.316.41028.635.1Financials
Total Produce766.22414.612.413Defensives
MJ Gleeson400.745.
River and Mercantile251.270.816.520.48.02Financials

Source: Stockopedia                           Past performance is not a guide to future performance

Great growth companies are often popular in the stockmarket, which can result in steep valuations - and investors in stocks like Fevertree know too well. So, balancing strong growth with reasonable valuation inevitably leads to companies that the market is less certain about. Leading the list is financial trading firm Plus500, which some fear could be hit by tighter regulation in the future. So far, though, the stock has proved to be very successful for its holders.

Others range from small stocks like the gold mining business Griffin Mining and corporate broker Numis, to FTSE 100 giants like the equipment hire group Ashtead and the housebuilder Persimmon.

GARP strategies like this are a popular route for many investors because they tend to pick up exciting, fast moving stocks. Uncertainty around some of them, or concerns about cyclical trends or regulation can suppress their valuations - and this is what GARP investors look for.

It's important to remember that those concerns are real though, so careful research is required. It's also the case that in bullish periods the number of growth stocks on modest valuations can fall very low. But over long periods this kind of approach has proved to be very successful.

About Stockopedia


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These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.

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