Prompted by a commission to pick my top six stocks for Money Observer’s forthcoming ‘Wealth Creation Guide’, a supplement that goes out in the January edition of the magazine, I’ve reassessed every share ranked by the Decision Engine.
I won’t preempt the article by revealing my selections, but obviously they come from the top ranked shares, those with a score of seven or more that inhabit what is colloquially known as “the buy zone”.
Since the last update on the Decision Engine a month ago, I’ve had a good hard look at Finsbury Food (FIF), Haynes Publishing (HYNS), Tristel (TSTL) and FW Thorpe (TFW) because they’ve recently published annual reports.
It’s also six months since the main reporting season, which means half-year results have been cluttering my feed. I don’t obsess about these like I do annual reports, but I do pick up on things that might change my opinion on what makes a company special, and therefore worth investing in.
If that weren’t enough disruption, share prices have moved up and down, which influences valuations, and….
…I’ve rejigged the Decision Engine algorithm very slightly, so it quantifies my largely subjective views, deciding the extent to which the business is:
I’ve got a lot to report on, and the new criteria are almost indistinguishable from the criteria I’ve been using for years, so I won’t dwell on them now. I’ll dwell on them in the first update of 2018.
The trade column on the right isn’t for you. It’s for me, but you might find it interesting as it shows how I use the Decision Engine to prompt my infrequent trades.
It shows the percentage of the Share Sleuth model portfolio I have notionally invested in each share. If the share scores highly and the portfolio’s holding is low, the Decision Engine’s urging me to add more shares in that company. If the portfolio’s holding is greater than the Decision Engine’s score, it’s urging me to reduce the portfolio’s holding.
If the share scores less than five, it’s urging me to sell it entirely. The reason no Share Sleuth constituent scores less than five is I’ve removed those shares from the portfolio, except Quartix (QTX), which I’ve never added.
Old favourite Castings (CGS), which casts and machines ductile iron parts for heavy trucks mostly, has moved down the rankings due to my ongoing concerns about three big risks it faces:
1. Brexit. Most of Castings’ customers are in Europe. Trade barriers would make it more difficult to compete with large German foundries.
2. Scania. One of Castings’ biggest and oldest customers is now owned by VW (VOW). VW uses German suppliers, and there is a risk Scania might switch.
3. Electric trucks. Electric vehicles have fewer components and they’re made from lighter metals so unless Castings can learn new tricks, its castings may no longer be required in the distant future.
In some ways, Castings defies analysis. A profitable history, and a focus on investment and customer relationships score highly as does constant and equitable management, but it’s not at all obvious how the company will adjust to these challenges.
Events at CNC Speedwell, which machines parts often cast in Castings’ foundries, are worrying.
Hitherto, the machine shop has been a focus of expansion and investment but the business made a loss in the first half of Castings’ financial year and its MD since 1990 has resigned.
Following production problems, new projects have been stopped and Castings is retreating to its core customers. The company believes there are sufficient opportunities to restore growth.
1. Castings’ releases to the stock exchange are so cryptic it’s difficult to know what’s going on.
2. It looks like Castings was trying to adapt, and failed.
3. The core-customer base may shrink rather than expand in the long-term.
Dart's (DTG) the package tour company you’ve never heard of, unless you’re a long-time shareholder (in which case, congratulations) or you live in the north, holiday on the beaches of Europe and take an unnatural interest in the parent companies of the airlines you fly with.
It operates Jet2, an airline, and Jet2holidays, a package tour operator and it’s overtaken Thomas Cook (TCG) to become the second largest UK tour operator judging by the number of passengers it’s licensed to carry. Tui (TUI) (formerly Thomson) remains top.
Tui, which also owns First Choice, got there by acquisition. Jet2 is doing it all by itself.
Revenue and profit increased sharply in the first half-year of Dart’s financial year, even though Jet2 earned less per seat.
That’s because it flew far more flights as it expands southwards with new routes from Stansted and Birmingham.
It looks as though Tui and Thomas Cook have wised up to the challenge. Both have stopped selling Jet2holidays in their stores.
