Profit from volatility with these 10 cheap growth shares

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Profit from volatility with these 10 cheap growth shares

The volatility in equity markets this week has had a mixed reaction. After a long period of calm, upward price trends, a pull-back naturally struck fear into some investors. Faced with vapourised profits and uncertainty about the future, those concerns are understandable.

But for other investors, this modest correction was quite welcome. For several months we've talked in this column about areas of stretched valuations, frothy prices and the risks they pose. A decline of less than 10% - which is roughly what we've seen so far - perhaps won't be enough for bargain hunters. But for investors that want to pay a more reasonable price for popular growth shares, a correction like this can offer momentary opportunities.

Who would want lower stockmarket prices?

While the financial headlines this week have been dominated by gut-wrenching warnings of a market collapse, the reality, so far at least, is a bit different. On average, the main indices are off by around 8%. That's roughly the same fall that we saw just after the EU referendum in June 2016. If you were a buyer in that panic, you'd have caught the start of a two-year bull run.

The subject of lower prices was picked up by Warren Buffett in his 1997 letter to Berkshire Hathaway shareholders. In it, he asked:

"If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?"

Whether you're a buyer of hamburgers or cars, the answer is that you'd prefer prices to be lower. Yet Buffett insisted that stockmarket investors don't always see things the same way. He said:

"If you expect to be a net saver during the next five years, should you hope for a higher or lower stockmarket during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense."

Buffett's point was that if you are a buyer of shares over the medium term, you should be happy to see prices lower.

How volatility can help GARP investors

Buying growth shares at reasonable prices is the territory of investors like the top performing UK fund manager, Mark Slater of Slater Investments. It involves buying good quality shares with strong earnings growth and strong momentum, but not overpaying for them. There are several ratios that can be used to screen for this kind of share, but a typical growth at a reasonable price (GARP) screen would look for:

● Double digit compound earnings-per-share growth rate over three and five years

● Below average price/earnings (PE) Ratio (and it must be below 20x)

● Double digit Return on Capital Employed that is growing year-on-year

● Net margins are growing year-on-year

● Positive relative price strength against the market over the past year

Here's a list of 10 stocks that are currently passing those rules:

Name Mkt Cap £m EPS 3 Year Compound Growth % PE Ratio Return on Capital % 1 Year Relative Price Strength
Games Workshop 706.8 32 14.1 82.4 155.1
CMC Markets 437.9 16.4 8.3 28.6 32.2
Berkeley 5,212 33.7 7 30.7 31.9
Redrow 2,195 35.2 8.5 21 27.9
International Consolidated Airlines 12,653 60.4 7.4 15.9 26.5
Persimmon 7,522 32.9 10.8 28.1 22.1
MJ Gleeson 369 45.2 13.9 19.1 17.9
Numis 353.3 14.8 12.6 28.5 15.7
Barratt Developments 5,701 26.4 9.2 16.2 10.8
Abbey 283.1 41.4 5.9 19.8 3.22

It's immediately obvious that housebuilders are a strong presence in the list. Groups like Berkeley (BKG), Redrow (RDW), Persimmon (PSN) and Barratt Developments (BDEV) have been a near-constant presence on growth screens over the past two years, but they've all seen their share prices come under pressure this year.

Games Workshop (GAW) is another firm that was are star performer among small- and mid-caps in 2017, but it, too, has seen its shares fall this year. Among the others are the FTSE 100 airline group International Consolidated Airlines (IAG), together with the much smaller financial trading group CMC Markets (CMCX) and the corporate broker Numis (NUM).

To varying degrees, all of these companies have seen their prices fall during the early weeks of 2018 after a strong run last year. For some, the market is uncertain about their future - and it's here that careful research is needed.

But it's also the case that in a correction, herd behaviour in the market can cause prices to tumble across the board. And for growth stock investors who were previously frustrated by high valuations, this can be a momentary opportunity to buy at a knockdown price.

 

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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Ben HobsonAbout the Author

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

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