Shares for the future: how I pick the best ones

25th February 2022 15:50

by Richard Beddard from interactive investor

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Buying businesses that prosper through thick and thin is the holy grail for many investors. Our shares analyst Richard Beddard explains how he does it, using tactics employed by a Nobel Prize winning psychologist and investing heroes Peter Lynch, Benjamin Graham and Warren Buffett.

In less than two weeks I will be talking at the Conference of Student Managed Investment Funds (SMIFs) at the University of York. It has got me thinking hard about thinking.

SMIFs are mini financial institutions that run real money. In the US, there are hundreds, some of which run funds worth millions of dollars, but in the UK they are relatively new.

At the last count, the UK had 17 SMIFs. The first, the Griff Fund, was set up at York in 2014, seeded with £10,000 donated by a former student. It is worth about £17,000 today.

The Twikker Fund run by students at Sheffield University claims to be Europe’s largest SMIF. It is worth £200,000.

Having chatted to Natassja Krajewski, the chief executive of the Griff Fund, I can tell you working for a SMIF is a commitment. The 50-or-so analysts in the fund meet weekly during term time, pitching new investments and presenting quarterly or half-yearly updates, which are put to the vote. Sector heads mentor team members, and experienced analysts teach fresher ones.

The students learn about the stock market, share some of the profits with charity, network, and prime themselves for a career in the City. Maybe if there had been a SMIF when I was at university, I would have joined, but I doubt I would have coped with the workload!

Reducing bias, improving decisions

I am an individual, not an institution, but the topic I selected for my talk, bias and decision-making, is relevant to all investors. It is the subject of this column because my Decision Engine is designed to reduce bias and improve my decision making.

I thought it would be an easy talk to prepare. I have, after all, written about the Decision Engine once a month here on interactive investor for about six years, and it evolved from earlier Heath-Robinson spreadsheets designed to beat the market by being more systematic, which I wrote about for many years before.

But any system, if it works well enough, fades into the background. All the user has to do is feed the engine with more data.

To jog my memory about what inspired the Decision Engine, and why I decided to score and rank shares, I have dug deep into my article archive, reading old columns.

Thinking Fast and Slow

The column which started me on this adventure was written in 2012 and archived long ago. It retells a story told by Daniel Kahneman, the psychologist, in his book Thinking Fast and Slow.

In 1955, nearly 50 years before he won the Nobel Prize in Economics, Professor Kahneman was tasked with improving the interview process for the Israeli army.

The existing process involved a 20-minute interview, which the army’s own evaluations indicated was “almost useless”.

Instead, Professor Kahneman created a series of questions eliciting factual information about each of six personality traits. Interviewers were required to ask the questions and score the answers without forming an overall judgement of the candidate’s suitability.

The bias he was seeking to avoid is the “Halo effect”, our tendency to be dazzled by our first impressions of a subject, obscuring things we should be concerned about. If a candidate is good looking for example, we are more likely to regard them as pleasant, honest and intelligent - even when they are not.

The classic example of the Halo effect in investing is past performance. If an investment has increased in price, investors will often be attracted, even though the reasons for its ultimate reversal may be already apparent to a more rigorous analyst.

Professor Kahneman would tot up the scores and use them to determine who to take on, but the interviewers rebelled. They did not want to be reduced to robots mechanically collecting the answers to a questionnaire.

As a concession he instructed the interviewers to close their eyes at the end of the interview, imagine the recruit as a soldier, and score him from one to five. However, he would still have the individual scores from which to calculate his verdict.

The new system was a substantial improvement, but the big surprise was that the intuitive scores of the interviewers were just as good as the algorithmic scores.

Kahneman learned a lesson he has never forgotten: “Intuition adds value...but only after a disciplined collection of objective information and disciplined scoring of separate traits.”

If a Nobel Prize-winning psychologist thought scoring and ranking was a superior way of selecting recruits, I thought it might be a superior way of selecting shares.

All I needed was to establish the traits of a good investment and the questions I would ask of the numbers and a company’s management to establish whether a particular share measured up.

Those criteria and questions have evolved, informed by the writings of feted investors such as Peter Lynch, Benjamin Graham, Warren Buffett and the business strategist Richard Rumelt.

I write up one share a week, scoring it in terms of its profitability, risks, strategy, fairness and price, as Professor Kahneman evaluated recruits under headings like responsibility, sociability and “masculine pride”.

I tot up my scores, as he did, occasionally allowing intuition to intervene, but only after the faithful collection of facts, and once a month I publish the table in rank order.

As always, the highest-ranked shares, those nearest the top of the table, are, according to my evaluation, the best long-term investments.

