Jim Slater strategy: 10 small-cap growth stocks on the move

Stockopedia’s Ben Hobson examines how this famous growth strategy has reacted as conditions change.

Faced with a world where earnings are likely to be pummeled over the next couple of years, you’d imagine that investing in growth stocks had got a great deal harder.

After all, the alchemic earnings uplift you only really get from small, confident, fast-moving companies tends to need stable economic conditions to make it work. That’s partly why small-caps often sell-off so hard in times of fear (see the economic crisis in 2009).

But, of course, every major setback has its own dynamics. Just over a decade ago, equities were, for a time, so loathed that investors recoiled in the face of once-in-a-lifetime cheap prices. But what are we seeing in this crisis?

A barometer of sentiment

One interesting barometer of sentiment that we’ve seen over the years is how famous growth stock strategies react when conditions change. For example, a classic ‘growth at a reasonable price’ approach will look for stocks where earnings are growing (and forecast to grow further), where prices are trending ahead of the market but are still reasonably priced.

When turmoil hits, prices crater and forecasts are slashed, which often leaves that kind of strategy out of ideas. Jim Slater, who’s well remembered for his swashbuckling attitude to finding exciting growth stocks, took exactly this approach. And, unsurprisingly, he used to get a lot of grief for the fact his strategy often stopped working in a downmarket. It was great in good times but fell short of ideas when prices turned south.

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Yet, with the FTSE All Share index still down by 21% since the start of this year - and earnings forecasts under huge pressure - there are still growth stocks fitting these GARP investing rules. They’re growing quickly and their prices are ahead of the market - it seems that investors still want these kinds of shares.

Growth at a fair price

Slater’s strategy typically chases small, profitable stocks with robust cash flows, low debt and prices that are already rising. He was keen on firms with a competitive edge, offering new products or services that were steered by good management.

One of his most distinctive tools for picking shares is the price-earnings growth factor, or PEG. This compares the price-to-earnings with the earnings forecast growth rate. A PEG of less than 1.0 indicates that the stock offers an attractive trade-off between price and growth.

Screening for Slater stocks

At Stockopedia, our modelling of the kind of rules used by Slater shows how reliable this kind of approach can be over time. This version of the Jim Slater screen looks for stocks with a PEG below 1.0, a price-to-earnings (PE) ratio below 20x, a return on capital employed greater than 10% and earnings that are expected to grow by at least 15%.

Importantly, the shares also need to have positive relative strength against the market over the past year. Here are some of the shares currently passing those rules:

At the extreme, Sylvania Platinum (LSE:SLP) shows how a low PE and high EPS growth rate results in a very low PEG. To varying degrees the same applies to stocks ranging from aviation services firm Air Partner (LSE:AIR) and independent financial adviser AFH Financial Group (LSE:AFHP), to cake franchise business Cake Box Holdings (LSE:CBOX) and giftware maker IG Design (LSE:IGR).

In the current climate, some of these businesses will be operating in compromised conditions, and earnings may well come under pressure. But for those with robust financials and the strength to weather the conditions over the coming years, their slightly lower prices (which are now recovering) could make them worth a closer look. 

For the time being at least, the old Slater strategy barometer of sentiment is finding that small-cap growth is attracting favour in parts of the market.

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