The veteran US fund manager Richard Driehaus, once said that he wasn’t at all interested in buying shares that were out of favour in the hope they’d eventually bounce back. Instead, he preferred the idea of buying growth shares on an upward trend and was happy to take the risk that they might fall.
This “buy high, sell higher” approach made Driehaus one of the influential early adopters of ‘momentum’ investing. He was partly responsible for taking momentum from academia into the investment mainstream. And through his fund firm Driehaus Capital Management, he’s still doing it today – with notable success.
Hunting for growth stocks on the move
For onlookers, the big lesson from Driehaus’s approach is the potency of blending growth and momentum in small and mid-cap stocks. In essence, it’s about looking for firms with a track record of earnings growth and share prices that are already rising. From that respect, it echoes the strategies of well-known investors like Mark Minervini and William O’Neil.
Indeed, Driehaus pinpoints long-term earnings growth as the main driver of share price movement. So, central to his strategy is a focus on finding growth companies with rising rates of earnings per share and then figuring out which of them are likely to keep on delivering.
Doing this means that this strategy hinges on the academic evidence that trends in both share prices and earnings tend to persist. In other words, a share price that has risen in the past tends to keep rising as more and more investors accept that the company is improving. In the same way, companies with rising profits that are beating market expectations tend to keep beating those expectations.
For these reasons, Driehaus takes the view that rising prices tend to be more important than valuations, or even above-average debt, as long as their earnings growth looks assured. In terms of earnings, he looks for a track record of growth but, again, wants to find companies that are beating analyst expectations and delivering positive earnings ‘surprises’.
A focus on price and earnings momentum
Stockopedia’s own modelling of a Driehaus-inspired strategy has enjoyed a strong performance over the past year, with an impressive 42.3% gain. The returns are not always that strong, but recent returns reflect the popularity of growth stocks in the current market.
With this in mind, we’ve recreated the Driehaus approach with a few of his favoured measures. These companies have all been seeing impressive earnings growth and strong support for their shares over the past year.
Name Mkt Cap £m EPS Growth Streak EPS Growth % EPS Surprise % Last Year 1 Month Relative Strength James Cropper 181.8 5 30.2 24.6 +8.7 Luceco 397.2 3 118.9 21.0 +4.9 Marshall Motor Holdings 124.6 4 59.2 14.0 +12.6 Zytronic 99.9 3 19.8 13.0 +8.5 XLMedia 292.2 3 24.5 7.6 +7.6 Johnson Service 516.8 4 27.0 7.3 +1.0 Churchill China 112.2 8 30.2 6.5 +15.7 Impax Asset Management 137.3 3 57.7 6.4 +5.2 Applegreen 425.6 4 19.2 6.0 +6.5 Zotefoams 159.4 3 34.0 5.2 +12.0
Leading the list is the specialist paper and advanced materials business, James Cropper (CRPR). This is a firm that has seen rapid earnings growth over the past five years in tandem with a robust re-rating of its shares. On conventional valuation measures, this is likely to look expensive to value investors. Yet it’s precisely this kind of high growth, high momentum stock that Driehaus looks for.
Elsewhere, specialist lighting business Luceco (LUCE), only floated on the market a year ago, but its accounts point to a promising trend in earnings growth. As an ex-private equity controlled business, debt is high but under control and falling, again making this a potentially interesting momentum play.
Followers of this column will also recognise other names on this list as regularly coming up in high quality, high momentum small-cap strategy screens. Among them are Zytronic (ZYT), XL Media (XLM), Impax Asset Management (IPX) and Zotefoams (ZTF).
There is no doubt that the Driehaus approach to momentum makes this strategy exciting, and targets some of the fastest moving smaller companies in the market. However, with strong momentum comes the risk of sudden price crashes if things go wrong, or if the mood of the market changes. So, this approach to screening needs watching like a hawk. But for those looking for growth stocks on the move, it’s a strategy that could be worth exploring.
Interactive Investor’s Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard’s review of Stockopedia.com and learn more about the site.
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About the Author
Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including “How to Make Money in Value Stocks” and “The Smart Money Playbook”
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.