Armed with a quality checklist, this stock screen reveals profitable and dependable listed companies.
The political heat is rising in Westminster and the likely outcome of Brexit remains far from certain. So what impact is this having on UK shares?
In one sense you could argue that there's an inescapable sense of tension in the market. Index valuations have risen since the summer, but it's hard to claim that equities are rallying. But some shares seem to be oblivious to the problems around them, and in some cases their prices have been surging. Brexit? What Brexit?
For individual investors, one of the interesting consequences of all this uncertainty is that there's been much more discussion about the general risks that companies face. Where do they make their money? What would happen if the pound plummeted or investor sentiment slumped? How they might be affected by various economic scenarios?
This of course is bread-and-butter stuff to company analysts, but Brexit is perhaps forcing more investors to really think about these issues. It has sharpened the focus on "what if?" - and that's no bad thing.
Some companies are doing a great job of explaining the facts. Take Next (LSE:NXT), for example. This week the retail giant issued a solid set of half-year figures. But with them came a detailed analysis of the likely impact of Brexit on its business - and it has been doing this for a while. For boss Lord Wolfson, the prospect of leaving the EU doesn't seem to hold much concern. Some might disagree, but at least Next is explaining where the important moving parts are.
Another company that has considered the outcome of Brexit is Rightmove plc (LSE:RMV), the online property sales and lettings portal. This is a business that the market loves, but you would think it's sensitive to the housing market. Could an economic shock cause problems? Rightmove doesn't think so - in fact it appears to be confident of withstanding any outcome.
So what is it that makes a company like Rightmove such a resilient business? The answer is that it displays many of the characteristics of some of the highest quality companies in the market. This is a topic we like to cover in this column because the most profitable, efficient and financially safe stocks are surprisingly easy to find with some basic financial ratios. So here's a quality checklist...
Signposts to high quality shares
Return on capital employed - or ROCE. The return a company generates from the investment in makes in itself. A high return on capital, particularly over a long period, can be a pointer to stocks with strong and defensible brands and franchises that can be rolled out very profitably.
Operating margin. High margins are often a hallmark of companies that can command high prices from their customers and have strong competitive advantages.
Return on equity. This is the technical term for comparing a company's net income to all the cash that investors have put into it. It's a popular way of comparing the profitability of companies in the same sector. ROE varies from industry-to-industry, but 15% is generally thought to be desirable.
Free cash flow to sales. This useful comparison measures the proportion of sales revenues that actually turn into cash after everything else has been paid. Companies are sometimes criticised for producing impressive-looking accounts yet fail to generate hard cash. This cash flow ratio should help to spot them.
With these profitability measures in mind, this week's Stockopedia screen puts them to work to get an idea of some of the highest-quality FTSE 350 stocks. The results are sorted by ROCE because it's a useful initial starting point in the search for profitability and efficiency. The table also includes the one-month relative price strength of these shares so show how they've performed relative to the FTSE All Share over the past year.
|Name||Forward P/E Ratio||Forward Yield %||ROCE % 5y Avg||ROE % 5y Avg||Op Mgn % 5y Avg||Rel Strength % 1y|
|Games Workshop (LSE:GAW)||22.5||2.98||56.15||49.6||23.52||21.3|
|Hargreaves Lansdown (LSE:HL.)||33||2.42||78.31||67.8||60.44||-8.63|
|Auto Trader (LSE:AUTO)||21||1.57||52.79||122.4||60.82||9.61|
|Berkeley Group (LSE:BKG)||12.2||4.79||26.8||28.2||26.35||17|
These rules show just why Rightmove is one of the most consistently profitable businesses in the UK market. Its web-based property search tools for home purchases and lettings have helped it capture a strong position, and that translates into very impressive profitability metrics and a share prices that has held up well over many years.
Others that regularly make this list include the consumer payments specialist PayPoint (LSE:PAY), the popular gaming business Games Workshop (LSE:GAW), investment platform Hargreaves Lansdown (LSE:HL.) and the price comparison website, Moneysupermarket (LSE:MONY). Businesses like these often have the traits of 'economic moats' that insulate them from competition so they can produce strong, compounding returns over long periods.
Good quality, profitable companies can be some of the most dependable investments in the stock market. This is why many of these stocks have been relatively unphased by market uncertainty and the unpredictable outcome of Brexit.
And while they aren't immune to volatility, they can recover quickly. In the investor toolkit there are various ways of measuring that profitability - and they can be used on any occasion to separate those firms that are flattering their figures from those that are genuinely profitable.
It's worth remembering that high-quality stocks can end up with expensive valuations that put them out of reach of investors with an eye for value. But from time to time, even the most popular names go on sale.
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These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.
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