Think "small growth stocks", and you probably think of flashy,
exciting stocks that may generate high returns -- but not without a
lot of risk and a lot of volatility.
But it doesn't have to be that way. My "Guru Strategies" --
investment models picked using the approaches of such great
investors as Warren Buffett, Benjamin Graham, and Peter Lynch --
run the gamut from large value strategies to small growth
strategies to hybrid growth/value models. And, since I started
tracking them nearly eight years ago, the best performer of all has
been a small growth approach -- and it's one that's also been
remarkably consistent and only slightly more volatile than the
The approach: my Motley Fool-based model, which is based on the
strategy that brothers and Motley Fool creators Tom and David
Gardner laid out in their 1996 book The Motley Fool Investment
Guide: How the Fool Beats Wall Street's Wise Men and How You Can
Too. Since I started tracking it in July 2003, a 10-stock portfolio
picked using the method has gained 224.3% (through May 15). That's
16.2% annualized during a period in which the S&P 500 has
averaged annual gains of just 3.7%.
What's more, while even the best strategies will have years in
which they lag the broader market, the Fool-based portfolio has yet
to do so -- it's the only one of my portfolios that can make such a
claim. It's beaten the S&P by at least 6.4 percentage points
every year. In addition to significantly outperforming the market
during bullish periods, it has also fared well when times have been
tough. In 2007 and 2008, while the S&P was losing a total of
37.3%, the Fool portfolio lost just 7.5%. Plus, it's generated its
strong returns with a beta of just 1.1, meaning it's been only
slightly more volatile than the broader market.
A Comprehensive Growth Approach
How has the approach fared so well? By being thorough -- very
thorough. While all of my models look at a variety of variables,
the Fool-based strategy looks at the more than any of them,
examining about 17 different criteria.
And those variables run the gamut. Some, like 12-month relative
strength (which should be at least 90), look at price and momentum.
But most examine the stock's underlying business, making sure that
a strong and improving business is supporting the stock's
performance. After-tax profit margins should be at least 7% in the
most recent year, for example, and margins should be consistent or
rising over the past three years. Recent earnings and sales growth
must also be strong, with both net income and revenue rising at
least 25% in the most recent quarter.
The Fool-based model is also big on cash. It likes to see a
positive free cash flow per share, and it doesn't like debt -- a
firm's long-term debt/equity ratio should be no higher than 5%.
Other areas it looks at include the accounts receivable/sales
ratio, income tax levels, and research and development budgets.
While it's a growth model, the Fool-based model includes a key
valuation metric: the "Fool Ratio", which is essentially the
P/E/Growth ratio that Peter Lynch made famous. This ideally should
be no greater than 0.5, though it can be slightly higher if the
firm's other fundamentals are excellent.
While it doesn't have a market cap criterion, the Fool-inspired
portfolio tends to focus on smaller stocks. That's because it keys
on firms with less than $500 million in annual sales, daily dollar
volumes no greater than $25 million, and prices below $20 a share,
since those are the companies that tend to fly under the radar.
Hard to Please
When you put all of this together, you get a rigorous growth
strategy that is not easily impressed. Right now, only two stocks
get "strong interest" (scores of 90% or above) from the Fool-based
model. Here's a look at those two, along with a few others that get
very solid scores in the 80%-90% range:
MercadoLibre, Inc. (MELI):
This Argentina-based online commerce platform is Latin America's
version of eBay, with major presences in Argentina, Brazil, Chile,
Colombia, Venezuela, Mexico, and several other countries.
MercadoLibre is currently my Fool-based model's favorite stock
in the entire U.S. market, earning a 96% score. It isn't a
small-cap ($3.9 billion), but its $232.2 million in annual sales
puts it on my Fool-based model's radar. The strategy likes the
firm's excellent recent growth -- last quarter it upped EPS by
45.5% and sales by 33.8%. The market has taken notice; since late
November 2008, MeracadoLibre's shares have risen more than 10-fold,
and it has a relative strength of 91.
A few more reasons the Fool-based approach likes MercadoLibre:
Its profit margins are high and increasing (13.7%, 19.2%, and 25.9%
over the past three years); it's conservatively financed, with a
debt/equity ratio of just 0.09%; it's producing $1.23 in free cash
flow per share; and it's shares are attractively priced, with a
P/E/G ratio of 0.43.
lululemon athletica inc. (LULU):
Vancouver-based lululemon ($5.1 billion market cap) makes athletic
clothing, focusing on apparel for yoga, running, and dancing. My
Fool-based portfolio picked up its shares back in late November
2009, and since then, the stock has surged more than 270%.
The strategy thinks it has more room to run. The stock currently
gets a 92% score from the approach, thanks in part to the firm's
strong recent growth (it upped EPS 90% and sales 53% in its last
quarter) and increasing profit margins (11.1%, 12.9%, and 17.1%
over the past three years). The strategy also likes that the stock
has plenty of momentum behind it, with a relative strength of 96,
and that it has no long-term debt and a P/E/G ratio of 0.6.
Amtech Systems, Inc. (
Based in Tempe, Ariz., Amtech makes capital equipment used in
fabricating solar cells and semiconductor devices. It's a small-cap
($209 million), and it's really turned things around in the past
year. Its trailing 12-month EPS are $2.28; in the previous 12
months, they were -$0.02. Sales for the past 12 months, meanwhile,
have more than tripled vs. the prior 12 months.
That strong recent growth is one reason the Fool-based model
likes Amtech, which earns an 87% score from the approach. It also
likes its 96 relative strength, its 10.7% after-tax profit margin,
lack of any long-term debt, and 0.31 P/E/G ratio.
MarketAxess Holdings Inc. (MKTX):
This New York City-based firm operates an electronic trading
platform that lets investment professionals trade corporate bonds
and other fixed-income instruments. It has a market cap just under
The Fool-based approach gives MarketAxess an 87% score. It likes
its strong recent growth (EPS rose 59% and sales rose 25% last
quarter), and the firm's high and increasing profit margins (8.5%,
14.1%, and 21.5% over the past three years). It also likes its
positive free cash flow ($1.19 per share) and reasonable 0.6 P/E/G
One of MarketAxess' only flaws according to this model is that
its relative strength isn't high enough, though at 74 it's not
First Cash Financial Services (
Texas-based First Cash ($1.2 billion market cap) operates pawn
stores and cash advance stores. It stands to reason that pawn
stores would do well when the economy is struggling, and First Cash
fared quite well throughout the Great Recession. But its strong
track record goes back much further -- the firm has actually upped
EPS in each year of the past decade.
First Cash gets an 87% score from the Fool-based model, which
likes its 13.1% profit margins and strong recent growth (it upped
EPS 51.5% and sales 27.7% in the first quarter). It also likes the
First Cash's 91 relative strength, and tiny 0.4% debt/equity ratio.
One of the only blemishes on the stock is that it's not dirt cheap,
selling for a P/E/G of 0.91. Still, that's not all that expensive
for a fast-growing, fundamentally sound stock.
I'm long MELI, LULU, ASYS, and MKTX.