44% compound annual EPS growth rate

The Atalaya Mining (LSE:ATYM) share price has been volatile recently, having fallen 28.5% in the last month. Yet over the last year, it’s down by just 2.7%. At the time of writing, it’s trading at 294p.

Between 2017 and 2021, the company – a copper mining firm operating in Spain – exhibited strong earnings growth. During this time, earnings per share (EPS) rose from ¢15.5 to ¢96.7. By my calculations, this results in a compound annual EPS growth rate of 44.2%. 

While I’m aware that past performance is not necessarily indicative of the future, this earnings growth rate is fast by anyone’s standard. Over the same time period, pre-tax profits increased from €21.91m to €159m. 

While there are threats from cost inflation and rising energy prices, the business still achieved operating cash flow of €28.3m in the first three months of 2022. Furthermore, it had a healthy cash position of €86.8m in March.

Rapid profit growth

The share price of Keywords Studios (LSE:KWS) has been similarly volatile recently. While down 11% in the past year, it’s fallen 16% in the last six months. The shares currently trade at 2,300p.

Between 2017 and 2021, EPS rose from ¢31.18 to ¢89.24. This means that the company – which provides support services for the gaming industry – had a compound annual EPS growth rate of 23.4%. While this is slower than Atalaya Mining, it’s still a very solid rate.

During this period, pre-tax profits also increased from €12m to €48m.

In 2021, revenue increased by 37.1% and pre-tax profits grew by over 50%, year on year. These improving financial results enabled the business to reinstate its dividend, with a yield of 0.1%. While this may not seem much, it’s an improvement from 2020, when the company withdrew its dividend.

In any case, I’m attracted to the firm for its growth potential, not for an income stream.

What’s more, higher game player numbers and a slate of new game launches mean that the coming years may continue to be profitable for the company. However, there is the threat that the cost-of-living crisis leads to a decline in demand for games.  

Overall, both of these firms exhibit consistent and rapid earnings growth. While this is obviously not guaranteed to continue, it’s a good indication of well-run enterprises. In an effort to benefit from quality growth stocks, I’ll be adding both Atalaya Mining and Keyword Studios to my portfolio this month. 

Warren Buffett’s compounding growth

In 1999, a shareholder asked Buffett how he achieved such staggering wealth. He said, “Start early … I started building this little snowball at the top of a very long hill. The trick to have a very long hill is either starting very young or living to be very old.” For Warren Buffett, therefore, time is the greatest barrier to amassing a fortune. 

This is because we can usually only see the power of compounding growth over a relatively long period. It might be surprising, but Buffett acquired 99% of his $100bn after the age of 50 years old. 

So, how do we go about calculating compounding growth? It may be achieved through this formula: 

(V_final/V_begin)^1/t − 1, where V = value and t = time

Breaking this down, we may have a set of data like earnings per share (EPS), that begins in 2017 at 1.3p and ends in 2021 at 4.5p. The ‘final value’ is 4.5p and the ‘begin value’ in 1.3p. Dividing these gives us 3.46. The time period is five years, so t = 5. We therefore calculate 3.46^(1/5), which equals 1.28. Finally, 1.28 − 1 = 0.28, so our compounding annual growth rate of this set of EPS is 28%.

Some of Warren Buffett’s biggest holdings, like McDonald’s, exhibit consistent growth in this way. It is therefore a key part of his investing strategy.

2 FTSE AIM stocks that fit the bill

I’ve found two FTSE AIM shares that have consistent earnings growth based on Warren Buffett’s technique. The first, Atalaya Mining (LSE: ATYM), is a copper mining company operating in Spain. Using the formula above, I have calculated its earnings growth over the five calendar years from 2016 to 2020 as 14.4%. 

What’s more, the company is using the profits that it keeps, the ‘retained earnings’, for further expansion. For instance, it is building a new industrial plant to create more efficient mining of copper and reduce its carbon footprint. Just last month, however, it stated that the budget may need to be revised if gas prices stay as high as they are.

The second stock is dotDigital Group (LSE: DOTD), a software marketing automation platform. As per the calculation, for the period between the years ended 30 June 2017 and 2021, this company boasts a compounding annual growth rate of 10.8% for its EPS. Again, this is strong, consistent, and adheres to Warren Buffett’s principle.

Although Canaccord recently downgraded the shares based on apparent “slowing momentum”, retained earnings are being directed towards research and development. This has resulted in a 22% increase in revenue from better product functionality, as recorded in a trading update for the six months to 31 December 2021.

Strong earnings growth and the competent deployment of retained earnings are important to Warren Buffett. These techniques give me a good chance of obtaining consistent growth over the long term. I will be buying both Atalaya Mining and dotDigital now.   

Novacyt

First up is former penny stock Novacyt (LSE: NCYT). Based on analyst projections, shares in the clinical diagnostics specialist trade on just five times earnings. That seems ludicrously cheap considering this month’s half-year numbers.

Total revenue jumped 50% to £94.7m in the first six months of 2021 compared to the same period last year. A little under £54m of this came from overseas orders and the private UK testing market. The latter includes buyers operating in, for example, the film and travel industries.

Looking ahead, Novacyt thinks there could be more growth ahead thanks to fresh contracts, a new PROmate Covid-19 test launch, travel routes reopening and the colder weather arriving. While this all sounds great, there’s a chance that the last two of these won’t happen as quickly as the company would like. An ongoing dispute with the Department of Health and Social Care isn’t ideal either. 

Taking into account how volatile the shares have been over the last year, Novacyt is still only a cautious buy for me.

Serica Energy

Another ‘cheap’ AIM stock is Serica Energy (LSE: SQZ). The North Sea-focused oil and gas company’s shares trade on just five times earnings. That might prove a bargain in time.  In July, SQZ announced promising flow test results from its 50%-owned Columbus development well. The stabilised rate was “at the upper end” of what Serica expected. Once up and running, it’s believed the well will produce roughly 7,000 boe/d (barrel of oil equivalent per day).     As someone with only mixed success in this sector, I’m hesitant to buy shares in Serica. That said, I like that the company began 2021 with no debt and £90m in cash. The fact that the AIM stock is already producing from its Bruce, Keith and Rhum fields (previously owned by BP) is another positive. 

However, the risks involved in future drilling campaigns (such as the North Eigg project), not to mention the opportunities available elsewhere, can’t be overlooked. So, Serica would be another cautious buy for me.

Atalaya Mining

For an even lower valuation, I’d check out Atalaya Mining (LSE: ATYM). It’s trading at just four times forecast earnings. 

Atalaya produces copper concentrates and silver by-product at its 100% Proyecto Riotinto site in Spain. It also has an agreement to own up to 80% of Proyecto Touro, a brownfield copper project in the same country. And, based on recent numbers, this is another AIM stock that could prove to be a steal.

Benefiting from a strong copper price, EBITDA rose to just under €100m in the first half of 2021. Like Serica, Atalya also has a strong balance sheet with net cash of €37.8m at the end of June.

Of course, risks abound. Aside from setbacks that plague exploration, ATYM is never in complete control of its fate. Long-term demand for copper looks robust but commodity prices can be very hard to predict in the near term. That’s fine if I’m being paid to wait. However, there’s no dividend stream with Atalaya.

It goes on my watchlist for now.