By The Numbers: Consistent Growth Stocks With Strong Fundamental Momentum

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Includes: ADBE, ALGN, AMZN, ANDV, BEAT, CRZO, CSTR, CVCO, CYBR, DK, DPZ, ECHO, EQT, ETFC, ETSY, FANG, GIII, GLOB, GOGL, GOOS, GWRE, HOME, HQY, ISRG, JBL, KFY, LEN, LULU, MEET, MMYT, NEWR, NVDA, NVTR, OLLI, PATK, PE, PII, PLAY, SBLK, SFIX, SIVB, SPY, SQ, TDOC, TECD, TUSK, TX, UPLD, WRD, YY, ZUMZ
by: Andres Cardenal, CFA
Summary

Investing in high-growth stocks is a double-edged sword. The strategy carries both superior potential for returns and above-average risk levels.

When picking the right growth stocks, finding names with consistent and sustainable growth rates is absolutely key.

The following article introduces a quantitative system that looks for companies with consistently above-average growth rates and strong fundamental momentum.

Backtested performance is quite encouraging.

Past performance does not guarantee future returns, but it makes sense to expect attractive returns when investing in companies with consistent revenue growth and vigorous fundamental momentum.

Investing in growth stocks can generate outstanding returns over the long term. However, growth stocks are also particularly volatile, and companies with superior growth can many times carry above-average risks too. The key, like usually happens, is separating the fundamentally sound companies with consistent growth prospects from companies going through a temporary phase of unsustainably high growth.

No quantitative formula can generate infallible results in the market. However, relying on cold-hard quantitative indicators to evaluate stocks is a far sounder approach than making investing decisions based solely on subjective opinions and speculation. In that spirit, the following article is introducing a quantitative system focused on investing in consistent growth leaders with strong fundamental momentum.

System Design

The following quantitative system focuses on multiple time frames in order to find the most consistent growth stocks in the market. In particular, a company must have revenue growth rates above the 50% of companies in the industry over three different time frames: The most recent quarter, a trailing twelve-month period, and the past three years.

These growth retirements are quite demanding. Among a universe of nearly 6,000 stocks, only 1,162 have delivered above-average growth rates in the three time frames considered. From that universe of 1,162 names that meet the specified growth criteria, the system selects the 50 stocks with strongest fundamental momentum.

Fundamental momentum measures a company's ability to deliver financial performance numbers above expectations and to generate increasing expectations about future performance. Stock prices don't simply reflect business fundamentals, but fundamentals in comparison to expectations can be even more important.

When financial performance is better than expected and analysts are increasing their earnings forecasts for the company, this is generally a powerful upside fuel for the stock price.

Besides, one of the main risks when investing in growth companies is that a high bar is hard to beat. If the market is expecting a lot from a company, and this is reflected on valuation ratios, a disappointment in financial performance can be quite problematic for investors in such stock. By focusing on growth stocks that are also delivering earnings numbers above expectations, the system avoids these kinds of scenarios.

Mathematically, fundamental momentum is calculated by measuring the difference in expected versus reported sales and earnings numbers over the past several quarters, as well as measuring the percentage change in earnings expectations for both the current year and next year. The system averages down those numbers to reach a final fundamental momentum score for the different companies in the universe under consideration.

Leaving the mathematical considerations aside, it's important to understand the key drivers behind the quantitative system in order to truly comprehend what the system is trying to do.

In a nutshell, investors are always pondering two questions, what to buy and when to buy it. This system is basically looking to buy companies with consistently above average growth rates, and it’s looking to buy those stocks when they are performing better than expected and expectations about future performance are also rising.

Backtested Performance And Recommended Portfolio

The following backest builds an equally-weighted portfolio with the 50 stocks recommended by the quantitative system, and it evaluates performance since 1999. The portfolio is rebalanced every four weeks, and it has an assumed annual expense ratio of 1% to account for trading expenses and similar considerations. The benchmark is the SPDR S&P 500 ETF (SPY).

Backtested performance numbers are quite strong, since January of 1999 following the portfolio recommendations from the system produced an average annual return of 16.62% versus 6.39% for the SPDR S&P 500 in the same period. System Alpha was 10.24% during the backtesting period.

In plain English, a $100,000 investment in the SPDR S&P 500 ETF in January of 1999 would have a current market value of nearly $325,500, and investors following the portfolio recommendations from the quantitative system would have made as much as $1.8 million based on the backtesting data.

The quantitative system is far more volatile than the benchmark. This is to be expected, since the system is more concentrated and growth stocks are also more volatile than stable and predictable companies. However, the system significantly outperforms the benchmark on a risk-adjusted basis; the system has a Sharpe ratio of 0.67 versus 0.35 for the ETF.

The table below shows the 50 stocks currently selected by the system. For your viewing pleasure, data in the table also includes market capitalization and sales growth for the 3 time periods considered: the most recent quarter, a trailing twelve-month period, and the past 3 years.

