Zulu growth stocks passing Jim Slater's investing rules
Jim Slater, the businessman and one of Britain’s most popular share traders, once wrote that “investment is essentially the arbitrage of ignorance”. He insisted that individual DIY investors could get an edge against professional money managers by going where most of them feared to tread: into smaller, less well-known growth shares.
In his 1992 book The Zulu Principle, Slater said the successful investor “believes he knows something that other investors do not fully appreciate”. But he noted that this was next to impossible with large-caps because the market knows so much about them.
By contrast, given that most brokers can’t spare the time or money to cover small-caps, Slater said it was this relatively under-exploited area of the stockmarket that you’d be more likely to find a bargain (with some ignorance to arbitrage).
Nearly 30 years after he first made that observation, small-cap investing still hinges on the idea that it’s an area of the market where individual investors can find an edge.
On the hunt for growth shares
Part of Slater’s considerable legacy is his strategy for finding the most promising, reasonably priced growth shares in the market. He described it in detail in The Zulu Principle, which remains a bible for growth company investors everywhere.
Central to his strategy is a focus on investing in companies that are potentially poised to deliver impressive earnings growth but can still be bought at a reasonable price. These are typically small, profitable stocks with robust cash flows, low debt and share prices that are already rising.
Slater was keen to find firms with strong competitive advantages, offering new products or services that were steered by effective and enthusiastic management.
One of his most distinctive tools for picking these Zulu shares is something called the price-earnings growth factor, or PEG. He saw this as a crucial measure of whether a stock offered an attractive trade-off between price and growth.
The PEG is worked out by dividing forecast price-to-earnings ratio (PE) by the expected rate of earnings-per-share growth (G). As Slater saw it, stocks with a PEG of less than 1.0 had higher growth rates than their PE ratios and were thus ‘cheap for their growth’. For instance, a stock on a forecast PE of 20 but expected to grow at 25% would have a PEG of 0.8.
Screening for Zulu stocks
At Stockopedia, our modelling of the kind of rules used by Slater shows how reliable this kind of approach can be over time. Over the past three years the model portfolio (pre costs and refreshed quarterly) has achieved a return of 52 percent, and over five years that rises to 103 percent. You can view the Jim Slater Zulu Principle Screen here. One of the drawbacks - which tends to afflict other growth strategies - is that it can suffer during market downturns. When markets drift or sentiment wavers, the stocks it holds can be hit hard and it struggles to find buying candidates. For that reason, the strategy has underperformed the market over the past 12 months. On the upside, it responds swiftly when confidence picks up again, which makes it an interesting barometer of the general market.
In detail, the Zulu screen looks for stocks with a PEG below 0.75, a price-to-earnings ratio below 20x, a return on capital employed greater than 12% 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:
Name | Mkt Cap £m | P/E Ratio | PEG Slater | EPS Gwth % | Relative Price Strength 1y | Sector |
104.5 | 4.9 | 0.14 | 34.2 | +87.2 | Basic Materials | |
369.3 | 4.2 | 0.20 | 20.5 | +68.7 | Energy | |
410.7 | 12.3 | 0.37 | 33.7 | +20.9 | Financials | |
95.9 | 15.7 | 0.50 | 31.3 | +22.5 | Technology | |
158 | 10.7 | 0.55 | 19.4 | +0.78 | Consumer Cyclicals | |
288 | 16.0 | 0.63 | 25.3 | +6.54 | Financials | |
209.6 | 10.4 | 0.65 | 16.1 | +48.3 | Industrials | |
974.1 | 18.4 | 0.73 | 25.0 | +20.9 | Utilities |
In what are cautions market conditions, the strategy still manages to find a number of potential Zulu shares, led by resource stocks Sylvania Platinum, the small-cap mining firm, and Serica Energy. Elsewhere, firms like Liontrust Asset Management, Ten Entertainment, Mortgage Advice Bureau and Telecom Plus are regulars contenders on this screen.
Right now, many investors are likely to be sitting on their hands ahead of what could be a volatile end to the year as Brexit negotiations come to a head. But in the hunt for growth stocks at reasonable prices, the Zulu strategy can be a useful gauge of the market and be the first place to find potential new buys during upturns.
Part of the appeal of this strategy is its blend of growth and value to ensure a focus on buying the fastest moving stocks without overpaying for them. The strategy’s effectiveness, together with Slater’s enduring popularity are likely to keep it a favourite of many UK stock pickers.
