Jim Slater's Zulu Principle: Growth Investing mixed with Value

In Brief 

Zulu Investing is a GARP investing style which uses a combination of growth and value, looking for shares where brokers are forecasting high earnings growth, but which are currently valued at a price that is low relative to their forecast earnings. As Slater puts it: "I have always been attracted to growth shares, particularly those that can be purchased at what I perceive to be a discount to their proper value”. 

Background to Zulu Investing 

Jim Slater is a UK investment guru who specialises in growth investing. He believes growth shares to be the most rewarding investments, with unlimited upside if the right companies are picked. Slater originally rose to prominence with a share column, “The Capitalist” in the Sunday Telegraph. In 1990 he published his book articulating the strategies and investment criteria that underpinned its success. He called the book The Zulu Principle to illustrate the importance of specialisation, the key to his investment strategy - the name was triggered when his wife started to read up on Zulus and quickly became an expert.

Jim Slater recommends that you specialise in a certain aspect of investing and concentrate your efforts as that way, you should be able to exploit share opportunities that elude the generalist. He also prefers smaller companies that have been undervalued by the market on the basis that:

 “Most leading brokers cannot spare the time and money to research smaller stocks. You are therefore more likely to find a bargain in this relatively under-exploited area of the stock market.

In 1993, Jim Slater teamed up with Hemscott to create Company REFS (Really Essential Financial Statistics) to help investors to apply his system by listing key ratios and company information.

What are the Zulu Investing Principles? 

Slater’s Zulu Principles are split into categories based on their relative importance. They have been through various incarnations – the list below is based on the 2011 Kindle edition of Beyond The Zulu Principle: 

Mandatory Criteria

• A low PEG (price-earnings ratio relative to the growth rate) below, say, 0.75
• A prospective price-earnings ratio less than 20 – “the preferred range for a P/E is 10-20 with forecast growth rates of 15-30%”. He is wary where growth exceeds these levels, as that sort of growth rate is usually unsustainable.
• Strong cash flow per share in excess of earnings per share (EPS), both for the last reported year and for the five-year average. 
• Strong financial liquidity evidenced by positive cash or gearing below 50%, although exceptions are made where a stock is unusually cash generative or there are pending asset sales.
• High relative strength in the last one (or three) months and the previous twelve months compared with the market, with the 12 months being higher than the one month. A technical as opposed to a fundamental measure is used as a sign that investors are beginning to appreciate the company’s potential.
• A good competitive advantage, which will be usually evidenced by a high return on capital employed (ROCE, excluding intangibles above 12% and ideally in the region of 20%) and good operating margins relative to the industry (although recognising that exceptional margins may attract competitution). 
• No selling of shares by a group of directors.

Highly Desirable

• Accelerating EPS, especially if the source (e.g. "cloning") can be identified as sustainable.
• A group of director of directors buying shares;
• A small market capitalisation in the £30m-250m range. 
• A dividend yield. Dividends are not required but they are “preferred”

Bonus Criteria

• A low price to sales ratio (PSR) is seen as “an excellent value filter that can be applied to growth stocks, to give additional reassurance”.
• Something new (a change of CEO, new products or a major acquisition)
• A low price to research ratio (PRR), useful for identifying research-led businesses that are not yet profitable but investing significantly in development.
• A reasonable asset position.

Calculation / Definition of a Zulu Screen

The stated Zulu Screen screen criteria used by Company REFS are as follows: i) PEG < 0.75, ii) PER < 20, iii) EPS Growth Rate % > 20, iv) 1 Year Relative Strength  > 0, v) 3 Month relative Str > 0 and vi) Market Capitalisation > 20. However, there are a number of extra conditions built into the PEG criterion as, in order to be awarded a Slater PEG, this requires: 

• Positive EPS growth in at least four of the last five years (however, this can include forecast periods, so companies with only two years of past EPS growth and two year’s future forecast growth could be considered).
• There must be broker forecasts available, ideally more than 1.
• Property companies are excluded, while companies in the Building & Construction sectors may not have incurred a loss or EPS decline in any of the last five years due to the cyclical nature of these industries
• No losses in the last five years and where four periods of growth follow a previous setback, it must have achieved its highest normalised EPS in the latest period out of the last six.

Does Zulu Investing Work?

According to Company REFS, Irish stockbrokers Merrion back-tested a Zulu Principle portfolio of stocks over the nine and a half year period from October 1994 and reviewed it every six months. In October 2004 they concluded that a Zulu Principle portfolio would have delivered an almost 10 year CAGR of 24.5% (excluding costs), compared to just 4.4% CAGR for the FTSE All Share index.

More anecdotally, the ghost portfolio in “the Capitalist” investment column in the Sunday Telegraph  appreciated by 68.9% against the market average of 3.6% over a two year period. In the late nineties, Jim Slater’s “Mail on Sunday” column achieved a 87.9% return over a 27 month period.

How can I run this Screen? 

On Stockopedia Premium, of course! Sign up now for access to our exclusive Beta!

Watch Out For 

Slater avoids property companies and investment trusts, whilst companies in cyclical sectors (e.g .building & construction) are subject to very stringent requirements.

Jim Slater also lists more qualitiative criteria that he feels a share should meet before it qualifies as a good buy, in particular, Slater looks for an optimistic chairman’s statement. If the chairman is pessimistic about the future, Slater views it as a possible signal that earnings growth is at or near an end.

The management should own shares in the company. Slater recommends keeping an eye on Director Dealings. If the directors are ditching large shareholdings in their own company “I start to worry”.

From the Source

Jim Slater’s Zulu Principle (1992) was the one of the firsts book to present British Investors with a homemade screening strategy. You can find it on Amazon. Other subsequent publications include:

• "Investment Made Easy" (1995)
• "Beyond The Zulu Principle: Extraordinary Profits From Growth Shares" (1996, 2011)
• "How To Become A Millionaire" (2000).
• " Make Money While You Sleep" (2002).

You can also read more on his website - http://www.jimslater.org.uk/ - including an interesting discussion on When to Sell. 

Other Sources

• Investor’s Chronicle Stock Screening Newsletter – November 2005
• Jim Slater Biography
• Wikipedia on the Zulu Principle
• Wikipedia on Jim Slater
• Fool School on Jim Slater