Shares for the future: three top stocks and reducing IHT
1st October 2021 15:35
by Richard Beddard from interactive investor
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This month’s updated Decision Engine table features a hat-trick of high scoring stocks at the top. Find out who they are and how they made it.
This month’s Decision Engine table has a somewhat compressed feel.
As usual it ranks companies from zero to nine, nine being the most attractive long-term investments and zero being the least attractive, according to my methodology.
As usual, there are very few shares scoring less than five out of nine because five is my arbitrary lower limit for investment.
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Although I am prepared to make exceptions like Jet2 (LSE:JET2), which currently scores four, generally companies that score less than five are dropped from the table because I only have time to keep tabs on 40-or-so shares.
Something we have experienced less often though, is the paucity of shares scoring very high scores. It is rare for shares to score a maximum nine out of nine (though far from unprecedented), but usually there is a gaggle scoring eight.
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Today, there are three, Cohort (LSE:CHRT), Dewhurst (LSE:DWHT) and James Latham (LSE:LTHM), and there have been occasions in the last few months where there have been none.
In other words, the vast majority of shares score 5,6, or 7. This is unnerving for two reasons.
The first is that the Decision Engine has become less discriminating. The second is that there may be less value in it.
Score compression
Company | Description | Score | |
1 | Manufactures military technology, does research and consultancy | 8 | |
2 | Manufactures pushbuttons and other components for lifts and ATMs | 8 | |
3 | Imports and distributes timber and timber products | 8 | |
4 | Manufactures PEEK, a tough, light and easy to manipulate polymer | 7 | |
5 | Casts and machines steel. Processes minerals for casting jewellery, tyres | 7 | |
6 | Supplies kitchens to small builders | 7 | |
7 | Manufactures power adapters for industrial and healthcare equipment | 7 | |
8 | Publishes books and online resources for academics and professionals | 7 | |
9 | Designs and manufactures tableware, candles and reed diffusers | 7 | |
10 | Manufactures personal care and beauty brands | 7 | |
11 | Manuf's rugged computers, battery packs, radios. Distributes electronics | 7 | |
12 | Retails clothes and homewares | 6 | |
13 | Distributes essential everyday items consumed by organisations | 6 | |
14 | Acquires and operates small scientific instrument manufacturers | 6 | |
15 | Manufactures/retails Warhammer models, licenses stories/characters | 6 | |
16 | Supplies vehicle tracking systems to small fleets and insurers | 6 | |
17 | Manufactures filters and filtration systems for fluids and molten metals | 6 | |
18 | Manufactures natural animal feed additives | 6 | |
19 | Supplies schools with equipment and IT, and exam boards with e-marking | 6 | |
20 | Manufactures and distributes fasteners and other low cost components | 6 | |
21 | Develops and integrates Customer Data Platforms | 6 | |
22 | Manufactures vinyl flooring for commercial and public spaces | 6 | |
23 | Manufactures tableware for restaurants and eateries | 6 | |
24 | Whiz bang manufacturer of automated machine tools and robots | 6 | |
25 | Makes light fittings for commercial and public buildings, roads, and tunnels | 6 | |
26 | Manufactures specialist paper, packaging and high-tech materials | 6 | |
27 | Translates documents and localises software and content for businesses | 6 | |
28 | Manufactures respiratory protection equipment and body armour | 6 | |
29 | Sells promotional materials like branded mugs and tee shirts direct | 5 | |
30 | Supplies software and services to the transport industry | 5 | |
31 | Sources, processes and develops flavours esp. for soft drinks | 5 | |
32 | Sells hardware and software to businesses and the public sector | 5 | |
33 | Manufactures disinfectants for simple medical instruments and surfaces | 5 | |
34 | Develops marketing automation software | 5 | |
35 | Designs recording equipment, loudspeakers, and instruments for musicians | 5 | |
36 | Casts and machines parts for vans and trucks, primarily | 5 | |
37 | Manufactures surgical adhesives, sutures, fixation devices and dressings | 5 | |
38 | Operates tenpin bowling and indoor crazy golf centres | 5 | |
39 | Manufactures connectivity components and power cord | 4 | |
40 | 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.
