This Small-Cap Growth Screen is Beating the Market Big-Time
When most people think of aggressive growth strategies, one of the first things that come to mind is small-cap stocks. Indeed, when I'm searching for aggressive growth stocks, I'll usually get plenty of small-cap stocks coming through regardless of whether I'm specifically looking for them or not.
One of the reasons why small-cap stocks are so closely associated with aggressive growth is because they are typically newer companies in the early part of their growth cycle. And historically, that's when a company grows the fastest.
Of course, not all aggressive growth stocks are small-caps. There are plenty of mid-caps and large-caps that fall into this category too. Especially if a company that has been in existence for a while comes up with a new product or service and is lighting sales on fire. You may see some spectacular growth rates from these as well.
But, for this screen I set out to create an aggressive growth strategy that only focuses on small-caps. And the results were amazing.
Parameters
• Market-Cap less than or equal to $1 Billion
This is the stock price multiplied by the number of shares outstanding. The definition of what a small-cap stock or large-cap stock is seems to change every so often as the market changes. For now however, the generally agreed upon definition is as follows:
Small-Cap less than or equal to $1 Billion
Mid-Cap greater than $1 Billion and less than or equal to $5 Billion
Large-Cap greater than $5 Billion
• Zacks Rank equal to 1
This screen only selects Zacks Rank #1 Strong Buys. Since Zacks Rank 1s have the best performance and a relatively larger selection of small-cap stocks in that group, there was no need to go beyond it for this one.
• Price greater than or equal to $1
Even though plenty of small-cap stocks trade at lower prices, we drew the line at penny stocks. Nothing wrong with those, but many penny stocks trade for mere pennies for a reason. Plus, I've found the bid/ask spread on many to be relatively wide (percentage-wise), making them difficult to trade. So they need to be trading at a minimum of $1 to get through.
• Average Dollar Trading Volume greater than or equal to $500,000
This is a different way to look at trading volume. Instead of looking at just the number of shares traded, this is looking at the number of dollars traded, i.e., the amount of money changing hands each day. For example: if a stock was trading at $1, but had an average trading volume of 500,000 shares, its dollar volume would be $500,000 and it would mean that $500,000 worth of shares trade in and out of the stock each day. And that's the bare minimum for this screen.
• Estimated One Year EPS Growth greater than or equal to 1.20 * the X (Expanded) Industry Median, but less than or equal to 50%
For this one, we want the stocks to be projecting growth rates at least 20% higher than the median for their respective Industry. But we are excluding stocks with actual growth rates greater than 50%. Why? This is a growth screen isn't it? Yes it is. But we also want to keep the odds of success in our favor. And growth rates that are 'too high' often don't pan out. In my testing I have found that once the growth rate exceeds 50%, returns start to drop. On the occasions where they may tick-up a bit, I normally see an accompanying increase in risk. Below this cut-off is the sweet spot and why it's in the screen.
• P/E using F(1) Estimates less than or equal to X Industry Median
We're determining value here by comparing the stock's valuation to that of its Industry. One thing to keep in mind is that often times, small-cap stocks or stocks with aggressive growth will trade at higher valuations than non-aggressive growth stocks. Why? Because many traders are willing to pay a little more for these higher-growth companies now, believing that they will likely be trading at even higher valuations later, if they wait. So, while these stocks might be trading at levels higher than a classic value stock, this item still finds those that are trading at values lower than the median for their peers.
• Price/Sales Ratio less than or equal to X Industry Median
Just like the P/E ratio, the P/S industry comparison helps us find the stocks that are still reasonably priced (value-wise) and sometimes downright 'cheap' vs. their peers.
• Price/Sales Ratio equal to Bottom # 7
We used the P/S ratio one more time in this screen to narrow the list of stocks down to just the 7 'best', i.e., the 7 best growth stocks with the lowest P/S ratio. (Note, sometimes there are periods when less than 7 stocks qualify. That's OK. But, this screen will never produce more than 7.)
Results
Over the last 16 years (2000 thru 2015), the Small-Cap Growth strategy, using a one-week holding period, showed an average annual return of 64.0%.
And so far in 2016 (thru 5/27/16), it's up 14.3% vs. the market's 3.7%.
Take note, the backtest results above do not include commission costs or fees. A user, of course, will incur transactions costs, so his results will be lower. I point this out so a trader can adopt realistic expectations when deciding if a strategy is right for him.
But, looking at the trajectory of the returns, it's clear that this strategy works and has a high probability of picking winning stocks.
Stocks
There are 7 new stocks coming thru this screen this week. Here are 5 of them:
WNC Wabash National
LXFR Luxfer Holdings
RRMS Rose Rock Midstream
NEFF Neff Corp.
WTW Weight Watchers
Get the rest of the stocks on this list and start looking for the newest companies that fit these criteria. It's easy to do. And it could help you find your next big winner. Start screening for these companies today with a free trial to the Research Wizard. You can do it.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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WEIGHT WATCHERS (WTW): Free Stock Analysis Report
WABASH NATIONAL (WNC): Free Stock Analysis Report
ROSE ROCK MIDST (RRMS): Free Stock Analysis Report
NEFF CORP-A (NEFF): Free Stock Analysis Report
LUXFER HOLDINGS (LXFR): Free Stock Analysis Report
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