Stock market cycles dictate that there are times when certain styles of investing will seriously struggle for buying ideas. In bull markets, when prices are rising, value strategies dry up. In bear markets, when fast-moving stocks can get pulverised, momentum strategies suffer badly.
Then there are growth strategies. Growth has been a major driver of returns in recent years - particularly in small-cap stocks. But since the middle of 2018, we’ve see a sharp fall in the number of companies making the grade as genuine growth shares investments. So why is that?
Part of the answer is down to the way growth stock strategies work. While these strategies often differ on the finer details, most rely on a few key concepts. First, they look for a growth streak in company earnings. Second, the stocks shouldn’t be too expensive. And third, there should be at least some positive momentum in these shares.
Let’s look closer at these ideas…
Fast and persistent earnings growth
I don’t think you’ll find a regular growth strategy that doesn’t take some kind of lead from a company’s earnings. Historic profitability and the expectation that earnings will keep growing is usually a must.
If you’re a fan of US traders like Mark Minervini or William O’Neil, for example, you’ll be looking for quarter-on-quarter acceleration in earnings growth. If Robbie Burns (the Naked Trader) or perhaps Jim Slater are more your style, then earnings growth should at least be positive over the past year. Meanwhile, others, who take a longer-term view view of “growth at a reasonable price” (GARP) might look for five- or even ten-year positive earnings growth rates.
Growth at what price?
So earnings are important, but what about the price you’re prepared to pay? This issue divides growth investors into two camps. In one, GARP specialists like Robbie Burns usually won’t overpay for a share. A P/E ratio of 20 is generally the ceiling in their kinds of strategies. That would definitely have priced you out of some of the best performing growth stocks in recent years. But it might also have saved you from some sudden disappointments..
Other types of GARP investor, like Jim Slater and Peter Lynch, focused their strategies on the relationship between price and growth. They both used interpretations of the price to earnings growth…
