14 shares for the future

When there is political turmoil and economic uncertainty it takes a pretty thick skin to be optimistic about any share, but Richard Beddard's Decision Engine is revealing opportunities than ever before.

When there is political turmoil and economic uncertainty it takes a pretty thick skin to be optimistic about any share, but Richard Beddard's Decision Engine is revealing opportunities than ever before.

Like many investors, I grew up during the dot.com crash that started in 2000 and came of age in the financial crisis of 2008. Perhaps we are experiencing another crisis in global capitalism. 

I have no idea how Brexit and all the other political upheavals threatening economic stability will unfold. What kept me going through earlier crises is the conviction that at its best capitalism drives prosperity, so I should focus on capitalism at its best and avoid its worst excesses.

The Decision Engine keeps my attention focused on responsibly managed businesses that provide valuable goods and services, and decide which are the most attractively priced shares. 

I score each share once a year soon after it publishes its annual report, and update the scores if I learn anything significant during the year, judging each business by its profitability, adaptability, resilience, and equitability (see the August update for more detail). 

Having scored the shares, the Decision Engine incorporates their valuations in real time and ranks them. The most attractive shares have the highest scores:

Shares scoring seven or more are good long-term investments in my opinion. Those scoring less than five give me the heebie jeebies.

At this time, five shares are ranked eight or more, which may be unprecedented. I deal with Solid State below, and I profiled XP Power in April, Goodwin in November, Howden Joinery in April, and Dewhurst in January.

Since the last Decision Engine update in November, news from Castings, Solid State and FW Thorpe has caused me to think again...

Castings: Still stuck

Castings is still stuck between a rock and a hard place. Heavy truck manufacturers are increasingly demanding machined parts, but Castings, a foundry that primarily casts the parts, is not very good at machining.

In the half year to September 2018, revenue and profit moved in opposite directions. Revenue increased because machined parts are more expensive but ongoing problems in the machine shop, delays passing on rising steel prices, and the introduction of new production processes in the foundry reduced profitability.

Losses from machining were reduced somewhat following a change in management. Castings is delivering orders on time again and repatriating business it had to subcontract, which should reduce costs. But the company says it will take an unspecified amount of time for production improvements, efficiencies, and targeted investments to generate significant returns.

The overall reduction in profit was very modest, but it would have been worse had Castings not increased the useful life of recently acquired machines for accounting purposes. The company is spreading their cost over 15 years, rather than 10, reducing the annual depreciation charge.

This could be accounting trickery designed to flatter profits, but I am inclined to give Castings the benefit of the doubt. Perhaps not surprisingly given its struggle to generate a return from its investment in machining, it intends to get the maximum value from the machines it has bought rather than continuing to splurge on new ones - especially as it is focusing ambitions on its core heavy truck market.

Although the extended duration of the machine shop's turnaround is unnerving, Castings remains profitable. I do not think it is necessary to change the score I gave the firm when I evaluated it in August, which recognised the considerable risks Castings faces.

Solid State: Big acquisition is no surprise

Solid State improved revenue and profit modestly in the half-year to September 2018, however it expects more from the second half due to a burgeoning order book. The big news, though, is the acquisition of Pacer Technologies in November.

Pacer joins Solid State's value-added distribution division, which customises and distributes electronic components. Pacer supplies displays and optoelectronics (LEDs, light sensors and lasers for example), bringing Solid State new customers in the growing medical sector, and a new production facility for the whole group.

The acquisition should come as no surprise, in fact it was overdue. Solid State has grown by acquisition and for a number of years it has been promising a large one, its first in the £5 million ballpark (about two times Solid State's annual operating profit). Pacer cost £3.73 million, but add the £1.5 million in borrowings on the company’s balance sheet at its year end in March and you get to £5 million.

What has taken me aback slightly is the valuation. Solid State's acquisition history is littered with bargains but, as I anticipated when I scored the company last July, larger acquisitions are unlikely to come as cheaply. Pacer achieved operating profit of a fraction over £500,000 in 2018. On a debt-adjusted basis, Solid State paid nearly 13 times earnings for Pacer, which is a higher valuation than Solid State's (11 times earnings).

No doubt Solid State expects to lift group revenues by more than the addition of Pacer's sales by selling its own products to Pacer's customers and Pace's products to customers of the rest of the group. In its final set of results as a private company, Pacer anticipated a "further increase in profitability" in 2019 after years of investment.

These expectations will have to be realised for Pacer to be worth the money.

FW Thorpe: Harder times are here at last

FW Thorpe, said operating profit at the half-year about to conclude will be 10% lower than last year and although orders are recovering and the company has reduced costs by closing a production line, it does not expect to recoup all the lost profit in the second half of the year.

Thorpe has been warning of a lighting industry downturn for some time, but contraction is a new experience for all but the company's most seasoned shareholders due to the rapid adoption of LED lighting systems, which has lifted demand over the last decade even when fewer new buildings were under construction.

I am told there remain significant opportunities to supply LED lighting systems to hospitals, and for rail and street lighting projects, but apparently it is no longer enough to completely mask the natural ebbs and flows of the construction cycle.

My view is unchanged since I somewhat anxiously reviewed FW Thorpe's results in November, but we should not overlook the many qualities of the business. It will probably grow in most of the years ahead.

Computacenter is a new addition to the Decision Engine. An IT reseller, it has caught my eye because of consistently improving returns on capital, which suggest the business is not only getting bigger, it is getting better. The demise of the so-called "box-shifters" has long been anticipated as hardware and software companies sell products and services directly over the Internet, but they still play an important role. In fact, I have my eye on another one: Softcat, which is even more profitable. I have already scored it 6 (provisionally - a full profile will follow in the New Year).

Growth eluded James Halstead in 2018, a fantastically profitable business that pays most of its profits as a dividend. It is as dependable as a carthorse but valued like a racehorse.

Finsbury Food is a decent business grinding out results in a tough market, but in my opinion it is paying its executives too much. My attitude towards excessive pay hardened while I was reviewing Tristel, one of my favourite business married to one of my least favourite executive pay schemes, and as a result, I have reduced Finsbury Food's ranking too.

Both companies score less than five, Tristel's valuation is sky-high, and I cannot see Finsbury Food's situation getting any easier.

Avon Rubber and Treatt have published annual reports, which I will review and update soon, and we can also expect annual reports from Victrex and Dewhurst early in the New Year. 

Richard owns shares Castings, Solid State and FW Thorpe as well as many of the companies included in the Decision Engine. 

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.