How to find growth stocks in bullish markets

Investing in fast growing companies can produce stunning returns – and that’s exactly what we’ve seen in recent months. Growth strategies have been in a sweet spot since the EU referendum, but the popularity of many growth shares means that some now look pretty expensive. So if you were a buyer now, how could you tackle this challenge?

Part of the answer is in understanding how many growth investing strategies work. Take a look at those used by popular British investors like Robbie Burns and the late Jim Slater, and you’ll see some common themes.

Typically, they look at a number of ‘growth’ measures, particularly earnings growth, and mix them with positive price strength and a fair valuation. The key is that they want growth and momentum at a reasonable price – and it’s a strategy that has a big following.

On the flipside, there’s another set of growth strategies that also look for common growth features. But the difference is that they pay no attention to valuation. Instead they take much more interest in price action.

This is undeniably a much more trader-oriented approach, with more precise rules on when to buy and sell. But it can open the door to fast-paced growth stocks that might appear expensive, but show signs of momentum that will carry their prices higher.

A key feature of growth strategies with a focus on price action is they often use both fundamentals and chart signals. It’s a combination that doesn’t have to be complicated. In fact, one of the leading players in this field is Charles Kirkpatrick, whose growth strategy is actually quite straightforward – and it’s one that’s performing very well right now.

How to find growth stocks at any price…

Kirkpatrick is a legend among growth investors. Back in the 1960s he was inspired by academic research into the predictive power of relative price strength. And while no-one paid much attention at the time, Kirkpatrick went on to devise a handful of very successful strategies. He continues to track them through his newsletter, The Market Strategist.

One of those strategies is a growth checklist that uses relative rankings based on two main features. First is a focus on stocks in the top 10% of the market for relative price strength over the past 130 days. Second is a focus on stocks in the top 10% of the market for relative reported earnings growth (operating profit) over the past four quarters.

So this is a strategy looking for fast growing profit potential in companies that have already captured the interest of investors. For purists, Kirkpatrick prefers a minimum market cap of $1bn and also uses Point amp; Figure charts to guide his timing in and out of trades.

… and when to sell them

Because the growth strategy overlooks valuation, the sell rules are important. They include:

1. When the relative price strength rank falls to below 30% in the market.

2. When the relative reported earnings growth rank falls below 70%.

3. When the stock price falls below two previous notable lows.

Modelling Kirkpatrick’s growth strategy

Not all of Kirkpatrick’s rules can be easily modelled. But Stockopedia’s interpretation of his strategy does capture the spirit of it. It looks for stocks in the top 20% of the market based on the 130 day moving average. Plus it looks for stocks in the top 10% of the market for operating profit growth based on trailing twelve month data. The market cap limit is lowered to £200m.

Importantly, this screen can’t capture the sell rules, but it is possible to set Alerts for when a stock sees a fall in its 130d MA or its operating profit growth.

The Kirkpatrick Growth screen has seen a 24.6% gain in the past 6 months, and 15.5% annualised since we’ve been tracking it. It’s an approach that has done well when we’ve had periods of strong growth among smaller companies, notably from mid-2012 into 2014 and through the second half of 2016. Here’s a snapshot of some of the companies passing the rules now:

Kirkpatrick isn’t alone in running a growth strategy without valuation rules. A similar approach is used by William O’Neil in his CAN-SLIM strategy. The emphasis is really on keeping a very close eye on these sorts of stocks for a meaningful reversal in their growth and price trends. It certainly isn’t a buy-and-hold strategy, but it does ease the challenge of finding growth stocks that are expensive but may have further to go. A pure focus on the biggest movers in bullish conditions could offer some ideas.

Stockopedia