Join our community of smart investors

My top gold picks

FEATURE: Jim Slater has produced a comprehensive checklist for investing in gold miners. He shares his demanding criteria with Investors Chronicle readers and reveals some of the most exciting prospects he's found so far
March 25, 2010

I have always believed that intelligent investment should be based on a method that can be refined and improved by experience. My view was reinforced by James O'Shaughnessy's excellent book, What Works on Wall Street, in which he demonstrated that over the 40 years to 2000 superior investment returns would have been produced by buying shares that measured up to just one sensible criterion. Obvious examples were that shares with low price-earnings (PE) ratios performed better than those with high ones; shares with low price-to-cash flows (PCF) performed better than those with high ones; and shares with positive relative strength in the previous year performed better than shares that did not keep up with the market.

James O'Shaughnessy found that combining criteria produced even better results. One of his best mixes was putting together a low price-to-sales ratio with positive relative strength in the previous year.

I have based my own method of growth share selection on combining several criteria:

■ A relatively low PE ratio in relation to a high earnings per share (EPS) growth rate. This produces a low price earnings growth factor (PEG);

■ Cash flow per share in excess of EPS;

■ Little or no debt;

■ Positive relative strength in the previous year;

■ No major sales of shares by directors. The odd sale is fine but beware of cluster selling.

There are other factors to take into consideration. Based on the principle that elephants don't gallop, I much prefer small-cap shares to market leaders. Also, small-cap shares tend to be comparatively under-researched and are more likely to be taken over. Over the past 50 years, small-cap shares in the UK have massively outperformed the leaders.

A tailwind provided by being in the right sector at the right time is also a great help. Good management is of course a key factor with growth shares, but is best determined by results. It is hard to evaluate management by meeting a few of the executives at an annual meeting, for example. They will be on their best behaviour and out to impress. My wife thinks I am too impressionable so she advises me to stick to the figures.

Success stories

It is hard to find many shares that measure up to my demanding criteria but it is well worth the hunt, because when you find a really good one it can perform magnificently. Last year Education Development (EDI) ticked all my boxes. The shares at the beginning of the year were 37p and are now 131p. Even after this very substantial rise, they are still relatively cheap, and on a very attractive multiple in relation to the growth rate with plenty of spare cash and very strong cash flow. Other UK growth shares in which I have a substantial interest and which measure up to my criteria are Andor Technology and Advanced Medical Solutions.

Early last year I began to feel that gold looked promising again. In spite of the sceptics, gold has performed well in each of the last 10 years. There are growing sovereign debt problems and doubts about most currencies, sterling being a particular case in point. Also, one is in good company with Paulson, Tudor Jones and Soros all heavily invested in gold. Persuaded too by my own gut feeling, I started to invest in bullion. However, I soon found that well-chosen gold mining stocks performed much better. As I began to invest in them, I realised that very different criteria would be necessary to develop a successful method.