Dart operates no stores and sells most of its holidays directly, which may be the principal reason for its prosperity. Stores, and travel agents, are expensive and Dart is the low-cost challenger.
Next's (NXT) new chairman Michael Roney has bought nearly £200,000 worth of shares in the company. Roney is no stranger to business success.
He was chief of executive of Bunzl between 2005 and 2016.
Rule number 1 in contrarian investing is not to be swayed by the opinions of others, so this event has not changed the Decision Engine’s ranking.
However the Decision Engine does favour executives that hold substantial holdings, so it’s a good start to Roney’s tenure.
Perhaps it’s an unwelcome harbinger for companies like Castings and Haynes Publishing that make money from the internal combustion engine, but engineering and environmental consultancy Ricardo (RCDO) reports a strong rise in orders generally, and in particular for work relating to electric and hybrid vehicles, which now comprise 25% of the total.
I saw little in Solid State's (SOLI) half year results to knock the company from its lofty ranking.
The manufacturer and distributor of rugged electronics reported strong sales but a small drop in gross profit margin, the result of growth in lower margin businesses, principally distribution and batteries.
It recently acquired Creasefield, a battery manufacturer, so perhaps we can expect it to improve manufacturing efficiency there.
Market researcher and prototype low-cost ad agency System1's (SYS1) half-year results confirmed profit may be 60% lower over the full-year.
Consumer goods behemoths like Unilever (ULVR) and Procter & Gamble (PG) have cut their advertising budgets to juice profits.
Conventional wisdom would suggest advertising will recover quickly, because the spending power of these companies is a significant competitive advantage and they won’t want to fall behind in promoting their brands.
New conventional wisdom is Unilever, P&G and the rest aren’t actually growing that fast, so perhaps advertising isn’t working as well as it should.
Falling revenue has been compounded by increased costs.
System1 has rebranded, which may have distracted people from the day job of selling market research. It’s also been expanding in the US, its biggest market.
In other words hiring expensive executives.
I think there is bound to be a temporary element to this. System1 has been extraordinarily, but not consistently, profitable over the last decade.
But I am concerned that it’s becoming a bit of a one product company. That product is ad. testing, which is still growing strongly, and integrated into most of its other products.
Despite all my doubts, System1’s still rated highly by the Decision Engine because of its profitable past and entrepreneurial management.
Vp (VP.) has acquired Brandon Hire, which seasoned investors may remember was listed on the stock market until 2006. It’s given me something to think about. Two things in fact.
As is too often the case with tool and plant hire firms, Vp is heavily reliant on external finance to fund its hire fleet and hire centres.
In terms of net debt and debt like obligations, principally my estimate of the value of operating lease contracts, I reckon Vp is one of the more indebted hire firms listed today.
Yet it also stands out for a good reason: profitability has been stable for a long time.
You wouldn’t necessarily expect this. Builders just hand back equipment if there’s less building going on, which happens periodically, and it’s not uncommon for hire firms to get into dire straits.
I’ve tolerated Vp’s indebtedness on the grounds that, demonstrably, it can handle it. I have two theories why: It’s specialist, and it’s diversified.
The acquisition of Brandon Hire (now subject to a Competition & Markets Authority investigation) is Vp’s biggest ever acquisition and funded entirely by debt.
Brandon Hire has specialist businesses that compliment Vp’s, but it’s also a general tool hire firm.
It looks to me like the acquisition may make Vp less specialist, and more indebted, which is why it’s slipped down the rankings.
Treatt (TET), Dewhurst (DWHT) and Victrex (VCT) have published preliminary results but I won’t be updating the Decision Engine until they have published annual reports.
Preliminary results miss out some of the statistical information I need, and often skimp on explaining the company’s strategy and the risks it faces. To be honest, the annual reports often leave me wanting too, but they’re more comprehensive.
Both Victrex and Dewhurst are big exporters, and both were saved from somewhat pedestrian performances by the weak pound.
Treatt made hay, revelling in delivering its strategic plan three years early.
It also raised an equally impressive £21m in a placing, which it’s going to use to build a completely new site in the UK and upgrade its US operation.
The total investment will be £35m. It will surely depress profitability for a while, but I expect it will be money well spent.
Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard
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.