This year, my Jim-Slater-inspired stock screen struggled to find shares that met all its criteria. But, as they say, necessity is the mother of invention, and hopefully the changes I've made to the Slater screen will make the strategy more effective, as well as producing a larger number of positive results.
At the heart of Mr Slater's investment approach, as set out in his classic book The Zulu Principle, is the price-earnings-growth (PEG) ratio. This valuation measure attempts to balance out the price investors have to pay for a company's earnings and the company's earnings growth rate. Essentially, Mr Slater targets smaller companies with low PEG ratios (0.75 or less in the case of this screen) that also boast a number of other attractive qualities.
Unfortunately, rising valuations during the bull market of the past few years have made compelling PEG stocks hard to come by. The struggle to find value was also evident a year ago when only four stocks qualified from my Slater screen. The combination of a very concentrated selection of stocks, coupled with market volatility, made for a particularly rocky ride for the screen last year. The four shares ultimately delivered a total return of just 0.4 per cent, compared with 3.1 per cent from a 50:50 combination of the FTSE Small Cap and FTSE Aim All-Share.
| Name | TIDM | Total return (16 Jul 2014 to 7 Jul 2015) |
|---|---|---|
| M Winkworth | WINK | 18.1% |
| Grafenia | GRA | 10.9% |
| MP Evans | MPE | -7.6% |
| Gem Diamonds | GEMD | -19.7% |
| Average | - | 0.4% |
| FTSE Small Cap | - | 7.8% |
| FTSE Aim All Share | - | -1.7% |
| FTSE Small Cap/Aim | - | 3.1% |
Source: Thomson Datastream
The dud performance in 2014 follows a credible performance from the screen in 2013, the first year I ran it, when it delivered a 19.4 per cent return compared with 13.9 per cent from the indices. On a cumulative basis, the total return from the screen stands at 19.9 per cent over two years, compared with 17.5 per cent from the indices. However, if I add in a fulsome 2 per cent charge to account for dealing costs and high small-cap spreads, the cumulative total return drops to 15.2 per cent, less than the return from the indices over the period.
Slater PEG screen v Index
One of the changes I have made to the screen this year is also a nod to Mr Slater's advice that investors should look for companies that have recently produced optimistic chairperson's statements. The proxy I've used to reflect this sense of optimism is to screen for earnings upgrades of at least 10 per cent in the past year.
Due to the paucity of results from this year's screen, I have allowed stocks to fail one of the screen's tests as long as it is not the PEG test or the market cap test.
The full list of criteria is as follows:
■ A PEG ratio (PE divided by average forecast earnings growth for the next two financial years) of less than 0.75 ■ Market cap of less than £500m but more than £10m ■ Net-debt-to-cash-profits ratio of less than 1.5 ■ Cash conversion of 90 per cent or more ■ Return on equity of more than 12.5 per cent or an operating margin of 15 per cent or over ■ Three-month momentum higher than the median average, or forecast EPS upgrades of 10 per cent or more over the past year ■ Forecast earnings growth in each of the next two financial years and average forecast growth of more than 10 per cent but less than 50 per cent (anything above 50 per cent is considered an unsustainable growth rate for the purposes of this screen) |
The two stocks that passed all of the screen's tests (Shanta Gold and Cambria) are written up below, along with the three stocks with the lowest PEG ratios that passed all but one of the tests. A further 10 stocks that passed all but one of the tests are listed in the table that follows.