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
12 comments
I’ve been asked to expand on my comment above that Jim Slater’s late-90s newsletter “Investing for Growth” (IfG) trialled screens in the REFS database to shortlist investment ideas. I’m posting this rather long response here so that refugees from the defunct REFS can see it and maybe find it helpful.
IfG was a brilliantly written testing bed for screening REFS - the precursor to today’s Stockopedia. Jim Slater stayed with it for about 2 years, then gracefully retired right at the top of the Dotcom bull market.
The REFs PEG was *not* the simple ratio implemented in Stockopedia: it applied only to companies with at least 4 years of growth numbers (preferably 2 forecast and 2 reported; otherwise 4 reported for companies without broker forecasts). Sadly, Stockopedia does not implement this rule directly so we must assess the track for ourselves. In PEG-based screening it is vital that we are first satisfied a company is in sustainable growth or the expectation of it, not merely in recovery from a setback. To quote Slater:
“The PEG factor is designed especially to measure growth stocks. It does not work well for recovery stocks and asset situations…A low PEG factor is, by itself, not a sufficient reason to buy a share. Although compromises are often necessary, the selected company should ideally have a competitive advantage, strong cash flow, insignificant debt and positive news-flow”. He goes on to reason that very high growth rates are not sustainable, earnings numbers must be comparable across different companies, and broker forecasts be treated like weather forecasts. All this neatly states the need to screen for several factors.
Neither REFS nor Stockopedia are restricted to PEGs or growth shares. Other indicators highlight asset situations, recovery shares, etc. In the present market you might be looking at value-based approaches following Dreman, O’Shaughnessy, or your own mix of criteria. A note I have from Jim Slater suggests a value screen: PSR < 0.6; +ive 1 month relative strength; low PER < 12 or even zero to negative; gearing < 75%; outlook statement shows that trading is not worsening; meaningful buying of shares by directors. I would also look at the trend of margins that will convert barren turnover into future profits.
It is often complained that Slater’s advice was weak on when to sell. This need is now served by the 2015 book “The Art of Execution” by Lee Freeman-Shore. It is also complained that his use of Relative Strength is a one-dimensional substitute for technical analysis, when there is more to it in the right hands. For those who find heavy going in Edwards & Magee’s technical analysis, try the 2007 book “Marber on Markets” by Brian Marber, a friend of Slater’s and that rare beast, a successful and wealthy UK technical analyst who can write a great book.
With that said, here is a listing of Jim Slater’s monthly screens from IfG. You can see his mind at work, adapting to new market conditions. Notice the January 99 PEG screen which improves on earlier variants, the “growth at any price” screen when the late bull market was going a little mad, and the “proxy for cash” when things looked (and were) dangerously toppy.
PEG with PSR (August 97). Combines PEG criteria with a stringent value measure
PER < 13.5; forecast GR > 15%; PEG < 0.8; Cashflow/EPS > 1.25; 1 month RlStr > 5%; PSR < 0.75
PEG (January 98). PEG screen with no PER cap.
PEG < 0.7; forecast GR > 20%; Cashflow/EPS > 1.3; 1 year RelStr > 0; 5-year margin trend >0; Gearing < 50%
Growing sales/share (February 98). Emphasis on fast-growing sales
Sales/share trend > 25%; 5-year margin trend > 10; forecast GR > 17.5; PEG < 1; Cashflow/EPS > 1.3
Return on Capital (March 98). The factor emphasised by Warren Buffett and Terry Smith
ROCE > 30%; 5-year historic GR > 30%; 1-year RelStr > 0; PEG < 1
Cashflow (April 98). Emphasis on cashflow.
Historic Cashflow Trend > 20%; Cashflow/EPS > 1.5; Net Cash in balance sheet; forecast GR > 25%; PEG < 1; 1-month RelStr > 0
PEG (May 98). Another variant on the PEG approach.
PEG < 0.75; forecast GR > 20%; Cashflow/EPS > 1; 1-year RelStr > 0; Margin trend > 0; Gearing < 50%
PEG & Relative Strength (June 98). Another variant on the PEG approach.
PEG < 0.75; forecast GR > 20%; 3-year historic GR > 20%; Cashflow/EPS > 0; 1-year, 3-month, 1-month RelStr all > 0
Return on Capital (July 98). Variation on the March screen.
ROCE > 30%; forecast GR > 20%; 5-year GR > 30%; 1-year RelStr > 0; PEG < 0.75; optimistic outlook statement; no reductions in broker forecasts in the last 3 months
PEG (August 98). Another variant on the PEG approach.
