Eleven cheap growth shares with momentum

However, investment strategies such as those set out in Mr O'Shaughnessy's 1996 book 'What Works On Wall Street' are long-term propositions and not get-rich-quick schemes. He found his growth screen, which combines the concepts of earnings growth, value and share price momentum, produced terrific long-term results. Between 1954 and 1996 he found the growth strategy returned an average of 18.5 per cent a year. So perhaps his growth screen will soon enjoy its time in the sun?

While it is possible to see sound investment logic in why Mr O'Shaughnessy's screen might identify outperforming shares, his approach to screening is based purely on his observations about what works and what doesn't according to the statistics. The approach is based on rigorously testing different data items (valuation ratios, growth rates etc) to see which have the best share price predicting powers. He then devised screens (we'll run his value screen next week) based on his findings.

Our version of his growth screen is based on testing shares in companies with market values of over £75m for the following factors.

Value

The price-to-sales (PSR) ratio was found by Mr O'Shaughnessy to be the best indicator of value and the growth screen demands that shares have a PSR under 1.5. The popular explanation for why PSR is important, as advanced by the likes of contrarian investor Ken Fisher, is that profitability can often drop away at certain points of a company's life, at which time the market will drop the stock without seeing the potential for margins to rebound later. But it's worth remembering that PSR also tends to be justifiably low for companies where profits are unreliable or margins are permanently low.

Growth

Mr O'Shaughnessy looked for five years back-to-back earnings per share (EPS) growth. However, following the market's recent run, we've had trouble finding many stocks that meet this criteria and the PSR criteria. Our screen therefore looks for only three years of EPS growth.

Momentum

The ability of share price momentum to predict further strong performance also impressed Mr O'Shaughnessy. His original screen suggests looking at one-year momentum, however other academic studies suggest looking at three-month momentum may be a superior guide. Mr O'Shaughnessy has acknowledged the potential for using momentum measured over shorter periods. We're therefore looking at three-month price movements.

ELEVEN CHEAP GROWTH SHARES WITH MOMENTUM

The 11 stocks we've highlighted below have all outperformed the 8.1 per cent rise achieved by the FTSE All-Share over the past three months, although our table shows the stocks that passed the value and growth test but have not kept pace with the All-Share over the past three months. Mr O'Shaughnessy's suggestion was to build a portfolio based on the 50 stocks showing the most momentum. As our results only reach 34 stocks in total - despite the softening of the growth criteria - we don't have that luxury!

EasyJet

Shares in easyJet have been soaring on the back of ongoing earnings forecast upgrades. The most recent good news was of robust January traffic and guidance of first-half revenue per seat growth in the range of 6-8 per cent. The company has been benefiting from a reduction in capacity on its routes by rivals (broker Numis estimates rivals withdrew 3 per cent of the market capacity over winter), which is allowing easyJet to expand to fill the gap. The group is also attempting to increase profits by attracting more business travellers and it has recently reduced its targeted dividend cover to five times, which has given shareholders an income boost. Nevertheless, there is a good reason for the market to put a low value on airlines' sales as profitability tends to be very hard to predict. With fuel prices high, the economy fragile and significant negotiation over slots at Gatwick and Geneva coming up, there are reasons for uncertainty following the recent strong share-price run (last IC view: Sell, 744p, 20 Dec 2012).

Source: S&P CapitalIQ

Cranswick

The habit of pig prices to fluctuate makes it hard for pork product specialist Cranswick to control margins and helps explain why the price-to-sales ratio is low. However, given the variable input costs it has to deal with, the company tends to do a very good job of delivering strong returns for shareholders. A spike in pig prices, which saw a new three-year high hit in December, has now largely been mitigated by price increases and efficiency savings. The company traded strongly in its recent third quarter, increasing like-for-like sales by 7 per cent. It also has a strong balance sheet and a reputation for keeping investment in its assets at a healthy level. The group has also been putting more emphasis on export markets - especially for the so-called 'fifth quarter' of pigs, such as trotters and ears - and has recently gained permission to export directly to China, which should boost profitability (last IC view: Buy, 810p, 26 Nov 2012).

Porvair

Specialist filters company Porvair has been trading well for a couple of years. While some of its end markets are cyclical, its products address environmental and safety issues, which provides it with a long-term structural growth opportunity. The company has also been investing successfully in its business over recent years, which has resulted in some noteworthy contract wins as well as the development and sale of higher-margin products. Cash generation is strong and debt has been falling even though the group has made acquisitions to strengthen its operations. Porvair has been in recovery mode over the past couple of years and profit growth is now expected to moderate, but, with a healthy order book and strong trading momentum, prospects continue to look good (last IC view: Buy, 177p, 28 Jan 2013).