Name

Mkt. Cap ($Millions)

Sales% Qtr

Sales% TTM

Sales% 3Years

Adobe Systems (ADBE)

$117,611

23.88

24.45

20.75

Align Technology (ALGN)

$27,554

40.79

38.95

24.6

Amazon.com (AMZN)

$825,203

42.92

35.51

25.97

Andeavor (ANDV)

$19,687

58.36

48.73

-5.13

BioTelemetry (BEAT)

$1,484

69.1

50.94

19.85

Carrizo Oil & Gas (CRZO)

$2,298

48.84

59.59

1.65

CapStar Financial (CSTR)

$220

19.28

13.05

10.95

Cavco Industries (CVCO)

$1,865

22.49

12.59

15.42

CyberArk Software (CYBR)

$2,216

21.59

19.98

36.46

Delek US Holdings (DK)

$4,218

99.05

87.76

1.16

Domino's Pizza (DPZ)

$12,024

25.82

15.31

11.82

Echo Global Logistics (ECHO)

$789

38.81

21.88

18.31

EQT (EQT)

$14,904

60.33

99.96

11

E*TRADE Financial (ETFC)

$16,311

27.97

23.87

6.73

Etsy Inc (ETSY)

$5,067

24.79

22.43

31.15

Diamondback Energy (FANG)

$12,902

104.14

114.87

34.46

G-III Apparel (NASDAQ:GIII)

$2,260

15.63

17.56

9.86

Globant SA (GLOB)

$1,936

34.9

31.38

27.47

Golden Ocean Group (NASDAQ:GOGL)

$1,255

82.91

81.63

69.29

Canada Goose Holdings (GOOS)

$6,270

155.68

52.67

33.91

Guidewire Software (GWRE)

$7,082

13.8

25.12

13.66

At Home Group (HOME)

$2,429

20.92

23.52

24.07

HealthEquity (HQY)

$4,761

26.13

28.58

37.73

Intuitive Surgical (NASDAQ:ISRG)

$54,804

24.71

18.38

13.65

Jabil Inc. (JBL)

$4,733

21.1

15.57

6.54

Korn/Ferry International (KFY)

$3,422

16.39

12.2

19.51

Lennar Corp. (LEN)

$16,949

67.36

31.14

17.69

lululemon athletica (LULU)

$16,953

24.87

17.28

13.81

The Meet Group (MEET)

$317

87.64

70.57

40.29

MakeMyTrip Ltd. (MMYT)

$3,204

31.47

50.86

31.1

New Relic (NEWR)

$5,638

34.24

34.76

47.61

Nvidia (NVDA)

$146,202

65.57

45.64

27.55

Nuvectra (NVTR)

$223

187.89

153.98

104.99

Ollie's Bargain Outlet (OLLI)

$4,548

21.15

21.75

19.07

Patrick Industries (PATK)

$1,432

59.75

42.94

30.51

Parsley Energy (PE)

$8,100

95.53

94.4

47.32

Polaris Industries (PII)

$7,685

11.95

18.62

6.61

Dave & Buster's Entertainment (PLAY)

$1,928

9.22

11.51

15.14

Star Bulk Carriers (SBLK)

$834

86.63

61.29

31.08

Stitch Fix (SFIX)

$2,762

29.24

26.33

137.19

SVB Financial Group (SIVB)

$15,435

34.05

26.95

11.02

Square (SQ)

$24,644

44.86

35.19

37.58

Teladoc (TDOC)

$3,594

108.97

101.22

75

Tech Data Corp. (TECD)

$3,169

21.71

37.97

9.95

Mammoth Energy Services (TUSK)

$1,603

559.3

306.87

35.86

Ternium SA (TX)

$6,798

42.71

38.4

3.44

Upland Software (UPLD)

$740

52.35

39.62

14.9

WildHorse Resource Development (WRD)

$2,520

302.93

278.04

111.02

YY Inc. (YY)

$6,512

57.27

57

44.32

Zumiez Inc. (ZUMZ)

$679

13.87

12.8

4.55

It’s interesting to note that many of these companies are not only consistently outgrowing the industry but also showing an acceleration in their revenue growth rates. This is not easy to do at all, especially for relatively big businesses such as Amazon, Nvidia, and Domino’s Pizza, to name a few remarkable examples. Growth generally slows down as a company gains size over time, so it takes an exceptional business to deliver accelerating revenue growth for a large revenue base.

Past performance does not guarantee future returns, and only because a stock is included in the quantitative system, that doesn’t mean that it will necessarily produce market-beating returns going forward.

That acknowledged, making investing decisions based on quantified data is certainly a sounder approach than relying on emotions and subjectivities when picking stocks. If the statistical evidence is any valid guide, it makes sense to expect attractive returns when investing in companies with consistently superior growth rates and strong fundamental momentum.

Disclosure: I am/we are long AMZN. 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.