By The Numbers: Growth Stocks With Superior Relative Strength

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Includes: AAXN, ABMD, ANET, AXGN, BOFI, BOOT, BUFF, CMPR, ENTA, ENVA, ETSY, EVBG, FARO, FBR, GMED, GTT, HIIQ, HUBS, IMGN, IPGP, MTCH, MU, MZOR, NFLX, NKTR, NOW, NTNX, NVDA, PAYC, PLNT, PRLB, PTCT, QLYS, RNG, SEDG, SGMO, SIFY, SQ, SRNE, SRPT, TBK, TREE, TRUP, TSG, TUSK, VCEL, VIRT
by: Andres Cardenal, CFA

Summary

Investing in growth stocks generally carries above-average volatility, but it can also be remarkably profitable when done right.

This article introduces a quantitative system focused on companies with above-average revenue growth and superior relative strength.

Backtested performance is clearly strong, and the system can be a valuable source of ideas with attractive potential for further research.

Investing in growth stocks is not easy at all, and high-growth companies usually carry above-average risk and volatility. However, focusing on companies with superior top-line performance can also be enormously profitable when done right.

The following paragraphs are introducing a quantitative system focused on companies with above-average revenue growth over different time periods. The main idea is finding companies with consistent performance as opposed to the ones going through a short-lived acceleration in revenue. Among the companies with superior top-line growth, the system also picks the stocks that are delivering superior relative strength in comparison to both the broad market and the industry in particular.

The numbers alone don´t make a complete investment thesis for a company. It's important to analyze the business behind those numbers in order to fully understand the main return drivers and risks. However, this kind of system can be remarkably effective at identifying candidates with attractive potential for further research.

Consistent Growth And Relative Strength

To begin with, the system excludes over the counter stocks from the investable universe, and it only considers companies with a market capitalization level above $250 million.

This requirement reduces potential returns, since small companies generally produce bigger gains in the long term. However, by leaving relatively small and illiquid names aside, the system is also more realistic and easy to implement.

In addition to that, sales growth needs to be above the market average over three specific measurement periods: The most recent quarter, on a trailing twelve months basis, and over the past five years.

In other words, the screen is looking for companies that generate revenue growth rates above the market average for different time frames, not just in a particular quarter. The main idea is finding companies with market-beating growth rates on a consistent basis.

Growth rates vary substantially across industries, companies in technology obviously tend to generate superior growth rates than those in utilities, for example. This is an important consideration to keep in mind when building a quantitative system such as this one.

On one hand, if you are going to focus on companies with the best growth rates in the market, then it makes a lot of sense to overweight those sectors which are fertile ground for growth. This is precisely what you get when you build a system looking for companies with growth rates above the market average, the most dynamic sectors such as technology obviously get a higher percentage of the portfolio.

However, there are also some good reasons to consider growth rates in comparison to industry levels. A rising tide lifts all boats, and even a mediocre business can deliver attractive growth rates when industry tailwinds are helping. If you also include growth rates in comparison to the industry average, then you eliminate many of those mediocre names from the system.

Besides, a company that is substantially outperforming the industry in terms of revenue growth can be a compelling idea to consider, even if those growth rates are not particularly high in comparison to the broad market.

For these reasons, the system also requires the company to produce revenue growth rates above the industry average in the three time frames considered: the most recent quarter, a trailing twelve months period, and the past five years.

To wrap up, the screening system first imposes some minimum requirements in terms of size and liquidity, and then it requires the company to outperform both the broad market and its particular industry in terms of growth rates over three different time frames.

Among the companies that meet such set of criteria, the system selects the 50 stocks with the best relative strength. This is calculated by averaging down performance over 13 weeks, 26 weeks, and 52 weeks in comparison to both the broad market and the industry in particular. Winners tend to keep on winning in the market, so the system prioritizes winning companies when building the portfolio.

Backtested Performance And Portfolio Recommendations

The following backtest picks the 50 stocks recommended by the system, and it builds and equally weighted and monthly rebalanced portfolio with those names. The portfolio has an assumed annual expense ratio of 1% to account for trading expenses and similar factors, and the benchmark is the iShares Russell 1000 Growth ETF (NYSEARCA:IWF).

