Five fast-growing small-cap stocks

This meant that for the first time in the four years we have been running our Small Cap Zweig screen, it failed to beat a hybrid benchmark of the FTSE Small Cap and Aim All-Share indices. In fact, the 17 shares which made last September's cohort failed by a country mile, posting a negative return of 16 per cent against an average gain of 9 per cent for the indices.

2015 PERFORMANCE

Source: Thomson Datastream

Mr Zweig was primarily concerned with paying reasonable prices for fast-growing companies, but he also placed a lot of emphasis on taking a broad view of the economy and markets to determine when to invest. We live in peculiar (some would say dangerous) times for monetary policy and equity valuations, so it's hard to know whether Mr Zweig would view current market conditions as suitable for investment. But given the period covered by the screen included a drop in UK interest rates, now should in theory be a good time to construct a Zweig screen. This appears to be borne out in the appreciation of the key UK indices, as well as our aggregated 2015 picks, since the Bank of England lowered interest rates towards the end of the screen's life, on 4 August.

But against an index, a stock screen provides limited shelter against individual corporate collapses. So it proved with the 2015 small caps, which included mobile enterprise software group Globo (GBO), whose high-growth figures made it past the Zweig screen despite the fact they are likely to have been faked. Indeed, we flagged both a recent high-yield bond offering and the high level of receivables on Globo's balance sheet when the company was selected last September. Weeks later, the Aim firm admitted to cooking the books and entered administration.

A total wipe out on one investment is bad enough, but the general performance was also fairly weak. Just five of the 17 stocks posted a gain on a total return basis, pushing the screen sharply into reverse on a cumulative basis. While this is still ahead of the benchmark, factoring in a 2 per cent annual charge to cover the sometimes wide bid-offer spreads that come with smaller stocks means a more realistic cumulative performance was a less impressive 64 per cent over four years.

Zweig vs Small-cap benchmarks (%)

Annual and cumulative performance

Source: Thomson Datastream

In fact, as the table below indicates, a buy and hold strategy would usually have been a more effective approach.

Buy and hold strategy

Source: Thomson Datastream

Zweig's tests are focused on three areas: growth, solvency and valuation, the latter of which is defined as a PE ratio above the lowest 30 per cent of all shares screened and below the highest 20 per cent. The remainder of the criteria, which are detailed in full below, are focused on a strong track record of earnings growth, although, where forecasts have been available we have factored in brokers' predictions for the future.

The investment criteria in full:

■ A five-year EPS compound annual growth rate (CAGR) of 15 per cent or more;

■ A five-year revenue CAGR of at least half the five-year EPS CAGR;

■ EPS growth in last year of 15 per cent or more;

■ EPS growth in last half year of 15 per cent or more;

■ EPS growth in each of the last three years and at least four of the last five years;

■ EPS growth in each of the last two half-year periods;

■ Net debt to cash profits of 2.5 times or less;

■ A PE ratio above the lowest 10 per cent of all stocks and below the highest 20 per cent.

While 16 Aim and FTSE Small Cap stocks passed at least nine of the tests, five Aim companies matched all of Zweig's screening criteria. The table below also provides a series of classic valuation measures for the companies, including price-to-book value and what this screen's creator Algy Hall has termed genuine value (GV), which is a stock's enterprise-value-to-operating-profit ratio divided by two year average forecast earnings growth and dividend yield.

FIVE FAST GROWING SMALL CAPS

Lowest price-to-book value: Inland Homes

Like many of its peers, shares in specialist housebuilder Inland Homes (INL) took a battering in the wake of the EU referendum. Despite this, chief executive Stephen Wicks said his company had seen "the same level of appetite from potential purchasers" for the company's affordable housing, and that trading was well "supported by strong fundamentals such as the current low interest rates and the Help to Buy scheme".

So while the shares' 32 per cent discount to Stifel's spot EPRA net asset value estimate of 93p looks unwarranted given Inland's market position in the housing market, further earnings growth also looks promising. That's because the company has substantial value in its land bank of 5,672 plots of which 1,146 have planning consent, 1,000 are awaiting planning decisions, and almost 2,000 are in the pre-application stage with planners. On this basis, analysts think the company is capable of generating annual land sales of between 300 to 500 plots, and revenue of £30m on a margin of 50 per cent.

Last IC view: Buy, 67p, 15 June 2016

Best 3-month momentum: Iomart