How to invest in the next outperforming growth star

Back in December, when Fevertree Drinks’ (LSE: FEVR) share price was 580p, I penned an article speculating about whether 2016 would be another good year for the firm’s investors. Today, the shares stand at around 997p, so I have my answer — yes!

I didn’t invest

At the end of last year, I said: “It would be easy to dismiss Fevertree on grounds of its valuation – the forward price-to-earnings (P/E) ratio sits at about 45 for 2016. That’s high. But I think the firm is worth keeping an eye on because the business model is compelling and growth could have much further to go.”

Well, I kept my eye on it, the valuation didn’t drop back, and the shares went on to outperform. Today, Fevertree trades on a forward price-to-earnings ratio of 48 or so for 2017, and City analysts following the firm expect earnings to rise 11% next year.

If I’d been on board the Fevertree Drinks story I’d be selling some shares now to lock in my gains, because the shares have multi-bagged over two years and the big, early advances in earnings could be over. But how can I find the next Fevertree and how can I justify an investment if a high valuation initially puts me off?

I found that the more I learnt about investing the better I became at keeping some of the stock market’s biggest winners out of my portfolio! Learning about strong balance sheets and attractive valuations made me over-cautious.

Searching for outperformers

Some of my biggest investing winners have been investments that felt a little less safe when I first entered the trade — maybe the valuation was high, or the firm carried high borrowings, or perhaps earnings had yet to catch up with fast-growing revenues. Yet despite such worries, the underlying businesses behind the shares had great potential, a good story, and the shares were probably trending up when I bought them.

I can measure the gains from some of my investments made in this way in the hundreds of percent, so this is a strategy worth pursuing, I reckon. Maybe there’s a small corner of your own portfolio that you could dedicate to trying to capture some of these multi-bagging investments on the London market.

Leading a search for investments with valuation tended to keep me out of some of the best-performing shares, so to pull this strategy off, I think it’s a good idea to switch investment logic on its head by  searching with the following priorities:

  1. momentum 
  2. quality
  3. value

Normally, I’d use that list backwards, first filtering for a low valuation, then for quality and lastly, if at all, looking for momentum in the share price. However, fast-growing businesses often come to my attention because their shares are going up, so it makes sense to start a hunt for these outperformers with momentum. Back that up with good quality fundamentals and buy as keenly as possible and you could have a winner on your hands.

Are you looking for capital growth?

You might be interested in evaluating a company identified by The Motley Fool analysts as a Top Growth Share.

The firm has a decent record of rising dividends and a clearly identified path to growth. If the dividend keeps rising, share-price appreciation could follow.

You can download this free research now by clicking here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.