Interactive Investor

Shares for the future: top-ranked company causes tricky situation

1st April 2022 14:25

Richard Beddard from interactive investor

As shares analyst Richard Beddard confesses, his methodology for stock selection is by no means perfect, and neither is he as its operator.   

I have been writing about the Decision Engine for many years, but a few weeks ago I presented it for the first time. It was just about the most terrifying experience of my somewhat privileged life.

Part of my fear was the unfamiliarity of talking to an audience, and I should say thank you to the Twitter followers who advised me on preparing the talk – particularly the wise investor who told me not to try and tell everything.

Part of it was imposter syndrome.

The Decision Engine is a collection of spreadsheets that calculate profitability and financial ratios and collate my judgments on how each business will make more money, what could stop them, and whether we will all benefit. Standing in front of the brightest of the bright, I feared the house of cards might fall down.

Happily, it did not, and here we all are at the first UK Conference of Student Managed Investment Funds, hosted by The University of York:

Photo: Kirkpatrick Photography

As I wrote last month, the theme of the talk was how I use an investing system to reduce bias and improve my decisions.

I explained how scoring shares helps me evaluate the qualities of a good investment independently so I am not, for example, in thrall to the telegenic hero running the company and ignoring the fact that he is always asking us for more money.

And I explained the design of the Decision Engine, which focuses my attention on the company’s score rather than its price, and nudges me to buy or sell shares.

The million-dollar question

Bringing the talk to a close, I had a stab at answering the million-dollar question: How well does it work?

The answer might surprise you, considering I use the Decision Engine to inform my decisions about the Share Sleuth portfolio here on interactive investor and that portfolio has grown sixfold since I started it in 2009.

I think it helps, a bit. There are problems with the financial data.

This is not a criticism of SharePad, my primary source of financial data. My conclusion recognises the fact that accounting numbers are not reality but an imperfect measure of a company’s finances.

There are also problems with permeability.

The Decision Engine is supposed to shield me from the influence of the near-random movement of share prices and associated market chatter, like the apocryphal tin foil hats worn by conspiracy theorists that supposedly protect them from mind control.

It does not stop readers reminding me when one of my favourite shares is down, though. Somehow market noise trickles in through fissures in the foil hat.

Incidentally, such emails, which are meant kindly, do not deter me from including my email address at the bottom of these articles. They are a small price to pay for all the very helpful emails about businesses and what makes them tick, and the opportunity to clarify and explain when I have unwittingly glossed something over.

The most obvious source of bias is me. The Decision Engine might tell me to buy or sell a share, but I do not always take its advice.

This may or may not be a good idea. As I wrote last month, Daniel Kahneman, a psychologist whose work inspired the Decision Engine, found that intuitive decisions made after the discreet evaluation of individual criteria are often as good as the scoring algorithms that use the same criteria (although he also recommended we use the algorithms regardless).

My somewhat grandiose choice of name for the system gives the impression that it is an efficient decision-making machine, when in fact it is far from efficient. It throws grit into my investing process, slowing me down, forcing me to reflect on my conclusions, and preventing me from rushing to judgement, which helps reduce bias. But it is full of holes through which bias can creep.

Thinking the unthinkable

During the Q&A one of the students asked how I go about deciding which Decision Engine candidates to research, and whether there is an opportunity for bias to creep in there.

It takes quite a while to score a company, so naturally I am selective. With a bit of study, I must believe I will be able to understand how a business makes money.

It must already be profitable, and preferably cash-generative, which shows it can make money.

I favour companies with experienced executives who own lots of shares. And I prefer them to have grown largely under their own steam.

Conversely, I avoid companies that repeatedly raise large amounts of money from investors and lenders to acquire other businesses or develop products that may never make it to market.

I do not even consider gambling and tobacco companies, believing they do mostly harm.

I also avoid businesses like housebuilders and miners, where profits depend substantially on factors out of their control: movements in the prices of the property they own, rather than the industry of their employees.

The more stable a company – as indicated by past profitability, the experience of management, the source of the growth and the strength of its finances – the more likely it is to have a coherent strategy, and the more likely I am to be able to work it out.

Rules of thumb like these – psychologists call them heuristics – simplify decision-making, but they can also introduce bias (systematic errors) if they are wrong more than they are right.

Potentially, the pre-selection of candidates for the Decision Engine is another hole in my tin foil hat. But given the performance of the portfolios I have made from the shares I have selected, I have some confidence these heuristics work.

