Avoid a Halloween shock with these stable, high-quality companies with a history of profitability.
As 31 October draws ever closer and the prospect of a no-deal Brexit becomes increasingly more likely, we should consider the potential impacts of the B-word on our investments. When the storm clouds start to swirl, it pays to reposition your portfolio to ensure that it is robust enough to weather macro shocks.
One way of doing this is to capture a broad spread of sectors and geographies by investing in solid, profitable large-cap companies.
While the UK market represents good value from an earnings and dividend yield perspective, the possibility of short-term turbulence appears to be on the rise - and it is during such periods that the pressure builds, our fingers hover over the 'panic' button, animal instincts take over, and the scope for making costly and uninformed trades increases.
The British economy contracted by 0.2% from April through June. This was the first quarterly decline since 2012, according to the Office for National Statistics. Is this unwelcome economic update an omen of things to come? Certainly, some have begun talking up the possibility of a recession.
News of 'Operation Kingfisher' - the government's evolving bailout package for businesses at risk of a no-deal Brexit - should sharpen minds. Certain companies might be heading for serious trouble in the coming months and these companies should, ideally, be avoided by investors in the short-term. It seems possible that the same dynamics that decided the market gyrations in 2016 might play out again.
Those businesses most at risk might be low-margin importers of foreign goods who sell domestically in sterling and are, perhaps, not used to routinely hedging currencies. Car manufacturers and food exporters have been touted as at risk, while any low-margin investments should be carefully evaluated as a matter of course.
Screening for Brexit-proof companies
To find companies that are relatively well-insulated from Brexit headwinds, we can screen for UK-listed large-caps with operating margins of over, say, 10%. This means that they have some room to play with should costs begin to increase.
Another measure to reduce risk is to exclude any companies with too much debt or too high a pension deficit. The screen below ensures the resulting companies have a net gearing (including pension deficit) of no more than 50%. This way we can be sure that annual debt obligations or pension commitments won't push these otherwise healthy companies into losses.
One further check we can add is for stocks that have had historically low levels of share price volatility. We can do this with RiskRatings, a classification system that splits the market into five groups according to their annualised adjusted share price volatility.
The five classifications (from least to most volatile) are Conservative, Balanced, Adventurous, Speculative and Highly Speculative. At any time, 10% of the market will be classified as Conservative, 15% Balanced, 20% Adventurous, 25% Speculative and 30% Highly Speculative.
For this screen, I am looking at only the two most stable stock price classifications: Conservative and Balanced. Here are the results:
|Name||Mkt cap (£m)||Op margin (%)||Risk rating||Sector||% UK sales|
|Carnival (LSE:CCL)||24,673.70||17.56||Balanced||Consumer Cyclicals||31.6**|
|Whitbread (LSE:WTB)||5,668.20||14.11||Balanced||Consumer Cyclicals||99|
|Informa (LSE:INF)||10,600.20||17.89||Conservative||Consumer Cyclicals||7.7|
|Homeserve (LSE:HSV)||3,697.30||15.21||Balanced||Consumer Defensives||39|
** Carnival (LSE:CCL) sales not split out; Europe revenue is reported instead
The table above presents a reasonably diversified group of stable large-cap stocks with comfortable operating margins. Most of them have diversified revenues across multiple continents (the '% UK Sales' figures are taken from each company's most recent Annual Report). All of them exhibit relatively low levels of share price volatility.
When the going gets tough, stable, high-quality companies with a dependable history of profitability tend to outperform. This kind of stock can provide your portfolio with some conservative spine to help you sleep at night and safely navigate stormy waters.
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