For many investors, the perennial appeal of fast growing stocks is their ability to deliver outsize capital returns. Forget value, forget dividend income… growth in its purest form is all about fast-paced earnings expansion lighting a fire under share prices. It’s about going big or going home. It’s the classic territory of popular traders like Mark Minervini and William O’Neil - and it’s a strategy that’s made them famous.
But there is another way. Growth investing doesn’t always have to be about buying fast moving shares at any price. Over the years, it has evolved a second strand. Once upon a time growth investors paid little attention to valuation. These days, “growth at a reasonable price” (GARP) is, for some, a much more palatable way of doing things.
Balancing growth and value
One of the early advocates for buying growth stocks at reasonable prices was Peter Lynch. The former Fidelity Investments money manager used what he called the price to earnings growth rate - the PEG - to ensure he wasn’t over paying for expected future growth.
The PEG works by taking last year's price-to-earnings ratio and dividing it by the consensus forecast earnings growth for the next year. A PEG of less than 1.0 means you could be buying growth on the cheap. Any more than 1.0 and it could be looking expensive
Lynch used this approach very successfully, and others followed. Today, GARP strategies are some of the best known go-to methods of finding small-cap stocks that could be tomorrow’s growth stars. In most cases, the strategies are multi-faceted: they look for a range of factors that tend to be the fingerprints of successful growth investments.
One of the most popular - and a long-term successful strategy modelled by Stockopedia - is the approach used by Robbie Burns, the Naked Trader.
Robbie is best known for his book, The Naked Trader: How Anyone Can Make Money Trading Shares. In it, he outlines a strategy that uses a range of measures spanning growth, price momentum and value factors and focuses on small and mid-cap stocks. He also uses some non-financial, qualitative rules in his analysis.
Like many GARP strategies, the Naked Trader approach looks for positive sales and earnings growth over the past year - and net debt should be well under control. In terms of momentum, the price of the stock…
