Five cheap growth shares

The 25 stock portfolio selected by the screen produced a total return of 6.5 per cent over one year compared with a 1.5 per cent loss from the FTSE All-Share, and over two years the portfolio has delivered 33.1 per cent, which is getting close to three times the 11.8 per cent return from the index (see table). What's more, while there have been some noteworthy disasters such as Chemring's two-year negative total return of 51 per cent, overall most stocks have proved good bets, with 68 per cent of them outperforming the index over one year, and 72 per cent outperforming over two years.

The screen results also suggest that value matters. Our genuine growth criteria included a test for a PEG ratio (PE/long-term EPS growth forecasts) of less than one, which is often regarded as an indication of cheapness. Stocks were not required to pass all the screen's criteria, but the 10 stocks that passed the PEG test have delivered a stunning total return over two years of 46.4 per cent. While history can never be relied on to repeat itself, this facet of the performance has encouraged us to focus on the five low-PEG stocks selected by the re-run screen in the write-ups below.

The screen itself starts by selecting all stocks from the full list that have an average growth rate of 15 per cent or more based on performance over the last three years and consensus broker forecasts for the coming year. While such growth is well above average, it was perhaps more of a challenge to achieve when the screen was last run in 2010, as the three-year growth record included the period when the credit crunch devastated corporate profits. We've therefore included an extra test for consistency of EPS growth by insisting that stocks display growth in at least three of the four periods being looked at. In addition, stocks have to pass at least three of the following four criteria:

■ Forecast EPS growth of at least half the average growth rate and positive EPS growth in each of the last three years;

■ EPS forecasts higher today than they were three months ago;

■ PEG ratio of less than one; and

■ Market capitalisation over £500m.

FIVE CHEAP GROWTH SHARES

SOCO International

The first half of 2012 saw a major ramp up in production at oil production and exploration company SOCO's key Vietnamese site, which was reflected in a surge in earnings and cash flow. Exploration potential is limited for the rest of the year, though, and the main challenge for SOCO now is to demonstrate that it can maintain output rather than increase it. While these are limiting factors for the shares, the enhanced performance in Vietnam has produced speculation that the company could now be ripe for a takeover, with broker Numis putting a 534p potential bid price on the shares. Alternatively, the Vietnamese field could be divested, and with net cash of $178m a return of capital is a possibility, too.

Source: S&P Capital IQ

Last IC view: Hold, 353p, 22 Aug 2012

Berkeley

Berkeley's shares are not cheap compared with the housebuilder's peers. In fact, it trades at the biggest premium to net asset value (838p a share) in the sector. But there are a number of reasons for its high rating. Its developments are focused on high-end parts of the London market, which continue to experience strong demand from buyers. The group also has a very attractive land bank that underpins long-term prospects. And, in addition to all this, management has promised to return £13 cash per share by 2021.

Last IC view: Buy, 1,424p, 29 Jun 2012

Rightmove

Property advertising website Rightmove is one of the only two stocks that our screen awarded full marks to - Telecity is the other. Its astonishing growth record, which also earned it a place in our genuine growth screen two years ago, is based on its dominance of the internet property search market and the ongoing movement of estates agents' marketing spend online. The company charges estate agencies a fee per office, so the slow property market is only a concern if it is sufficient to force closures. The company is also incredibly cash generative given its relatively low capital requirements.

Last IC view: Hold, 1,588p, 1 Aug 2012

Diploma

Specialist distribution company Diploma has achieved growth despite tough economic conditions. Its focus on niche markets such as life sciences and seals makes it less cyclical than many of its peers. The company has also benefited from its geographic diversity and a taste for bolt-on acquisitions funded from its own cash flows. Broker Numis is forecasting that underlying organic growth will slow by 5 per cent for 2013, reflecting the fragile state of the economies of the US and Europe, but acquisitions are likely to drive stronger overall growth.

Last IC view: Buy, 447p, 14 May 2012

Telecity

Telecity has been able to achieve incredible growth from building and operating data centres as businesses and individuals look to store and access ever more media and data remotely. But all good things must come to an end and ultimately data storage is a commodity product. Doubts have recently begun to surface among analysts about the rate at which Telecity will be able to build data centres in the future while keeping pricing high and its servers busy. This has led to some recent share price weakness. Nevertheless, long-term EPS growth forecasts still justify the high PE rating as measured by the PEG ratio.

Last IC view: Hold, 850p, 6 Aug 2012

And five not-so cheap growth shares...