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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.

The screen's method that I used to build this portfolio requires all stocks to comply with all following demands:

  1. The stock is included in the Russell 3000 index.
  2. The stock does not trade over-the-counter (OTC).
  3. Trailing P/E is less than 20.
  4. Forward P/E is less than 15.
  5. Average annual earnings growth estimates for the next five years is greater than 15%.
  6. Total debt to equity is less than 1.0.
  7. Gross margin improved in the past year.
  8. Current ratio improved in the past year.
  9. Return on investment, five years average, is among the 35% highest in the market.
  10. The ten stocks with the highest current ratio among all the stocks that complied with the first nine 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 Yahoo Finance, finviz.com and Portfolio123.

After running this screen on September 05, 2013, before the market open, I discovered the following ten stocks:

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The table below presents the trailing P/E, the forward P/E, the average annual earnings growth estimates for the next five years, the growth margin, the current ratio, and the total debt to equity for the ten companies.

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Geospace Technologies Corp (NASDAQ:GEOS)

Geospace Technologies Corporation designs and manufactures instruments and equipment used in the acquisition and processing of seismic data.

Geospace Technologies has no debt at all, and it has a trailing P/E of 15.06 and a very low forward P/E of 11.18. The PEG ratio is extremely low at 0.42, and the average annual earnings growth estimates for the next five years is very high at 20%.

Geospace Technologies has recorded consistent profitability and earnings growth during the last year, the last three years and the last five years, as shown in the chart below.

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Source: company presentation

Analysts recommend the stock. Among the seven analysts covering the stock; three rate it as a strong buy, two rate it as a buy and two rate it as a hold.

On August 06, Geospace Technologies reported its third-quarter fiscal 2013 financial results, which beat EPS expectations by $0.20 and beat on revenues. The company reported net income of $17.0 million, or $1.31 per diluted share, on revenues of $78.1 million for its fiscal quarter ended June 30, 2013. This compares with a net income of $10.7 million, or $0.83 per diluted share, on revenues of $55.2 million for the comparable quarter last year.

Geospace Technologies has recorded good revenue and EPS growth and it has compelling valuation metrics and very strong earnings growth prospects. Considering Geospace Technologies' ability to increase production output on drilling projects and the high cost of oil exploration, the growing demand for the company services should continue. In my opinion, an investor in GEOS stock can expect a significant capital gain.

Risks to the expected capital gain include a downturn in the U.S. economy, and decline in the price of oil and natural Gas.

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Chart: finviz.com

PhotoMedex Inc (NASDAQ:PHMD)

PhotoMedex, Inc., a skin health company, provides integrated disease management and aesthetic solutions to dermatologists, professional aestheticians, and consumers in North America, the Asia Pacific, Europe, and South America.

PhotoMedex has no debt at all, and it has a very low trailing P/E of 12.51 and a very low forward P/E of 11.84. The PEG ratio is very low at 0.61, and the average annual earnings growth estimates for the next five years is very high at 17.5%. The price-to-cash ratio is low at 5.18, and the price to free cash flow for the trailing 12 months is very low at 12.22.

Analysts recommend the stock. Among the six analysts covering the stock; four rate it as a strong buy and two rate it as a buy.

The PHMD stock price is 0.95% above its 20-day simple moving average, 0.36% above its 50-day simple moving average and 3.01% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

PhotoMedex has recorded very strong revenue and EPS growth during the last year, the last three years and the last five years, as shown in the table below.

Source: Portfolio123

On August 07, PhotoMedex reported its second-quarter financial results, EPS came in at $0.34 in-line with expectations. In the report, the company announced that its Board of Directors authorized the expansion of its share repurchase program by a further $30 million. The company commented about this decision:

The expansion of our share repurchase program by a further $30 million is reflective of the confidence we have in the growth of PhotoMedex, our ability to generate free cash flow and our commitment to building shareholder value.

PhotoMedex has recorded strong revenue and EPS growth, and it has compelling valuation metrics and very strong earnings growth prospects. Since the company is highly profitable, and it is expanding its share repurchasing program, a higher price for PHMD stock can be expected.

Risks to the expected capital gain include; a downturn in the U.S. economy, and decline in the acceptance of its products.

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Chart: finviz.com

Atwood Oceanics, Inc. (NYSE:ATW)

Atwood Oceanics, Inc., an offshore drilling contractor, engages in the drilling and completion of exploratory and developmental oil and gas wells.

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Atwood Oceanics has a very low trailing P/E of 10.60 and a very low forward P/E of 8.57. The PEG ratio is very low at 0.45, and the average annual earnings growth estimates for the next five years is very high at 23.5%.

Atwood Oceanics has recorded steady revenue and earnings growth during the last year, the last three years and the last five years, as shown in the chart below.

(click to enlarge)

Source: company presentation

On July 31, Atwood Oceanics reported its third-quarter fiscal 2013 financial results, which beat EPS expectations by $0.02 and was in-line on revenues. The company reported that it earned net income of $90.0 million or $1.37 per diluted share, on revenues of $272.7 million for the quarter ended June 30, 2013 compared to net income of $85.5 million or $1.28 per diluted share on revenues of $253.2 million for the quarter ended March 31, 2013 and compared to net income of $51.7 million or $0.79 per diluted share, on revenues of $178.6 million for the quarter ended June 30, 2012.

Atwood Oceanics has recorded strong revenue and EPS growth, and it has very strong earnings growth prospects. In my opinion, ATW stock is cheap in regard to its valuation metrics, and still has room to go up.

Risks to the expected capital gain include; a downturn in the U.S. economy, and lower oil and natural gas prices.

(click to enlarge)

Chart: finviz.com

Back-testing

In order to find out how such a screening formula would have performed during the last year, last 5 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 benchmarks (S&P 500, Russell 3000), 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.

Since some readers could not get the same results that I got in some of my previous posts, I am giving, in the charts below, the Portfolio123 exact codes which I used for building this screen and the back-tests. The number of stocks left after each demand can also be seen in the chart.

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One year back-test

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Five years back-test

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Fourteen years back-test

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Summary

The growth screen has given much better returns during the last year, the last five years and the last 14 years than the S&P 500 and the Russell 3000 benchmarks. The Sharpe ratio, which measures the ratio of reward to risk, was also much better in all the three tests. One year return of the screen was at 29.56%, while the return of the S&P 500 index during the same period was at 16.73% and that of the Russell 3000 index was at 18.27%.

The difference between the growth screen to the benchmarks was even more noticeable in the 14 years back-test. The 14-year average annual return of the screen was at 19.42%, while the average annual return of the S&P 500 index during the same period was only 1.98% and that of the Russell 3000 index was at 2.69%. The maximum drawdown of the screen was at 65.99%, while that of the S&P 500 was at 56.39% and the maximum drawdown of the Russell 3000 index was at 57.07%.

Although this screening system has given superior results, I recommend readers use this list of stocks as a basis for further research.

Source: Growth Stocks Portfolio That Has Outperformed The Market By A Big Margin