I tried to create a growth stocks portfolio that can outperform the market by a big margin. The following screen shows such promise. I have searched for companies that are included in the Russell 3000 index that have strong growth prospects and their gross margin and current ratio have improved in the past year. Those stocks also would have to show low debt.
Russell 3000 Index
The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. The Russell 3000 Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are reflected.
The screen's method requires all stocks to comply with all following demands:
- The Trailing P/E is less than 20.
- The forward P/E is less than 15.
- Average annual earnings growth estimates for the next five years is greater than 15%.
- Total debt to equity ratio is less than 1.0.
- The gross margin is greater than the gross margin one year before.
- The current ratio is greater than the current ratio one year before.
- The return on investment five years average ranks in the top of 35% of the Russell 3000 stocks.
- The eight stocks with the highest current ratio among all the stocks that complied with the first seven demands.
I used the Portfolio123's powerful screener to perform the search and to run back-tests. Nonetheless, the screening method should only serve as a basis for further research. All the data for this article were taken from Portfolio123.
After running this screen on May 18, 2013, I discovered the following eight stocks: Volterra Semiconductor Corp (VLTR), Kulicke and Soffa Industries Inc (KLIC), Vera Bradley Inc (VRA), Valmont Industries Inc (VMI), Female Health Co (FHCO), Bio Reference Laboratories Inc (BRLI), Cummins Inc. (CMI) and Calumet Specialty Products Partners LP (CLMT).
The table below presents the eight companies, their last price, their market cap and their industry.
The table below presents the trailing P/E, the forward P/E, the average annual earnings growth estimates for the next five years, the debt to equity and the return on investment five years average for the eight companies.
The table below presents the last gross margin, the gross margin one year before, the current ratio and the current ratio one year before, and the PEG ratio for the eight companies.
In order to find out how such a screening formula would have performed during the last year, last five years and last 14 years, I ran the back-tests, which are available by the Portfolio123's screener.
The back-test takes into account running the screen every four weeks and replacing the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. The theoretical return is calculated in comparison to the benchmark (S&P 500), considering 0.25% slippage for each trade and 1.5% annual carry cost (broker cost). The back-tests results are shown in the charts and the tables below.
One year back-test
Just a matter of curiosity, the table below presents the eight companies originated by the screen formula one year before, on May 17, 2012.
Five years back-test
The table below presents the eight companies originated by the screen formula five years before, on May 17, 2008.
14 years back-test
The table below presents the eight companies originated by the screen formula 14 years before, on April 24, 1999.
The growth stocks screen has given much better returns during the last year, the last five years and the last 14 years than the S&P 500 benchmark. The Sharpe ratio, which measures the ratio of reward to risk, was also much better in the last five and 14 years, and was a bit lower in the last year. One year return of the screen was at 41.27% while the return of the S&P 500 index during the same period was at 27.79%. The difference between the growth stocks screen to the S&P 500 benchmark was much more noticeable in the 14 years back-test. The 14-year average annual return of the screen was at 21.30% while the average annual return of the S&P 500 index during the same period was only 2.14%. Although this screening system has given superior results, I recommend readers use this list of stocks as a basis for further research.