Interactive Investor

Shares for the future: my reasons for downgrading this top 3 tip

This company still gets the maximum score for its dependable track record and for a cheap share price. But analyst Richard Beddard takes a red pen to his rating of this former star stock.

31st May 2024 15:12

by Richard Beddard from interactive investor

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So...much...news...

That is my three-word summary of the times we live in. It has me wondering whether a practice I have relied on to maintain my sanity for years is fit for purpose.

That practice is to alter the scores I give businesses only once a year when I read the annual report.

Things...keep...happening...

More than I remember in the previous two decades, cracks have developed in businesses where I would not have expected to see cracks.

This fragility is probably the rippling effects of the pandemic and the war in Ukraine, the shortages, the inflation, onshoring, and also the increasing geopolitical rivalry between the West and China, the tariffs, onshoring again, and the possibility of war between superpowers.

Let us add a side note here: technology, maybe in the form of artificial intelligence (AI) and its potential to upend business models.

My whole investing life, I have felt that companies that succeed globally are the real blue-chips because they have shown they can transcend economic problems at home and win almost anywhere.

The last two companies I scored, Garmin Ltd (NYSE:GRMN) and Judges Scientific (LSE:JDG) (to be published next week) are global winners.

I had to think hard about Garmin, which produces most of its brilliant products in Taiwan, a democracy but perhaps not a country, that China might reunify with by force.

I only had to get to the first item in Judges Scientific’s risk report to read this: “The tensions between the West and China may well degenerate into an open conflict.”

Judges Scientific exports around the world, including to China and Taiwan. As its chief executive David Cicurel says, it “thrives with peace and free trade”.

Maybe I am more attuned to risk now because I revamped the Decision Engine scoring system to determine whether a company’s strategy addresses risks last November.

But maybe we are also living in interesting times.

I am not a doom merchant. Even if things are getting worse, they may not continue getting worse. But my stop-gap method of dealing with new information and changes of heart, to put a question mark against the name of shares that I think might change score at the next annual appraisal, is presenting me with a problem.

The more uncertainty there is, the more question marks there are. The more question marks there are, the less potent the Decision Engine becomes. Currently there are two question marks, but I want to add another one.

I am not going to. Instead of adding a question mark, from now on I will re-score a share when I think my shifting perceptions warrant it. This should increase the potency of the Decision Engine and also make it more transparent.

As before, you will be able to read the annual write-up by clicking on a share’s name in the Decision Engine table. Updates will be linked in the “*” column next to it.

Hopefully this will not happen often.

We are going to start with RWS Holdings (LSE:RWS), the translation and localisation firm.

RWS: complexity risk

RWS has diversified to reduce its dependence on translating patents and to acquire capabilities in machine translation - a technology that is disrupting the industry. In the process it has become one of the world’s largest language services companies.

In the last Share Sleuth portfolio update, I worried that I had recognised the increased complexity in RWS when I scored it in February.

But I had not adequately reflected those doubts in the company’s score. A complex business is risky because a lot can go wrong, and also because it is difficult to judge whether the strategy will be sufficient to overcome the risks.

The evidence for this increasing complexity comes in three parts:

  1. RWS does not yet earn a good return on its investments. The after-tax Return on Total Invested Capital (including the price of acquisitions at cost) is 7%.
  2. The company has reacted to the complexity by reducing acquisition activity and focusing on integrating what it has already acquired, simplifying the business around one platform.
  3. Returns are stated after adding back the “exceptional costs” of restructuring and transforming the business, which are significant.

Consequently, I have reduced RWS’ score for “coherent actions” from 1 (out of 1) to 0.5 to reflect my doubts.

I think it needs to simplify, but the incoherence stems from actions the company has taken, acquisitions, which have created the challenge it is now responding to - complexity.

The Future (directed) [1.5]

  • Addressing challenges: Complexity, advancing technology [0.5]
  • With coherent actions: Technology, simplification, acquisitions? [0.5]
  • That reward all stakeholders fairly: Loyal customers, staff? [0.5]

Even before RWS announced last week that chief executive Ian El-Mokadem is to step down, I was beginning to think I had underestimated the risk.

Mr El-Mokadem came in to deal with the complexity in 2021 but will leave some time before early 2025 to “pursue the next stage of his career”. His resignation raises another scoring issue.

Despite the brevity of his three-year tenure on the board, he is the most experienced executive board member. The only other is chief financial officer Candida Davies, who joined in 2022.

There is an executive team beneath board-level, but many of its members are new appointees or came with recent acquisitions, reflecting the rapid diversification of the group.

Non-executive chair Andrew Brode is vastly experienced, having stepped down as executive chairman in 2023, but he is 83 years old and no longer running the company day to day.

The company has yet to appoint a new chief executive, so at least until then I have reduced RWS’ score for “experienced people” from 0.5 to 0.

The Present (distinctive) [1.5]

  • Discernible business: Hybrid man/machine translation at scale [1]
  • With experienced people: Chief executive has stepped down [0]
  • That creates value for customers: Efficiency, security, lower costs? [0.5]

I have also reduced the score for “creates value for customers” from 1 to 0.5.