The Decision Engine

This Thursday morning, as I prepared to file this article and my daughter got ready for work, she looked up from her phone and asked rhetorically: “Why is the news always bad?”

She is a midwife, so she knows good news often does not make the headlines. Even so, the world outside our cocoon in Cambridge seems particularly hostile, and the wind still rattling the windows and the tree still lying in the back garden are like reverberations of more momentous events elsewhere.

I am trying not to let negative thoughts interrupt my quest to find businesses that should prosper through thick and thin. It is my job to find them, it is their job to prosper, and we shall see if they continue to.

Since last month’s update, I have re-scored translator and provider of language and intellectual property services RWS Holdings (LSE:RWS), Victrex (LSE:VCT), a manufacturer of PEEK (a super tough polymer), and bowling alley and indoor crazy golf chain Hollywood Bowl Group (LSE:BOWL).

In compiling the Decision Engine table, their scores have been updated. So too has the price score of all 40 shares:

	Company	Description	Score
1	Cohort	Manufactures military technology, does research and consultancy	8
2	Dewhurst	Manufactures pushbuttons and other components for lifts and ATMs	8
3	Howden Joinery	Supplies kitchens to small builders	8
4	XP Power	Manufactures power adapters for industrial and healthcare equipment	8
5	Goodwin	Casts and machines steel. Processes minerals for casting jewellery, tyres	8
6	PZ Cussons	Manufactures personal care and beauty brands	8
7	James Latham	Imports and distributes timber and timber products	7
8	Next	Retails clothes and homewares	7
9	Portmeirion*	Designs and manufactures tableware, candles and reed diffusers	7
10	Games Workshop	Manufactures/retails Warhammer models, licenses stories/characters	7
11	Focusrite	Designs recording equipment, loudspeakers, and instruments for musicians	7
12	Solid State	Manuf's rugged computers, battery packs, radios. Distributes electronics	7
13	Quartix	Supplies vehicle tracking systems to small fleets and insurers	7
14	Treatt	Sources, processes and develops flavours esp. for soft drinks	7
15	RWS	Translates documents and localises software and content for businesses	7
16	FW Thorpe	Makes light fittings for commercial and public buildings, roads, and tunnels	7
17	Judges Scientific	Acquires and operates small scientific instrument manufacturers	7
18	Victrex*	Manufactures PEEK, a tough, light and easy to manipulate polymer	7
19	Bloomsbury Publishing	Publishes books and online resources for academics and professionals	6
20	D4t4*	Develops and integrates Customer Data Platforms	6
21	Porvair	Manufactures filters and filtration systems for fluids and molten metals	6
22	Anpario	Manufactures natural animal feed additives	6
23	Bunzl	Distributes essential everyday items consumed by organisations	6
24	Tristel	Manufactures disinfectants for simple medical instruments and surfaces	6
25	Churchill China	Manufactures tableware for restaurants and eateries	6
26	Renishaw	Whiz bang manufacturer of automated machine tools and robots	6
27	RM*	Supplies schools with equipment and IT, and exam boards with e-marking	6
28	Oxford Instruments	Manufacturer of scientific equipment for industry and academia	6
29	Trifast*	Manufactures and distributes fasteners and other low cost components	6
30	Hollywood Bowl	Operates tenpin bowling and indoor crazy golf centres	6
31	Softcat	Sells hardware and software to businesses and the public sector	6
32	James Cropper	Manufactures specialist paper, packaging and high-tech materials	6
33	4Imprint	Sells promotional materials like branded mugs and tee shirts direct	6
34	Volex*	Manufactures connectivity components and power cord	5
35	Tracsis	Supplies software and services to the transport industry	5
36	Hotel Chocolat	Chocolate maker and retailer	5
37	Advanced Medical Solutions*	Manufactures surgical adhesives, sutures, fixation devices and dressings	5
38	Castings*	Casts and machines parts for vans and trucks, primarily	5
39	James Halstead*	Manufactures vinyl flooring for commercial and public spaces	5
40	Jet2	Flies holidaymakers to Europe, sells package holidays	4

Scores and stats: Richard Beddard. Data: SharePad and annual reports

Shares marked with an asterisk* score less than 5 out of 6 for Profitability, Risks and Strategy. They are more speculative

Click on a share's name to see a breakdown of the score (scores may have changed due to movements in share price)

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

Richard owns shares in most of the companies in the Decision Engine, particularly those that score highest.

For more information about Richard’s scoring and ranking system (the Decision Engine) and the Share Sleuth portfolio powered by this research, please read the FAQ.

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

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.

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, individuals 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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