PEG < 0.7; forecast GR > 20%; Cashflow/EPS > 1.3; 1-year RelStr > 0; 5-year Margin Trend > 0; Gearing < 50%; ROCE > 20%
Our-of-Favour shares (December 98). After some market nervousness.
PER < 7; Yield > 7%; Div. Cover > 2; Cashflow/EPS > 0; forecast GR > 10%; has a PEG (i.e. satisfies the growth track criteria to have a PEG); Gearing < 70%
PEG (Jan 99). Final variant on the PEG approach - with a PER cap for more safety
PEG < 0.7; forecast GR > 20%; Cashflow/EPS > 1.3; 1 year RelStr > 0; 5-year margin trend >0; Gearing < 50%; PER < 16
Support Services sector (February 99).
Must be in Support Services; PEG < 0.75; PER < 20; forecast GR > 20%; ROCE > 30%; Cashflow/EPS > 0
Takeover Targets (March 99). A way to spot bid targets
PTBV < 1; PSR < 0.75; PCF < 10; Yield > 5%; Dividend Cover > 2; forecast GR > 0%; Market Cap > £20m; 1-month RelStr > 0
PEG without screens for Margin Trend or Gearing (May 99). To see what emerges.
PEG < 0.7; forecast GR > 20%; Cashflow/EPS > 1.3; 1-year RelStr > 0; PER < 17
Relative Strength (June 99). A variant on the June 98 approach.
1-year, 3-month, 1-month RelStr all > 0; PER < 17; forecast GR > 20%; Cashflow/EPS > 1.3; has a PEG (i.e. satisfies the growth track criteria to have a PEG)
Blue Chip Growth (August 99). Undemanding criteria for risk-averse investing.
Must be in FTSE 350; forecast GR > 10%; PER < 20; Cashflow/EPS > 1.2; 1-year RelStr > 0; Gearing < 75%
Growth - no PEG (September 99). For growth shares that do not qualify for a REFS PEG.
PER < 13; forecast GR > 20%; Cashflow/EPS > 1.3; Margin > 10%; 5-year Margin Trend > 0; ROCE > 15%; 5-year ROCE trend > 0; 1-year, 1-month RelStr both > 0
Growth at Any Price (December 99). Market going a bit mad, so join them?
Sales per share trend > 50%; 1-year, 3-month; 1-month RelStr all > 0; broker forecast increase in the last month; Net cash in the balance sheet
Proxy for Cash (August 2000). Jim Slater’s farewell note recommended ‘TT Group’ shares as a proxy for holding cash as he felt the market was toppy. He knew what he was doing: this was the great bull market top and the Dotcom crash was about to happen! TT shares featured:
Market Cap ~£200m; Div Yield ~7%; PER ~ 7; Div Cover > 1.5; PTBV 1.1; PCF ~ 5; PSR ~0.4; forecast GR +ive; outlook statement of trading in line; company buying in its shares.
Four of your selection fall foul of Slater's original view that EPS growth should not exceed 25% pa. Consistent EPS growth nearer 15% pa is arguably more attractive as the share price will be less vulnerable on the downside if there is any downward variation in EPS growth.
Some valuable comments here.
Yes, cashflow was/is fundamental to the Jim Slater approach. I have learned to regret when I ignore it. A particular problem arises with tech shares which vary so much in their approach to capitalising R&D spending, with distorting effects on reported metrics such as EPS, EBITDA.
Yes, when to sell was a very weak point in the Slater message. The brilliant "The Art of Execution" by Lee Freeman-Shor (published in 2015) fills that gap and I now regard it as the "when to sell" chapter missing from Jin Slater's books.
Yes also: Slater's attempt at a tip sheet ("Investing for Growth") was uneven in its major company tips. But the reason is interesting. Few of his main tips bore any relation to the Zulu books, the PEG, or even a disciplined screening approach. Readers asked him why, and he replied that they came instead from his widespread contacts! But the sheet also had a section trying out variations on screens, mostly PEG based but also searches for "growth at any price" or "proxies for cash", and so on. I've reproduced these in REFS online, and now my Stocko account, and they serve me well.
The official Zulu screen seems to have an unusual degree of churn? The oldest stock in the screen seems to be May 2019. Do followers of this screen try to reproduce the high level of trades that seem to occur?
Jim had a very interesting writing style and his books were always an enjoyable read. However his efforts to use his original PEG system in his own tip magazine (investing for Growth) had uneven results.
