10 star shares for the future

by Richard Beddard from interactive investor |

From his 30-stock portfolio, our companies analyst names his favourites and shares that face the chop.

Since the last Decision Engine update five weeks ago, dotDigital (LSE:DOTD), a developer of digital marketing software, and Softcat (LSE:SCT), a hardware and software reseller, have joined the Decision Engine. They take the total number of shares ranked to 30.  

Think of a football club. A portfolio is the first team. The first team is picked from the squad, which is all the companies currently available for investment whether they are in the first team or in the reserves. The Decision Engine is my squad, the shares I have scored and know well enough to invest in. It is ranked to make it easier to choose which shares to pick for the first team. The top, say, 20 shares, in my opinion, make a good portfolio.

Thirty is a large number of shares for one person to keep tabs on, while also scouting for new opportunities. It may not be the maximum squad size, but it feels close. To keep the squad manageable, and improve its quality over time, I must swap weaker squad members for stronger new recruits as I discover them.

Companies “at risk”

You might think that the lowest scoring companies would be at highest risk of expulsion from the Decision Engine. That bottom ranked James Halstead (LSE:JHD), a manufacturer of vinyl flooring, will be the first up against the wall when a new share gets a high score. But James Halstead and most of the other low-ranking shares are not at risk, at least not imminently. Before I explain why, let me remind you of the criteria I use to score the shares. 

There are five, each of which is scored out of two to give a total out of 10. They are:

1.    Profitability: Does the company make good money?
2.    Risks: What could prevent it from growing profitably?
3.    Strategy: How will it overcome these challenges?
4.    Fairness: Will we all benefit?
5.    Value: Are the shares cheap?

The table below shows how each company scores in the first five columns on the left, as well as the total score (the column c1 is profitability, c2 is risks, c3 is strategy, c4 is fairness, and c5 is value):

As I said, all of the criteria score a maximum of two. The first four criteria, which all refer to the quality of a business, score a minimum of zero. The fifth, value, is scored between -2 and 2. In other words companies on high valuations (an enterprise multiple of more than 25) get a negative score.

The bottom eight shares in the list are penalised in this way. They are good businesses, in other words, but the shares are expensive. All it would take to move one of these shares up the ranking is a significant fall in its share price.

We can even quantify how good these businesses are: James Halsted scores six out of eight for the four business quality criteria. The other seven shares, Treatt (LSE:TET), Renishaw (LSE:RSW), Churchill China (LSE:CHH), Porvair (LSE:PRV), dotDigital (LSE:DOTD), Avon Rubber (LSE:AVON) and Tristel (LSE:TSTL) score seven. James Halstead languishes on a score of 4.8 because 6 minus 1.2 (the value score) is 4.8.

To my mind, these companies are expensive for a reason. Traders can see they are good businesses and they are performing well enough, so the share price is high relative to profit. Having established that they are good businesses I do not want to forget about them, even though they look pricey because stock market traders are not known for the consistency of their opinions over time. Should these shares fall out of favour, they will shoot up the Decision Engine rankings as their valuations get cheaper, and I may want to include them in my portfolios. 

The businesses most at risk are those I am less confident about, either because they generally score less well in terms of business quality or because they score zero for one particular business criterion. Four shares (marked in pink in the table) scored less than six out of eight the last time I profiled them (they all scored five). They are: Castings (LSE:CGS), Portmeirion (LSE:PMP), RM (LSE:RM.) and Trifast (LSE:TRI). Two companies scored zero for a single criterion. They are Next (LSE:NXT) (for risks) and Castings (LSE:CGS) (also for risks). 

These five companies will be the first up against the wall. To see why, you can read the articles in which I scored them. Normally, we include the link in the table, but with the addition of extra columns this time, there was no space. There is a way though to find these articles quickly. For any of the shares in the Decision Engine just copy and paste this link into your browser:

http://bit.ly/swXXX2019

And change the XXX to the company’s stock market ticker code. For example, XP Power (LSE:XPP) is:

http://bit.ly/swXPP2019

There is one exception, Treatt, which I am profiling next week. You can read my profile from December 2018 here: http://bit.ly/swTET2018.

Richard owns shares in most of the shares ranked by the Decision Engine, including Avon Rubber, Castings, Churchill China, Portmeirion, Next, Renishaw, RM, Treatt, Trifast, and Tristel, which are mentioned in the text.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.

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, and 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.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

Details of all recommendations issued by ii during the previous 12-month period can be found here.

ii adheres to a strict code of conduct. Members of ii staff may hold shares in companies included in these portfolios, which could create a conflict of interests. Any member of staff intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. We will at all times consider whether such interest impairs the objectivity of the recommendation

In addition, staff involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.

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