Backtested performance numbers are quite strong. Since January of 1999 the system gained 13.41% per year, more than double the 5.54% per year produced by the benchmark. In cumulative terms, the system gained almost 1,018% versus a cumulative gain of 181.5% for the iShares Russell 1000 Growth ETF over the backtesting period.

Backtesting data and charts are from Portfolio123.

In other words, a $100,000 investment in the portfolio recommended by the system in January of 1999 would currently be worth more than $1.1 million, while the same amount of capital allocated to iShares Russell 1000 Growth ETF would have a significantly smaller current value of $281,600.

Past performance does not guarantee future returns, and companies in this system can be too risky for many investors. Please keep in mind that the system does not consider variables such as valuation or financial quality, so stocks selected by the system tend to be relatively expensive, and profit margins are in some cases thin or volatile.

Nevertheless, a system such as this one can be a materially valuable tool for investors looking to find investment ideas in companies with superior growth rates and stocks showing above-average relative strength. The main point is that the system can be a source of ideas for further research, the analysis process starts with the system, it doesn't end there.

The table below shows the 50 stocks currently selected by the system in alphabetical order. The table also shows revenue growth rates in the three different time frames considered: most recent quarter, trailing twelve months periods, and in the past five years.

Name Ticker Sales% Qtr. Sales% TTM Sales% 5Yrs
ABIOMED (ABMD) 31 29
Arista Networks (ANET) 43 46 53
AxoGen Inc (AXGN) 49 47 51
Axon Enterprise Inc (AAXN) 15 28 25
Blue Buffalo Pet Products (BUFF) 14 11 20
BofI Holding Inc (BOFI) 13 14 28
Boot Barn Holdings Inc (BOOT) 13 9 30
Cimpress NV (CMPR) 32 26 16
Enanta Pharmaceuticals (ENTA) 266 160 20
Enova International Inc (ENVA) 20 13 5
Etsy Inc (ETSY) 24 21 43
Everbridge Inc (EVBG) 37 36 35
FARO Technologies Inc (FARO) 16 11 6
Fibria Celulose SA (FBR) 44 20 3
Globus Medical Inc (GMED) 16 13 11
GrubHub Inc (GRUB) 49 38 53
GTT Communications Inc (GTT) 83 57 50
Health Insurance Innovations Inc (HIIQ) 37 39 44
HubSpot Inc (HUBS) 39 39 49
ImmunoGen Inc (IMGN) 185 137 25
Interactive Brokers Group Inc (IBKR) 176 30 10
IPG Photonics Corp (IPGP) 29 40 20
LendingTree Inc (TREE) 60 61 51
Mammoth Energy Services Inc (TUSK) 463 199 64
Match Group Inc (MTCH) 29 19 13
Mazor Robotics Ltd (MZOR) 36 79 40
Micron Technology Inc. (MU) 71 78 20
Nektar Therapeutics (NKTR) 155 86 31
Netflix Inc (NFLX) 33 32 27
Nutanix Inc (NTNX) 44 53 159
NVIDIA Corp (NVDA) 34 41 18
Paycom Software Inc (PAYC) 30 32 41
Planet Fitness Inc (PLNT) 15 14 22
Proto Labs Inc (PRLB) 30 16 22
PTC Therapeutics Inc (PTCT) 210 135 42
Qualys Inc (QLYS) 20 17 20
Rapid7 Inc (RPD) 28 28 34
RingCentral Inc (RNG) 34 32 34
Sangamo Therapeutics Inc (SGMO) 47 89 13
Sarepta Therapeutics Inc (SRPT) 957 2752 33
ServiceNow Inc (NOW) 42 39 51
Sify Technologies Ltd (SIFY) 30 25 13
SolarEdge Technologies Inc (SEDG) 70 24 52
Sorrento Therapeutics Inc (SRNE) 5335 2377 73
Square Inc (SQ) 36 30 61
The Stars Group Inc (TSG) 22 11 128
Triumph Bancorp Inc (TBK) 28 35 46
Trupanion Inc (TRUP) 30 29 34
Vericel Corp (VCEL) 30 7 397
Virtu Financial Inc (VIRT) 169 46 11

Disclosure: I am/we are long MU, NFLX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.