This year, like last year and the year before, I am using my ‘decision engine’ to select six shares for the annual Wealth Creation Guide.
The decision engine allows me to compare corporate apples and oranges: small companies and large companies, defence technology companies and kitchen suppliers. It’s a ranking system that uses five criteria: profitability, resilience, adaptability, equity and value.
The highest-ranked firms earn high returns on capital. They have advantages likely to sustain that profiftability, and strategies that build on those advantages.
They treat customers, shareholders, staff and suppliers fairly. If that weren’t a demanding enough list,the shares should be relatively inexpensive too. Though companies rarely score a perfect 10, I’m perpetually on the lookout for the best combination of factors, which I believe will earn investors high returns over the long term.
Fund manager Terry Smith has a good line about annual performance.
In Fundsmith’s Owner’s Manual, he writes: “… a year is a short period to measure things by. Moreover, a year does not have its foundations in the business or investment cycle. It is, in fact, the time it takes the earth to go around the sun and is therefore of more use in studying astronomy than investment.”
So these are early days for the two small bundles of shares previously picked using the decision engine; however, including dividends, they’re handily beating an equivalent investment in the FTSE-All Share index (ASX).
Only one past selection is losing money. It’s Next (NXT), selected last time, which returned -8 %. The winners are more impressive. Renishaw (RSW), one of 2016’s growth selections and XP Power (XPP), one of 2017’s, have performed so well that they are currently priced out of contention.
Renishaw shares have risen from £19.23 two years ago to £54.50 today, an increase of 183%. A year ago XP Power shares would have set you back £17.30 each. Today they cost more than twice that much (£35.00).
Share price 713p; earnings yield 8%; dividend yield 1.6%
Dewhurst (DWHT) has featured in both my previous selections. It’s a manufacturer of lift and ATM components, which made its name in pushbuttons but diversified the product range to LCD touchscreens as interfaces proliferated. The company should continue to prosper because its high-quality products are well-regarded by the lift consultants who specify them.
Share price 400p; earnings yield 11%; dividend yield 1.6%
System1 (SYS1) uses techniques from behavioural science to test advertisements and concepts.
Profits in the current year will take a substantial blow because its biggest customers – consumer giants like Unilever (ULVR) and Procter & Gamble (PG) – slashed advertising to boost profits. Simultaneously System1, formerly BrainJuicer, spent more on rebranding and hiring executives in the US, its biggest market.
But the company is highly entrepreneurial and a pioneer in the application of behavioural science. It should weather the storm.
Share price 314p; earnings yield 9%; dividend yield 2.3%
Since it floated in 2006, Cohort (CHRT) has assembled four defence technology businesses from acquisitions. Although the outlook for defence spending is unclear and Cohort is dependent on the UK Ministry of Defence, it has achieved high levels of prosperity through many years of austerity, probably by positioning itself in priority areas such as intelligence, surveillance, electronic warfare and cyber-security. Meanwhile, an export drive and the acquisition of EID are broadening the customer base.
Howden Joinery (HWDN)
Share price 443p; earnings yield, 6%; dividend yield 2.4%
Uniquely among major kitchen suppliers, Howdens (HWDN) only sells to the trade. From designing the kitchens so they are easy to fit, to giving the builder credit, Howdens generates goodwill and repeat business.
Builders are Howdens’ sales force, saving it the cost of running expensive showrooms. This symbiotic relationship means Howdens should continue to dominate its niche as it rolls out new depots in the UK and potentially in Europe.
Share price 168p; earnings yield 9%; dividend yield 4.2%
Once an indebted mini-conglomerate, Alumasc (ALU) has shed a number of businesses and slowly morphed into a group of market-leading or challenger building material suppliers.
They manufacture drainage systems and solar shading, for example – generally products that go on the outside of a building to keep it warm, cool it down, or protect it from rain. These materials need to look good and comply with building and environmental standards, so customers may be prepared to pay more for them.
Alumasc believes it can grow faster than the wider market, while paying a decent dividend.
Solid State (SOLI)
Share price 443p; earnings yield 7%; dividend yield 2.7%
Solid State (SOLI) returns for a second year. The company specialises in manufacturing rugged computer and communication systems, and batteries for a wide range of industries.
It also distributes electronic components.
Specialist expertise, and the accreditation to handle dangerous materials and sensitive information, mean competition is often limited.
Solid State makes big profits for a small company, and it’s growing by acquisition too, buying inexpensive but less efficient companies and bringing them up to its own standards.
This article was originally published in our sister magazine Money Observer. Click here to subscribe.
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