Just to recap, the shares are scored according to five criteria: profitability, risks, strategy, fairness and price.
The companies with the highest scores have demonstrated they can profit in cash and accounting terms through thick and thin. They do not face seemingly insurmountable risks, and their strategies address the normal risks they face like competition and recession. They are fair to customers, employees, directors and shareholders, and society in general.
I believe the profits of such companies should grow over the long term, and although their performance may vary from year to year they are unlikely to get into financial jeopardy.
The first four factors determine the quality of the business and are scored either zero, one, or two out of a total of two. The fifth factor compares its price to normalised profit and it is scored from minus two to plus one. It is a blunt way of telling us how much we are paying for the business.
The total score is a measure of relative value. The companies that score highest, give us the best bang (quality), for our buck (price).
Rising prices = falling scores
The compression in the scores is caused by rising prices. The last time I got edgy about share prices was at the end of 2019, just before the pandemic. Although the pandemic did trigger a very short sharp crash, the bounceback has more than restored the prices of the shares in the Decision Engine in aggregate.
The price score is unique among the five criteria. It is the only one that can reduce a company’s score, which happens if the price is high relative normalised profit.
The arbitrary pivot point between a positive price score and a negative one is a normalised price/earnings (PE) ratio of 20 (an earnings yield of 5%). Higher PE’s (lower earnings yields) result in increasingly negative price scores, and negative price scores weigh on a share’s total score, used in the table.
Since the prices of decent business have gone up a lot, their scores have gone down, and that is what has caused the compression.
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There is not much I can do about rising prices except keep trying to find new shares in decent businesses to invest in at lower prices.
If I fail to find them, returns from portfolios built using the Decision Engine may be lower for a while than they have been in the past, however I believe they will still beat the market handsomely over the long term.
Reduce Inheritance Tax with the Decision Engine
A reader asks:
With regard to your Share sleuth portfolio have you ever considered highlighting the AIM listed elements that are suitable for IHT planning purposes?
The short answer is I have not.
Business Property Relief (BPR), the tax rules that allow investors to shelter their investments from Inheritance Tax in shares listed on London’s Alternative Investment Market are complex. Generally, because I am a simple soul, I focus entirely on the quality of the businesses I invest in and how much to pay for the shares.
I regard good strategies and innovative and fair cultures as enduring characteristics, while tax breaks are something the government could remove at any time.
However investors have different needs and my understanding is most AIM shares qualify for BPR unless they are investment companies (i.e. they profit from investments in other companies or property rather than or substantially in addition to their own operations).
My colleague Andrew Hore explains more in AIM stocks for an inheritance tax ISA in 2021 and Stocks that fund managers own in their AIM ISA IHT portfolios.
You may need to consult a specialist adviser to determine for sure whether particular shares qualify. One of the problems is that companies’ situations change, but since I favour businesses that profit from their own operations it is likely that most of the AIM shares I follow would be suitable for an IHT portfolio.
Just in case you are wondering which of the Decision Engine shares are on AIM, here is a full list (you can click on their names in the Decision Engine table above to learn more about them).
- Advanced Medical Solutions
- Anpario
- Churchill China
- Cohort
- D4t4
- Dewhurst
- Dotdigital Group
- FW Thorpe
- James Cropper
- James Halstead
- James Latham
- Jet2
- Judges Scientific
- Portmeirion
- Quartix
- RWS
- Solid State
- Tracsis
- Tristel
- Volex
All shares in the Decision Engine qualify for inclusion in the Share Sleuth model portfolio, except those scoring less than five.
We will be publishing the monthly Share Sleuth update next week.
Richard Beddard is a freelance contributor and not a direct employee of interactive investor.
Richard owns most of the shares in the Decision Engine, particularly those that score most highly.
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.
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