One question leads to another, and I confessed to my questioner that I have never thought to address whether the subsequent analysis adds value. Perhaps just by selecting companies I think will score well, I am doing 80% of the work with only 20% of the effort...

Photo: Kirkpatrick Photography

40 shares ranked

Since last month’s update, I have re-evaluated vehicle tracking company Quartix (LSE:QTX), kitchen supplier Howden (LSE:HWDN), Bunzl (LSE:BNZL), a distributor of everything mundane and ordinary, and Tracsis (LSE:TRCS), a gaggle of technology and consultancy firms supplying the transport industry.

The scores of all 40 companies have been influenced by moves in their share prices too.

A brief word of warning is required about top ranked XP Power (LSE:XPP) The company, which I have admired greatly for many years, announced earlier this week that at a trial in the US the jury had ruled against it in a case brought by Swiss rival Comet.

Comet says the verdict proves XP Power stole trade secrets and used them to develop its next generation Radio Frequency (RF) power products, a relatively new part of XP Power’s product portfolio.

XP Power has been fined $40 million, not much less than it earned in the year to December 2021.

It disputes the verdict, and is considering its next steps, which could include an appeal.

The Times reports the current product range is not affected, but the roll-out of new products could be hampered.

This is a tricky situation for The Decision Engine (i.e. me). The cost is perhaps the smallest problem, if it is a one-off.

But the first of XP Power’s core values is integrity. I have always scored the company 2 out of 2 for fairness, which does not seem tenable if it has stolen trade secrets.

I have no expertise in law, so I will not be able to form an independent view on the court case or the likelihood of the verdict being overturned.

When I come to review XP Power in the coming weeks (it has recently published its annual report) I will probably feel compelled to reduce its score at least until there is a final resolution.

 

Company

Description

Score

1

XP Power

Manufactures power adapters for industrial and healthcare equipment

8

2

Howden Joinery

Supplies kitchens to small builders

8

3

Cohort

Manufactures military technology, does research and consultancy

8

4

Dewhurst

Manufactures pushbuttons and other components for lifts and ATMs

8

5

PZ Cussons

Manufactures personal care and beauty brands

8

6

Goodwin

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

7

7

James Latham

Imports and distributes timber and timber products

7

8

RWS

Translates documents and localises software and content for businesses

7

9

Next

Retails clothes and homewares

7

10

Portmeirion*

Designs and manufactures tableware, candles and reed diffusers

7

11

Games Workshop

Manufactures/retails Warhammer models, licenses stories/characters

7

12

Bloomsbury Publishing

Publishes books and online resources for academics and professionals

7

13

Judges Scientific

Acquires and operates small scientific instrument manufacturers

7

14

D4t4*

Develops and integrates Customer Data Platforms

7

15

Solid State

Manuf's rugged computers, battery packs, radios. Distributes electronics

7

16

Porvair

Manufactures filters and filtration systems for fluids and molten metals

7

17

FW Thorpe

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

7

18

Victrex*

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

7

19

Focusrite

Designs recording equipment, loudspeakers, and instruments for musicians

6

20

Treatt

Sources, processes and develops flavours esp. for soft drinks

6

21

Renishaw

Whiz bang manufacturer of automated machine tools and robots

6

22

Churchill China

Manufactures tableware for restaurants and eateries

6

23

Anpario

Manufactures natural animal feed additives

6

24

Tristel

Manufactures disinfectants for simple medical instruments and surfaces

6

25

Bunzl

Distributes essential everyday items consumed by organisations

6

26

James Cropper

Manufactures specialist paper, packaging and high-tech materials

6

27

RM*

Supplies schools with equipment and IT, and exam boards with e-marking

6

28

Trifast*

Manufactures and distributes fasteners and other low cost components

6

29

Oxford Instruments

Manufacturer of scientific equipment for industry and academia

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

4Imprint

Sells promotional materials like branded mugs and tee shirts direct

6

33

Quartix

Supplies vehicle tracking systems to small fleets and insurers

5

34

Tracsis

Supplies software and services to the transport industry

5

35

Volex*

Manufactures connectivity components and power cord

5

36

Hotel Chocolat

Chocolate maker and retailer

5

37

Castings*

Casts and machines parts for vans and trucks, primarily

5

38

Advanced Medical Solutions*

Manufactures surgical adhesives, sutures, fixation devices and dressings

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 many of the companies he scores and ranks. He weights his portfolio so the biggest holdings are in shares with the highest scores.

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.

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