Seven shares for the future

by Richard Beddard from interactive investor |

Our stock analyst is unhappy with just seven ‘magnificent’ picks. The solution is simple but not easy.

For a number of years now we have given this article, published every five weeks, the same title: “‘X’ shares for the future”, where X is a number, and the future alludes to the long-term. This version of the article, though, is the first where X has been less than 10. 

While it will not go down as a seminal event in stock market history, like Black Monday or The Great Crash of 1929, every time I think about it, I feel a bit uneasy. Right now, as I write about this number, my throat feels dry, betraying anxiety, perhaps even a tinge of panic.

Not so magnificent seven

What does this number mean, that it could have such an effect on me? It is the number of shares out of the 30-or-so that I rank using my Decision Engine that score 7.0 or more out of 10. The score is derived from five criteria, four relating to a firm’s quality, and the fifth relating to its valuation. 

Hitherto, I have used a score of seven to determine which shares to recommend for long-term investment. Shares that score seven or more have sufficient quality and value. This is nice and simple, it gives us our catchy headline, and I have used it to show readers which shares I would buy now if I were to start a portfolio from scratch.

Under current circumstances though, it is not very realistic. The share prices of the companies I have been following, some of them for more than a decade, have soared in 2019 and the tiny bit of 2020 we have already experienced, increasing their valuations. The scoring system penalises shares on very high valuations, by giving them a negative valuation score. Lots of companies are scoring less highly than they were, and the number scoring more than seven has fallen to 7. I don’t think I would ever be comfortable holding a portfolio that small and I feel a bit of a flop for not having dug up more opportunities that are both good and cheap.

The answer to this problem is, as always, simple but not easy. I need to find companies of equal quality or better trading at lower valuations. It’s simple because I can express it in a sentence. It’s not easy because the quality hurdle is high. The Decision Engine is full of good businesses that I know quite a bit about. Learning enough about new businesses to unseat the existing ones takes time and often what I learn will lead me to believe they are not good enough.

This is where the arbitrary, all-or nothingness of using a score of 7 to determine which shares are good long-term investments becomes a pain. In constructing my portfolios, I never use it. I think that all of the shares are good enough to hold for the long-term and I aim to own more of the highest ranked shares and fewer or none of the lowest ranked, depending on the size of the portfolio. 

Shares scoring more than 7.0 are merely the ones I have most confidence in, the best of the best, those that I am confident are not overvalued, but I personally own shares that rank as low as 29 and score as low 5.3 (Tristel (LSE:TSTL)). I suppose you might call them fairly valued, and I think it is better to hold shares in fairly valued companies than none at all.

Thinking in terms of absolutes can engender a kind of madness. A company doesn’t become a bad investment if it falls from 7.1 to 6.9 any more than it would if its price/earnings (PE) ratio rose from 19.9 to 20.1. Changes in valuation have a gradual impact on the attractiveness of an investment - otherwise we would be trading frenetically every time the share price triggered one of these absolutes. 

Triggers are for traders, long-term investors need to focus on their best ideas, which is why I rank mine. If I were to start a portfolio from scratch today, I would probably choose the 10 shares (those scoring more than 6.7), the top 15 (those scoring more than 6.3), or the top 20 (those scoring more than 5.9), although I would also consider staggering the investment to take advantage of any opportunities that arise over the year.

A man’s gotta do what a man’s gotta do...

I am pleased to report the cloying in my throat is clearing, partly because I have done away with an arbitrary complication, and partly because I know what I have to do. The average score of all 30 shares in the Decision Engine is 6.4, and, if I can nudge it up, that should improve our prospect of good returns over the long-term. 

In other words, I still have to find equally good companies at better valuations, but this is a marathon and not a sprint. The worst thing to do would be to panic and replace good companies just because they are a bit pricier than I would like with bad companies that are cheap, probably for good reason.

Last weeks write-up of Victrex (LSE:VCT) will be the last one where I judge a company by its absolute score. I will still report the score, but I will also report the rank so you can see how confident I am in the share in comparison to all the other shares I follow closely. Victrex scores 7.5, which ranks it third, as you can see from the Decision Engine table below:

Score Name Description
7.7 PZ Cussons (LSE:PZC) Manufactures personal care and beauty brands, in the main
7.6 XP Power (LSE:XPP) Manufactures power adapters for industrial and healthcare equipment
7.5 Victrex (LSE:VCT) Manufactures PEEK, a tough, light and easy to manipulate polymer
7.1 Anpario (LSE:ANP) Manufactures natural animal feed additives
7.1 Goodwin (LSE:GDWN) Casts and machines steel. Processes minerals for casting jewellery, tyres
7 Castings (LSE:CGS) Casts and machines parts for vans and trucks primarily
7 Howden Joinery (LSE:HWDN) Supplies kitchens to small builders
6.9 RM (LSE:RM.) Supplies schools with equipment and IT, and exam boards with e-marking
6.8 Portmeirion (LSE:PMP) Designs and manufactures tableware, candles and reed diffusers
6.7 FW Thorpe (LSE:TFW) Makes light fittings for commercial and public buildings, roads, and tunnels
6.7 Judges Scientific (LSE:JDG) Buys and operates small scientific instrument manufacturers
6.7 Next (LSE:NXT) Retails clothes and homewares
6.5 Solid State (LSE:SOLI) Manufactures rugged computers, batteries, radios. Distributes components
6.4 Games Workshop (LSE:GAW) Manufactures, retails Warhammer miniatures for collectors, gamers
6.3 Hollywood Bowl (LSE:BOWL) Operates tenpin bowling centres
6.3 Softcat (LSE:SCT) Sells hardware and software to businesses and the public sector
6.2 Bloomsbury (LSE:BMY) Publishes books, provides online collections to professionals and academics
6.2 Renishaw (LSE:RSW) Whiz bang manufacturer of automated machine tools and robots
5.9 Quartix Holdings (LSE:QTX) Supplies vehicle tracking systems to fleets and insurers
5.9 Dart (LSE:DTG) Flies holidaymakers to Europe. Trucks fruit and veg around the UK
5.8 Trifast (LSE:TRI) Manufactures and distributes nuts and bolts, screws, and rivets
5.8 Churchill China (LSE:CHH) Manufactures tableware for restaurants and eateries
5.7 Cohort (LSE:CHRT) Manufactures military tech. Does research and consultancy
5.7 Dewhurst (LSE:DWHT) Manufactures pushbuttons and other components for lifts and ATMs
5.6 Porvair (LSE:PRV) Manufactures filters and filtration systems for fluids and molten metals
5.6 dotDigital (LSE:DOTD) Developer of marketing automation software
5.3 Avon Rubber (LSE:AVON) Manufactures respiratory protection and milking equipment
5.3 Tristel (LSE:TSTL) Manufactures disinfectants for simple medical instruments and surfaces
5.2 Treatt (LSE:TET) Sources, processes and develops flavours esp. for soft drinks
4.7 James Halstead (LSE:JHD) Manufactures vinyl flooring for commercial and public spaces

As for future headlines. I think we’ll stick with the old formula. “30ish companies for the future, some more attractive than others” doesn’t have the same ring to it.

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.

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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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