When I first got interested in share investing, I was daunted by the sheer number of listed companies. How can you possibly get your head round them all?
The simply answer is you can’t — but you don’t need to. I soon read Jim Slater’s The Zulu Principle, and his key lesson was to focus on one specific aspect of your investing, and learn all you can about it.
His chosen thing at the time was growth shares, and he championed a ‘screening’ approach which narrowed the field down by filtering on some specific fundamentals. Mr Slater, along with many other growth investors, was a fan of the PEG ratio.
The PEG is a company’s forward P/E multiple divided by forecast EPS growth rate, and helps tie growth expectations to current valuation — it’s no good investing in great growth candidates if they’re already too highly valued. Growth investors typically set their PEG threshold at between 0.7 and 1, with lower being better.
Not too small
Here at The Motley Fool, we really don’t like penny stock tiddlers, as they tend to come with much wider share price spreads, and they’re far more susceptible to rumour (and, dare I suggest it, deliberate ramping.)
So what if we select only those FTSE companies with a PEG of under 1, a market capitalisation of at least £50m and a share price of at least 20p?
That narrows the market down to fewer than 50 companies. And interestingly, a few of those are in the FTSE 100.
One is Lloyds Banking Group, whose years of underperforming the index have left it on a forward P/E of only nine. EPS growth forecasts are erratic for this year and next, but if we even it out then we’re effectively looking at PEG ratios of around 0.3 per year. And that’s for a company paying good dividends too.
Another is NMC Health, one I’ve been positive about for some time. Last time I looked at it I was getting a bit wary over its share price climb, and with a PEG edging up to 1 now it’s not the screaming bargain I once saw it as. But it’s still one for consideration.
Beware of debt
One possible pitfall for growth investors is getting drawn into companies, especially smaller ones, that are funding their growth with high levels of debt. So let’s strip out any firms with gearing above 60%. That leaves a much smaller handful, some of which strike me as interesting.
One is dotDigital Group, on PEG ratios of 1 and 0.7 for this year and next. Dividends are only small at around 1%, but that’s positive at this stage in its growth. With EPS having risen 30% last year and with predicted gains of 25% and 28% to come, I reckon it’s worth a closer look.
There’s a few housebuilders in the list too, which to me is another sign, along with their healthy dividends, that the sector is not overvalued now.
Sofware provider IDOX on a 0.7 PEG also makes the cut, as does finance firm S&U on 0.6. Proactis Holdings, another software firm, has low growth expectations this year but 2019 forecasts drop the PEG to 0.4.
You’d need to do a lot more research before you decided whether to buy, but I think these are intriguing examples of ideas that a simple growth stock screen can throw up.
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Alan Oscroft owns shares of Lloyds Banking Group. The Motley Fool UK has recommended dotDigital Group, Lloyds Banking Group, and S & U. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.