The official screens select and churn every quarter (and don't include dividends or spread or costs).
I believe the Zulu basis of selling was a PEG of 1.2 or a 25% loss. I can't recall seeing other guidance in the books.
BTW for anyone who took a copy of my screen attempt I've tweaked the EPS growth section to try to ensure that Current > Prior and Forecast > Current . Using Rolling for this only confused things (i.e. me). OCF/EPS is an optional toggle.
I cannot help thinking that there is one important and key metric missing from this screen and that is that the operating cash flow per share should be greater than the earnings per share. Jim Slater said in the Zulu Principle that operating cash flow (OCF) should be equal or preferably exceed the earnings. The point is that earnings can be manipulated through accounting practices whereas cash flow either physically exists or it doesn't.
Applying the rule that OCF Per Share is greater than EPs would eliminate Silvania Platinum and Liontrust Asset Management from the screen because their 2019 OCF PS is below their EPS. Even more noticeable is the fact that Anexo's OCF is actually negative for 2018 and TTM, and would also be eliminated on that basis.
All the metrics used above are obviously part of the criteria but I have always regarded the cash flow criteria to be primary along with the PEG and Relative Strength. I think the introduction of this metric would strengthen the screen and provide more validation and confidence in the PEG.
I've been re-reading The Zulu Principal and Beyond The Zulu Principal over the last few days and have been struck by just how good the Zulu tenets are. The system, in factor terms, has valuation (peg/ p/e<20) , quality (various accounting metrics), momentum (relative strength and growth) and the qualitative (chairman's statements and local anecdotes). EDIT: And of course size too!
'Beyond' stresses the need to compromise aspects and pass companies that meet most of the criteria. This is a general problem with screeners which require all hurdles to be passed. The solution is to either relax thresholds by a certain amount or if there is sufficient overlap, use a blended ranked criteria, as a fuzzier threshold to eliminate those that fail a large proportion of criteria. Piotroski >= 6 (or the quality rank) and the growth rank >60 are I feel useful in this respect. Visual inspection of the companies that pass these relaxed tests is then needed.
Slater also stresses liquidity (Spread <300?) as a requirement.
Once shortlisted from a screener, if you have the additional stricter criteria set up (e.g. debt, quick ratio etc ..) then you can toggle these back on and using 'use this screen as a checklist' see where those now eliminated actually fail and make a decision if they are actually ok.
Slater makes reference in both books to What Works on Wall Street. The latest edition of WWOWS (2012), finds 6 months, rather than 12 months relative strength to be generally (slightly) superior. I wonder if he would revise his criteria? I feel he would as he seemed evidence based.
Also in Beyond I felt that on a few occasions he was moving towards relative valuations rather than absolute thresholds.
With those thoughts in mind here is my take on a Zulu Screen https://www.stockopedia.com/screens/zulu-mod-687766/
At the time of writing a different set of companies qualify.
Yes to geographic breakdown of sales and profits especially in the everlasting Brexit.
As an investor who started many years ago with the Zulu Principle and Company REFS, I would add one more thing to JonL's wish list and that is a geographic breakdown of sales and profits. Most useful for getting geographic diversification.
Fantastic that Stockopedia has partnered to take up what is left of REFS!
Stockopedia has developed beyond REFS in lots of ways, but there are still some cherries you could lift from REFS. My wishlist would include:
- the brilliant compression of the REFS 1-pager, to print out and scribble notes over. Stockopedia is more spread out as befits a web page
- the log scale REFS chart which compares price with relative strength, the EPS track, and 2 years of forecasts at a glance
- the REFS newsflow box which, until MIFID struck, offered an edited selection of announcements (in original language so the tone was part of the message) and quickly led to further research
- ownership box of major holders and directors with recent buying / selling
- best of all, individual listing of each broker forecast by broker name and date, showing at a glance their variance and the track. Everything about a PEG depends on how you assess those forecasts, so let's see them!
- I should also mention the particular requirements behind a Slater PEG such as 4-year track, etc. - not just a ratio
agree with the strategy which I use and currently hold a couple which have done very well over the last 6 to 9 months
This https://www.stockopedia.com/content/the-peg-ratio-dismantled-or-how-to-buy-your-growth-stocks-on-the-cheap-62191/ discusses interesting variations on the PEG ratio.
I don't suppose there was a secret Stocko research project that ran any of these variants against the Slater screen? Or is that one to add to the potential back testing list?