What’s The Best Growth Strategy For ISA Investors?

Stockopedia
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With more and more of us ploughing our hard-earned cash into ISAs each year, the subject of how that money is put to use over the long term has become critically important. With cash funds offering lacklustre rates and index trackers unlikely to sparkle in muted markets, there has never been a more pressing need to scrutinise potential returns and be prepared to take matters into our own hands.

According to the Investment Management Association, the rule change back in 2010 that increased the annual tax-free allowance from £7,200 to £10,680 sparked a surge in the number of ISA sales. It seems that more of us regard them as a real alternative to pensions, or at least a vital second savings route. Indeed, the IMA figures suggest that ISAs are more or less on a par with pensions as the tax wrapper of choice for retirement savings. Flexibility, choice and certainty are winning over savers who are prepared to concede the tax advantages of a pensions system that’s dogged by complexity and subject to occasional government meddling.

In the coming year the ISA allowance has been notched up to £11,280 and savers seeking inspiration and superior yields for their cash could be well advised to consider direct investments in growth shares. But where to start?

Small cap surge
A quick glimpse at index performances so far this year suggests that small cap companies are attracting increasing attention. While London’s Alternative Investment Market is off limits to ISA investors (with the exception of dual-listed stocks) its 14% growth in the first three months of 2012 reflects growing confidence at the smaller end of the market.

If you want to cash in on that growth, one option could be to consider smaller FTSE shares that qualify under ISA rules but still retain all the characteristics of growth stocks with promising prospects. This isn’t as simple as it sounds because even the smallest FTSE stocks attract a great deal more attention from analysts and institutional investors than AIM companies. But while finding these stock requires diligent research, with the right tools hidden gems can still be uncovered.

At Stockopedia we are modelling a range of growth strategies in the styles of some of the great investors, from such luminaries as Jim Slater, Bill O’Neill and Philip Fisher, in order to uncover potential growth stock stars. These strategies scour the market for companies showing strong and consistent historic growth rates – the kinds of stocks that, if their growth were to continue, could lead to capital growth.

Past performance is clearly no indication of future results, but so called ‘growth at a reasonable price’ strategies have been performing very consistently year to date. The best performing strategy has outstripped the FTSE 100 by almost 14% in the last three months (17.4% vs. 3.62%) and is currently highlighting 24 candidates for further research. The screen is based on principles developed by famous US investor, T. Rowe Price, who looked for reasonably priced stocks showing consistent growth across multiple timeframes with evidence of improving margins.

From the current lists of candidates in the top growth screens we’re tracking, we have plucked a few interesting names which may be worth of further research. It should be noted that the outperformance of these strategies to date has come from a widely diversified basket of shares showing these kinds of growth characteristics not from individual stocks and that these companies are illustrative only.  For the full lists of stocks qualifying for our modelled strategies, have a browse in our Growth Strategies section.

Companies qualifying for growth criteria
Optos (LON:OPTS), the £158 million market cap Scottish medical devices business that specialises in retinal technology is a notable presence on the T. Rowe Price screen. Shares in the company leapt ahead of its final results last November – indeed its financials have beaten expectations for the last two years. There appears to be ongoing enthusiasm for the shares and the company’s focus on new product development and international expansion is helping to underpin that. It should be noted that while historic growth has been strong brokers aren’t expecting any further growth over the next 12 months.

Another of T. Rowe Price’s stocks is Oxford Instruments (LON:OXIG), a company with a proud past and since 2010 a rapidly accelerating share price. Back in 1959, Oxford was the company that developed the technology used in MRI scanners in hospitals and these days it continues to specialise in developing high-tech tools and systems. Last year the £685 million market cap company put in the best financial performance in its history, delivering on a strategy to grow rapidly, move into new geographies and make acquisitions. The performance qualifies Oxford for other growth stock screens as well, among them those of investment gurus Philip Fisher and Charles Kirkpatrick.

On that note, our Philip Fisher stock screen has itself performed impressively against the wider market, up 13.66% over three months. One of the companies Fisher shares with T. Rowe Price is JD Sports , £383 million market cap sports and fashion retailer. While economic conditions have played havoc on the High Street, JD has delivered increasing profits through the downturn, indeed it recently took the chance to buy stricken peer Blacks Leisure. While that move might dent earnings this year, the company looks set to be somewhere close to expectations when it reports in the coming weeks. The stock has been much discussed in the blogosphere in recent months as many believe the company’s debt is understated by the use of operating leases which should be capitalised. Perhaps due to this accounting quirk the company’s fundamentals may look better than they are. Nonetheless it qualifies for six stock screens on Stockopedia, including growth, income and the Buffettology Sustainable Growth Screen.

For those investors with a preference for nuts and bolts over track suits and trainers, manufacturing group Diploma (LON:DPLM) could be worth further research. The supplier of instruments and components to sectors spanning life sciences to industrial machinery has had a strong 2012 so far, with the shares already up 64p at 416.8p. Diploma’s wide geographical spread and appetite for acquisitions have been a boon and the company has already said it expects to beat expectations when it reports in May. For those reasons, it qualifies for six screens on Stockopedia, among them the Zulu investing approach of seasoned UK investor, Jim Slater. Slater is something of a doyen of the UK investment community and this screen, based on his thinking, is currently ranked second under T. Rowe Price, with a three month return of 14.47%. The screen looks specifically for attractively priced stocks versus their earnings forecasts. But there’s more to Diploma than that. Its dividend payouts, strong share momentum and current price make it attractive for other reasons too and the added bonus of a nine-out-of nine Piotroski F-Score suggest that the company is showing top rated momentum across its fundamentals.

Finally, another stock that could merit further research from the Slater-based list of 31 companies is Vitec Group (LON:VTC), a business that supplies video, broadcast and photography products. Vitec’s shares have completely recovered from the effects of the economic slump that caused so much damage to London markets in recent years. Much of the reason for that was its efforts to broaden the scope of its operations geographically and through acquisitions. Latterly, that has meant introducing a division to service clients in the military, aerospace and government markets which, while lumpy, represent a huge opportunity where it believes it is making encouraging progress. With a market cap of £279 million and a price/earnings-growth (or PEG) ratio of 0.6, Vitec not only ticks Slater’s quantitative criteria but also qualifies as a momentum and value stock on other screens.

Hazard warning
It goes without saying of course that the decision to take a closer look at direct share investments as a means of boosting returns through an ISA should come with a health warning. Research on individual stocks is vital and should be allied with a strong dose of diversification and professional assistance. Nevertheless, with the right information and an insight into what some of the world’s most successful growth company investors might do, there could be handsome rewards for venturous investors.  

P.S. We are offering a 14 day free trial on our premium data product – for access to the full guru lists and custom screening functionality, click here. 

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