Successful growth shares can deliver marvellous returns. While not every investment ends up working out, investors who are able to spot winning businesses early on can achieve jaw-dropping returns. And on occasion, that’s enough to transform a small £1,000 initial investment into £5,000 – a 400% return!
Hunting British growth
The FTSE 250 and FTSE AIM indexes are filled with small- and mid-cap companies eager to expand their operations and climb the ranks towards the coveted FTSE 100. But over the last decade or so, the performance of these smaller growth enterprises has been largely underwhelming. In fact, most have actually lagged large-cap stocks as British economic growth remained stagnant.
However, not every business is the same, and a handful of companies such as Alpha Group International (LSE:ALPH) have defied expectations, delivering explosive returns in just a few years. Alpha, for example, is up more than 400% since the start of 2019. And when counting dividends, a £1,000 initial investment is now worth around £5,640.
There are a lot of factors influencing the success of this currency risk management and alternative banking enterprise. But three standout catalysts were:
- Niche focus – Alpha focused on small- and medium-sized enterprises ignored by its larger rivals, sidestepping most of the competition.
- Prudent capital allocation – Alpha has steadily diversified its portfolio away from cyclical currency risk management and into more stable alternative banking and corporate payment processing.
- Cash cow – Alpha’s business model generates recurring, high-margin revenue, paving the way for impressive free cash flow generation. That’s allowed management to be exceptionally flexible and keep the balance sheet entirely debt-free.
Of course, it hasn’t been a smooth ride. Even with diversification efforts, currency risk management remains a dominant source of income. With volatility in the currency markets on the rise, that’s actually quite favourable. But once stability eventually returns, the impact on growth could be quite significant. And this cyclicality risk is something shareholders and investors have had to bear since its journey began in 2017.
Finding the next Alpha
As one of my largest holdings, I remain bullish on Alpha. However, whether another 400% gain is in the cards seems unlikely at this stage. That’s because its tremendous performance hasn’t gone unnoticed. And after being approached, management’s now flirting with the idea of a takeover.
Fortunately, there are plenty of other hidden gems in the stock market waiting to be discovered. Unfortunately, spotting these winners is a tricky task. After all, if they were easy to spot, everyone would be quintupling their money on a regular basis.
However, by filtering out the businesses with weak free cash flow generation, high debt burdens, and ample competition, we can narrow the search for the best UK growth shares significantly.
