Our top-performing stock screen is up 37%

Not only can online readers now see how 33 different screens stack up against their benchmarks since inception – as well as over one, three, five and 10 years – but they can weigh different stock-picking methodologies side by side.

Judged on recent evidence, no one style stands out. ‘Quality’ works well in some cases, and not at all in others. A focus on higher-yielding stocks is ahead of the market in one screen and failing in another two. Size, value, and momentum strategies have collectively proven a mixed bag.

But within the pack, one method is proving its worth. Our Slater screen, derived from the investing principles of the iconic small-cap stockpicker Jim Slater, has racked up a headline average return of 15.2 per cent per annum in its decade of service. Not only is that far ahead of any other stock screen in our stable over 10 years. It’s up on most indices or actively managed equity funds, anywhere.

The Slater screen’s track record has been especially satisfying because it is forced to draw its selections from the lower reaches of the stock market, where volatility and sentiment shifts can be particularly swingeing. For example, as pandemic fears swept across markets in the six weeks to 18 March 2020, the screen suffered more than most of those we follow, falling 47 per cent.

By contrast, our High-Quality Large Caps screen – which has posted a slightly higher all-time annualised rate of return in its 12 years of service – witnessed a Covid-19 drawdown of 31 per cent. In times of acute market stress, the largest stocks can be a good place to hide, relatively speaking.

However, the Slater screen’s extra risks have been worth it. We know this from the screen’s Sharpe ratio, also known as the reward-to-variability ratio, which quantifies how much volatility an investor must stomach for every unit of reward they gain, defined as the return generated above the risk-free rate. Even if we factor in a generous 1.5 per cent average gilt yield for the past decade, alongside the screen’s high volatility, we arrive at a Sharpe ratio that is more than double that of its benchmark.

These credentials are mirrored in another bit of geeky portfolio analysis. The screen’s Treynor ratio (also known as the reward-to-volatility ratio), which measures excess returns per unit of the portfolio’s volatility risk relative to the broader market, is higher than that of the market itself. Put simply, it’s been a good investment strategy.

Last year’s screen was a particularly fine vintage. Though it only found five stocks, the Slater screen managed to select three from the top tenth of the entire market, by performance, including one – vending machine operator Me Group (MEGP) – which was in the top 1 per cent.

2022 Performance

Such a hit rate suggests to me that the screen’s combination of tests has real power, when applied under the right conditions. It also demonstrates the ability of a differentiated portfolio to add serious alpha. As the fund manager John Templeton remarked: “if you buy the same securities as other people, you will have the same results as other people.” The Slater screen has been successful at finding shares with excess returns, despite its focus on shares to which most investors have limited or no exposure.

One of the reasons for this success, I believe, is the type of stock it focuses on. By screening out all companies with a market capitalisation above £500mn, it is much less focused on the FTSE 350 than it is the FTSE Small Cap index, a slice of the market that has comfortably outperformed both the Aim All-Share and the FTSE All-Share over the past decade. Despite this, Slater stocks have beaten the benchmark in eight out of its 10 outings. When it hits, the screen certainly hits.

To some long-time readers, the methodology will be better known as the Slater PEG screen, named after its focus on shares with a low price-to-earnings growth (PEG) ratio. This metric, which Jim Slater helped to popularise in the UK, is a simple but effective way of weighing up a company’s share price against the growth on offer and is calculated by dividing a share’s price/earnings (PE) by its earnings per share (EPS) growth rate.

Another attribute Slater liked was evidence of insider share purchases. While director buying isn’t mandated by the screen’s methodology, I have run a shadow test on each of the selected companies to ensure insider holdings have remained neutral or increased on a net basis over the past three months, based on FactSet data. All eight stocks pass.    

The full screening criteria are:

■ A PEG ratio of 1 or less.

■ Market cap of less than £500mn but more than £5mn.

■ Net-debt-to-cash-profits ratio of less than 1.5.

■ Cash conversion of 90 per cent or more (based on operating cash to operating profit rather than the operating cash to Ebitda metric used in the table below).

■ 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).

■ (Shadow test): neutral or positive net insider share purchases over the past three months.

Slater was a big believer in an individual’s capacity for mastery over a subject matter about which most people know nothing – such as a relatively unknown small-cap stock. By automating Slater’s principles into a stock screen, we are bypassing this due diligence exercise entirely.

However, the screen’s track record suggests this is well compensated for by its strengths.

Since we started to follow the screen in 2013, it has produced a cumulative total return of 311 per cent, compared with 65 per cent from a fifty-fifty split of the FTSE Small Cap and Aim All-Share indices. While the screens in this column are meant as sources of ideas rather than off-the-shelf portfolios, the total return drops to 222 per cent if a 2.5 per cent annual charge to reflect notional dealing costs is factored in. The reason for such a high frictional cost is because small-caps can be very expensive to deal in due to their wide bid-offer spreads.

This year, the screen has identified eight companies from the main and junior markets that tick every criteria, and which are detailed in the table and downloadable spreadsheet below.