Computacenter

While our table cites forecasts of falling EPS at IT services group Computacenter, this masks an expected decline in the yet-to-be-reported 2012 financial year followed by a rebound in 2013 - broker Panmure Gordon has pencilled in EPS of 35.5p in 2012 (down from 37.3p in 2011), followed by a rise to 40.2p in 2013. The company has been making optimistic noises about the coming year based on a strong pipeline of potential services work and the potential to eke margin improvements from problem contracts in Germany. The encouraging words have helped calm the market's fears about the possibility of a margin squeeze in 2013. In fact, the current year could bring a treat from Computacenter in the form of a special dividend. The company's net cash stood at £131m at the end of 2012 and Panmure predicts a 50p payout could be on the cards, which along with forecasts of a regular dividend would be equivalent to a 15 per cent yield (last IC view: Buy, 376p, 31 Aug 2012).

Carr's Milling

This year, Carr's has a bumper performance from 2012 to beat. The company has been benefiting from strong demand for its animal feed, which is expected to continue, as well as strong orders from the nuclear industry for its engineering division. Investment in both these businesses should help underpin prospects. Overseas expansion is also putting wind in the group's sails - nearly half of profit comes from outside the UK. Trading has been much tougher for Carr's flour-milling division, though. The industry is suffering from overcapacity which is weighing on profitability. However, Carr's is currently building a state-of-the-art flour mill, which it believes will drive margins higher (last IC view: Buy, 934p, 9 Nov 2012.

Inchcape

While profits have been moving in the right direction for some time at international car dealer Inchcape, trading conditions remain fragile, which provides some cause for short-term uncertainty, but also longer-term recovery potential. There are also long-term opportunities arising from the group's strong position in emerging markets, where the prevalence of car ownership is expected to increase for some time to come. Recent share price strength suggests the recovery story may be gaining traction with the market. Decent earnings growth is also forecast this year. The recent weakness of the yen should help sales of Japanese cars through its dealerships. What's more, cash is starting to burn a hole in management's pockets. Broker Panmure Gordon forecasts that net cash stood at £191m at the end of last year and, if left to accumulate, will rise to £213m by the end of 2013. This increases the likelihood of merger and acquisition activity or potentially a return of capital (last IC view: Buy, 376p, 31 Jul 2012).

Prezzo

The UK summer of sport and rain in 2012 had a mixed impact across the leisure sector, but for Italian-style restaurant chain Prezzo the effect was negative. This should make trading comparisons favourable in the year ahead. The group, which has 210 restaurants, has a self-financing expansion strategy, with broker Canaccord Genuity predicting annual opening of about 25 units a year for the foreseeable future. Its fledgling Chimichanga chain, which consists of 29 restaurants, gives it added growth potential. The company has been at the forefront of promotional meal-deal offers since the credit crunch hit and margins have been slipping. If the group can use stronger trading conditions in 2013 to help rein in the discounting it could provide a positive surprise (last IC view: na).

Hilton Food

With 35 per cent of its business linked to Tesco, strong Christmas trading from the embattled supermarket chain (see below) was something of a boon for meat packager Hilton. Still, it is never good for a company to have its fortunes so bound to a single customer. So it is good news that Hilton has recently won a large contract with Australia's biggest retailer, Woolworth, which will be structured through a joint venture company. The win also marks a decisive move outside Hilton's European heartland. Hilton's contracts are often arranged so that it does not take on any of the risk of fluctuations in the meat price, which makes its margins more stable. That said, high meat prices and the sluggish European economy do have the potential to effect volumes, although there has been little sign of strain as of yet (last IC view: Buy, 310p, 24 Jan 2013).

Wynnstay

Agricultural supplier and specialist retailer Wynnstay also appeared in our John Neff stock screen two weeks ago. The company is benefiting from a strategy of acting as a consolidator in its industry and at the same time diversifying its end markets and expanding geographically to mitigate against fluctuations in agricultural markets. It also has a retail division that broker Investec expects to put in a good performance this year and offset any weakness in its agricultural operations (last IC view: Hold, 460p, 24 Jan 2013).

Cineworld

Cinema group Cineworld finished last year strongly thanks to a bumper crop of blockbusters, including Skyfall and The Hobbit. The new year has started well, too, and some noteworthy releases are on the slate for 2013, including Les Miserables and The Hobbit 2. The year should also benefit from the fact that there are no major sporting or royal events to distract people from their cinema going. Significantly, some major investments have been made which should benefit the current year. Conversion of cinemas to digital projectors will cut costs and make programming more flexible. Online innovations, such as eliminating booking fees, should help sales through this channel and investment in customer relationship management could also help drive sales. Analysts believe efforts to improve the company's retail offering also have significant potential and last year's acquisition of Picturehouse has seen the group move into the more affluent art-house cinema niche where there should be opportunities (Last IC view: Buy, 248p, 6 Dec 2012).

Tesco

Tesco is a good example of the type of contrarian situation low price-to-sales ratios often unearth. Its trading malaise is well known, but the group is now one year into a recovery programme and recently announced its exit from the US to concentrate on more profitable parts of the business. Some analysts are hoping to see a major reduction in capital expenditure, an increased focus on boosting returns on capital employed and cash generation, along with a firmer focus on online sales. There's certainly scope for profitability to improve and the recent share price strength - helped by strong Christmas trading, which was the best of the big four supermarket chains - could be a sign that sentiment has started to turn (last IC view: Hold, 338p, 5 Dec 2012).