When translation was a mostly human endeavour and RWS was focused on the intellectual property niche, its competitive advantage came from the translators it employs. They are subject specialists as well as linguists. The value it created was accuracy.

This is still important, but as machines do more of the work, RWS is emphasising efficiency and security, which stems from the machine translation and content management platforms.

On one hand, machines have vastly increased the amount of translation that can be done. On the other they will also change the competitive landscape.

I do not know whether RWS has the best technology and, even if it does, whether that position is defensible as the development of artificial intelligence marches on.

These changes reflect my uncertainty. RWS’ illustrious past means it still scores 3 for its dependable track record. The share price is low compared to normalised profit too, so it scores a maximum 1 for price.

But the present and future are speculative. RWS’ score has fallen from 8.5 to 7.0, and its rank in the Decision Engine table from 3 to 19.

19 Shares for the future

Here is the ranked list of Decision Engine shares. I review the scores once a year, soon after each company has published its annual report.

Generally, I consider shares that score 7 or more out of 10 to be good value. Shares that score 5 or 6 out of 10 are probably fairly priced.

Advanced Medical Solutions Group (LSE:AMS), Anpario (LSE:ANP), Churchill China (LSE:CHH)Judges Scientific (LSE:JDG) and Tracsis (LSE:TRCS) have all published annual reports and are due to be re-scored.

If a share is likely to be downgraded next time I score it, there is a “?” before its name in the table. This is usually because events have revealed something about the company that I had not previously considered adequately.

We will not know for sure until I have scored these companies again, but extra caution may be necessary.

0

Company

*

Description

Score

1

Churchill China

Manufactures tableware for restaurants and eateries

9.6

2

Focusrite

Designs recording equipment, loudspeakers, and instruments for musicians

9.0

3

Dewhurst

Manufactures pushbuttons and other components for lifts and ATMs

8.5

4

Howden Joinery

Supplies kitchens to small builders

8.4

5

Macfarlane

Distributor of protective packaging

8.3

6

? Oxford Instruments

Manufacturer of scientific equipment for industry and academia

8.1

7

Porvair

Manufactures filters and filtration systems for fluids and molten metals

8.0

8

Games Workshop

Manufactures/retails Warhammer models, licences stories/characters

7.9

9

Anpario

Manufactures natural animal feed additives

7.8

10

Bunzl

Distributes essential everyday items consumed by organisations

7.8

11

James Latham

Imports and distributes timber and timber products

7.8

12

FW Thorpe

Makes light fittings for commercial and public buildings, roads, and tunnels

7.7

13

Advanced Medical Solutions

Manufactures surgical adhesives, sutures, fixation devices and dressings

7.6

14

? PZ Cussons

Develops and manufactures hygiene, baby, and beauty brands

7.5

15

Marks Electrical

Online retailer of domestic appliances and TVs

7.4

16

Victrex

Manufactures PEEK, a tough, light and easy to manipulate polymer

7.4

17

Renishaw

Whiz bang manufacturer of automated machine tools and robots

7.4

18

Treatt

Sources, processes and develops flavours esp. for soft drinks

7.1

19

RWS

*

Translates documents and localises software and content for businesses

7.0

20

Quartix

Supplies vehicle tracking systems to small fleets and insurers

6.9

21

Celebrus

Makes marketing and fraud prevention software, sells it as a service

6.9

22

Goodwin

Casts and machines steel. Processes minerals for casting jewellery, tyres

6.8

23

Softcat

Sells hardware and software to businesses and the public sector

6.8

24

Auto Trader

Online marketplace for motor vehicles

6.7

25

James Halstead

Manufactures vinyl flooring for commercial and public spaces

6.7

26

4Imprint

Sells promotional materials like branded mugs and tee shirts direct

6.7

27

Hollywood Bowl

Operates tenpin bowling and indoor crazy golf centres

6.5

28

Jet2

Flies holidaymakers to Europe, sells package holidays

6.4

29

James Cropper

Manufactures specialist paper, packaging and high-tech materials

6.4

30

Next

Retails clothes and homewares

6.3

31

Solid State

Manufactures rugged computers, battery packs, radios. Distributes electronics

6.2

32

Garmin

Manufactures sports watches and instrumentation

6.0

33

YouGov

Surveys and distributes public opinion online

6.0

34

Bloomsbury Publishing

Publishes books, and digital collections for academics and professionals

5.7

35

Judges Scientific

Acquires and operates small scientific instrument manufacturers

5.7

36

Cohort

Manufactures military technology, does research and consultancy

5.6

37

Tristel

Manufactures disinfectants for simple medical instruments and surfaces

5.5

38

XP Power

Manufactures power adapters for industrial and healthcare equipment

5.5

39

Tracsis

Supplies software and services to the transport industry

5.1

40

Keystone Law

Runs a network of self-employed lawyers

4.4

Scores and stats: Richard Beddard. Data: SharePad and annual reports
Shares marked with a question mark 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)

An asterisk (*) next to a share’s name indicates that it has been re-scored since it was scored. Click the asterisk to see why.

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

Richard owns RWS and many shares in the Decision Engine. He weights his portfolio so it owns bigger holdings in the higher-scoring shares.

See our guide to the Decision Engine and the Share Sleuth Portfolio for more information.

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.

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