Shares for the future: how I’ll find great cheap shares in 2022
30th December 2021 13:03
by Richard Beddard from interactive investor
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This value investor’s portfolio offers reasons to be cheerful, but he must work even harder to find good businesses at the right price. This triple New Year resolution should help him do it.
Inevitably, I am thinking about the year we have just experienced, and that is making me ponder my approach to investing and whether I can improve it.
Decision Engine PLC
The lens through which I view the stock market is my Decision Engine, a ranked list of shares I consider to be good long-term investments.
The year started with only 32 shares in the list, plus six more that I had suspended and included in a separate sub-table of speculative shares because they were at the sharp end of the pandemic, and I no longer trusted my scores.
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The average score for the 32 was 6.8, which meant Decision Engine shares were, as a group, on the cusp of good value, at least judging by my arbitrary dividing line between shares to buy and shares to hold.
As a rough rule of thumb, I think of shares that score 7 or more out of 9 as good value, and shares that score 5 to 7 as fairly priced. Shares that score less than 5 are more likely to be pricey.
Fast forward a year. As we can see the average score is lower at 6.1:
Factor | Score |
Profitability | 1.8 |
Risks | 1.3 |
Strategy | 1.8 |
Fairness | 1.9 |
Price | (1) |
Average | 6.1 |
That sounds like bad news. Taken as a whole, the Decision Engine may be a less attractive group of stocks for long-term investment.
As we shall see, there are still many attractive shares, and at least part of the decrease in average score is due to a technicality. In financial terms, the average ratios do not look too shabby either, so perhaps there are reasons to be cheerful.
This is how the portfolio would look if it were a single company:
Net debt to capital | -4% |
Return on capital | 33% |
Cash conversion | 74% |
Earnings yield | 5% |
Decision Engine PLC has more cash than debt, it is highly profitable, reasonably cash generative, and while the shares are not obviously cheap, an earnings yield of 5% promises a decent enough return at current levels of profit, and I expect profit to grow considerably over the long term.
Now for the technicality. In April, I reduced the positive influence of the price score. The lowest price score a company can achieve remains -2, penalising shares that trade on high prices relative to their normalised profits.
I reduced the highest achievable price score from 2 to 1 because I feared the Decision Engine was becoming clogged with cheap but undistinguished companies. This meant the maximum score for each share fell from a satisfyingly stout total of 10 (a maximum of 2 for each factor), to 9 (a maximum of 2 for each factor except price, which has a maximum of 1).
Although the incongruity of scoring out of 9 nearly made my brain explode, it has stuck, so last year’s scores are not strictly comparable to this year’s.
Now for the individual shares. Even though the pandemic is still with us, the suspended shares have been reintegrated and today the Decision Engine has swelled to 40. Twelve shares score seven or more:
Company | Description | Score |
Manufactures pushbuttons and other components for lifts and ATMs | 8 | |
Manufactures military technology, does research and consultancy | 8 | |
Manufactures personal care and beauty brands | 8 | |
Casts and machines steel. Processes minerals for casting jewellery, tyres | 8 | |
Manufactures PEEK, a tough, light and easy to manipulate polymer | 8 | |
Imports and distributes timber and timber products | 7 | |
Manufactures power adapters for industrial and healthcare equipment | 7 | |
Supplies kitchens to small builders | 7 | |
Designs and manufactures tableware, candles and reed diffusers | 7 | |
Publishes books and online resources for academics and professionals | 7 | |
Retails clothes and homewares | 7 | |
Supplies vehicle tracking systems to small fleets and insurers | 7 | |
Makes light fittings for commercial and public buildings, roads, and tunnels | 6 | |
Manufactures/retails Warhammer models, licenses stories/characters | 6 | |
Manuf's rugged computers, battery packs, radios. Distributes electronics | 6 | |
Acquires and operates small scientific instrument manufacturers | 6 | |
Manufactures filters and filtration systems for fluids and molten metals | 6 | |
Manufactures natural animal feed additives | 6 | |
Develops and integrates Customer Data Platforms | 6 | |
Distributes essential everyday items consumed by organisations | 6 | |
Supplies schools with equipment and IT, and exam boards with e-marking | 6 | |
Whiz bang manufacturer of automated machine tools and robots | 6 | |
Manufactures tableware for restaurants and eateries | 6 | |
Manufactures specialist paper, packaging and high-tech materials | 6 | |
Manufactures and distributes fasteners and other low cost components | 6 | |
Sells hardware and software to businesses and the public sector | 6 | |
Sells promotional materials like branded mugs and tee shirts direct | 6 | |
Translates documents and localises software and content for businesses | 6 | |
Manufacturer of scientific equipment for industry and academia | 5 | |
Manufactures disinfectants for simple medical instruments and surfaces | 5 | |
Sources, processes and develops flavours esp. for soft drinks | 5 | |
Supplies software and services to the transport industry | 5 | |
Designs recording equipment, loudspeakers, and instruments for musicians | 5 | |
Chocolate maker and retailer | 5 | |
Casts and machines parts for vans and trucks, primarily | 5 | |
Operates tenpin bowling and indoor crazy golf centres | 5 | |
Flies holidaymakers to Europe, sells package holidays | 5 | |
Manufactures connectivity components and power cord | 5 | |
Manufactures surgical adhesives, sutures, fixation devices and dressings | 5 | |
Manufactures vinyl flooring for commercial and public spaces | 5 |
Scores and stats: Richard Beddard. Data: SharePad and annual reportsShares 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)
Regardless of changes in methodology, I must work hard in 2022 to find more good businesses, preferably at cheaper prices. Of course, I say that every year. It is the remorseless logic of value investing. The question is how.
New Year: three resolutions!
One source of regret in 2021 is that, if I count back correctly, I added only three companies to the Decision Engine. They are Advanced Medical Solutions (LSE:AMS), Focusrite (LSE:TUNE) and Oxford Instruments (LSE:OXIG). I dropped only one, Avon Protection.
That means most of the shares I scored in 2021 were shares I had scored in 2020, shares that were already members of the Decision Engine.
Although I think these shares are good long-term investments, there will be better ones among the 2,000 or so listed firms I have not scored in the last year. To make sure I am comparing the shares in my portfolios with decent alternatives I need to give more new shares a chance.
This is how I plan to do it:
- Research more shares. This goal implies less research per share as I do not want to do more work! To be more efficient I must be more ruthless about analysing only what really matters: news and numbers that reveal something about how companies make money and what could stop them.
- Change my attitude. Being a long-term investor, ditching shares goes against the grain. I need to get over that. The Decision Engine is not a portfolio, it is a research list, and just because I have researched a share one year does not mean I must repeat the research every year.
- Reduce the size of my portfolios. Since the purpose of the Decision Engine is to compare my portfolios with new candidates, I must include my Share Sleuth shares in the Decision Engine. The Share Sleuth portfolio hogs 28 slots in the Decision Engine, and I will consider whether it could be smaller in the first portfolio update of the year next week.
So there you have it, a triple resolution for 2022.
This month, as well as re-scoring Tristel (LSE:TSTL), I scored Oxford Instruments and added it to the Decision Engine. To make way for the new share, we say TTFN to DotDigital, a fine business that trades at a very high share price.
I feel liberated. Out with the old, and in with the new, as they say. Particularly at this time of year.
Richard Beddard is a freelance contributor and not a direct employee of interactive investor.
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
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.
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