Our columnist Richard Beddard likes shares in profitable businesses following coherent strategies for the benefit of all their stakeholders. Here are his top picks.
Happy New Year. We are starting with my least favourite article of the 100-odd I might write in 2022! It is the one where my editor puts a metaphorical gun to my head and says choose six of your babies.
I fear you may read into this new year ritual that I expect the share prices of these selections to increase significantly over the course of precisely one year. They may of course. On the other hand, they may not.
I look for shares in profitable businesses following coherent strategies for the benefit of all their stakeholders.
Strategies take many years to play out, so these selections are open ended. I expect they will do well given time, and, although you can never be sure in investing, they should not cause us too much anxiety along the way.
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Howden Joinery (HWDN)
Share price 923p, Earnings Yield 4%, Dividend Yield 1.9% (f)
Although Howden Joinery (LSE:HWDN) makes a good kitchen, what distinguishes the company is not so much what it makes, but who it sells the kitchens to.
Most kitchen companies operate retail showrooms and trade counters, but right from its beginnings in the 1990s Howdens has turned away the likes of you and me.
By focusing on the trade, it keeps prices confidential and allows builders to decide their own mark-up. It also gives them enough credit to finish a job before settling their account, and maintains nearly 100% stock availability.
These policies are costly, but Howdens knows the rewards are greater. It has no need for expensive showrooms and it spends little on advertising. Depot managers have the freedom to set prices and cultivate the local clientele.
Although tradespeople pay less, they are regular customers unlike the rest of us. We can go decades between kitchens.
The numbers bear out the strategy. Howdens is highly profitable and supplies about a third of all UK fitted kitchens, but it faces a challenge as the country fills up with depots.
The company must repeat its success in France where it has opened dozens of stores. Fitted kitchens are less popular there, a situation that resembles the UK market before Howdens entered it.
XP Power (XPP)
Share price £52.85, Earnings Yield 4%, Dividend Yield 1.8% (f)
XP Power (LSE:XPP) makes power converters that are built into industrial and medical instruments. Like the adapters that power domestic appliances they convert alternating power from the mains supply to direct current, or step the voltage up or down, but the demands of industry and hospitals mean they must be much better.
Reliability is critical because a production line or a medical procedure could be halted by a failing power converter. By designing more efficient converters that do not require cooling fans, XP Power has removed the main cause of failure while simultaneously helping customers reduce energy costs and burnish their environmental credentials.
It has also reduced the size of the converters, which means they can be easily adapted to fit into customers’ machinery. In recent years the profit from XP Power’s product families has been used to acquire rivals that, for example, manufacture converters capable of supplying higher voltages.
Thereby, it supplies more of the converters required by its blue-chip customers, which in turn are manufacturing more sophisticated machines often incorporating many converters.
These converters typically generate revenue for XP Power for many years, as long as the machines remain in production.
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Share price 385p, Earnings Yield 3%, Dividend Yield 2.3% (f)
Vehicle trackers allow businesses to keep tabs on their vans and how they are being driven. Quartix (LSE:QTX)’s product is special because of its simplicity.
The device is manufactured from off-the shelf components and designed to meet the needs of small businesses, like builders and plumbers. The hardware can be self-installed, and the software is cloud-based and self-configured.
Unlike, say, large haulage firms, most small businesses do not require bespoke features or welcome complex contracts, so Quartix’s low-cost device is typically supplied with no upfront fee and no strings attached after the first year.
The company’s main cost is marketing, and because selling through a field sales force is inefficient for smaller customers, Quartix has long specialised in direct telesales and internet marketing.
The beauty of this setup is the size of the market, and the high levels of recurring revenue Quartix generates from satisfied customers in the UK, where it has been established for twenty years, and increasingly in Europe and the US.
Admittedly, revenue and profit have not kept pace with the growth of fleet installations in recent years, but this is because of Quartix’s gradual withdrawal from the insurance market, which is less profitable, and the investment required to establish itself abroad.
PZ Cussons (PZC)
Share price 205p, Earnings Yield 6%, Dividend Yield 3.3% (f)
PZ Cussons (LSE:PZC), which owns famous hygiene, baby and beauty brands, has struggled to keep up as internet retailers and supermarkets have introduced us to a proliferation of competing brands.
That may change because the company’s new chief executive has simplified the organisation, and its aspirations.
Instead of competing globally, PZ Cussons is focusing on its most promising brands, for example Carex handwash and Original Source bodywash in the UK, St Tropez fake tan in the UK and the US, and Morning Fresh washing up liquid in Australia and Nigeria. The spoils from other brands are invested in these “must win” brands to develop and market new products.
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It is too early to say whether the strategy is working, even more so because its first years have coincided with the pandemic.
But there are good reasons to believe the company will succeed. Although its performance has deteriorated in recent years, PZ Cussons has remained profitable and cash generative.
It cancelled an acquisition strategy that starved its famous brands of investment, and has started rebuilding the company’s capabilities so it builds better brands instead.
It also has an eye-catching ambition to become a certified B-Corp by 2025 (a company’s practices, including governance and environmental, must attain a certain standard), burnishing its already strong environmental credentials without, the company says, compromising profitability.
Share price £32.35p, Earnings Yield 6%, Dividend Yield 3.2% (h)
Like PZ Cussons, Goodwin (LSE:GDWN) is a profitable company trying to restore profitability to higher levels achieved in the past.
The company has two divisions. One is dominated by Goodwin Steel Castings and Goodwin International, a foundry and machine shop that can manufacture very large components. The other is a collection of companies that quarry and process minerals used in the manufacturing of jewellery, tyres, and fire resistant materials.
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It is the first division, mechanical engineering, that has struggled since demand for its patented oil and gas pipeline valves dried up. The second division, refractory engineering, is growing strongly and has kept Goodwin profitable and cash generative while the first division has retooled so it can cast super-alloy in sizes only a handful of firms around the world can match.
Higher levels of profitability and growth depend on large contracts to supply nuclear submarine programmes and provide containers for the transport of spent nuclear fuel from power stations. These contracts promise orders for many years, but the orders are taking longer than expected to materialise.
The good news for investors is that we can wait, reassured by Goodwin’s profitability and its commitment to pay a substantial part of profit out as dividends.
Bloomsbury Publishing (BMY)
Share price 367.5p, Earnings Yield 5%, Dividend Yield 2.6% (f)
Bloomsbury Publishing (LSE:BMY) must get tired of being described as the Harry Potter Publisher when it has diversified so far from the magic money tree it discovered in the 1990s.
Its consumer imprints include the works of many other bestselling authors and, although JK Rowling almost certainly remains the most lucrative, Bloomsbury’s “great shining light” is the product of another part of the business, the academic and professional division.
Bloomsbury Digital Resources (BDR) is more than 30 collections of academic works covering subjects like drama, fashion and theology, which the company says are niches it can dominate.
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From a standing start little more than five years ago BDR earned Bloomsbury 18% of profit from just 7% of total revenue in 2021. More growth is anticipated as the company acquires more works, often paying print multiples and then digitising them and incorporating them into the fantastically profitable BDR.
Bloomsbury also has the opportunity to sell more collections to academic libraries that have already bought one, sometimes at more than £100,000 a pop, and continue its reputation for publishing bestselling authors.
Although Bloomsbury’s dividend yield is relatively modest, it has grown the dividend every year since 2005 except in the year to April 2021, the first year of the pandemic, when it paid out the same amount as it did in 2020.
*Prices and dividend yields are from SharePad, (f) indicates a forecast, and where there is no forecast available the historical dividend yield (h) is used. Earnings yields are calculated by the author from normalised profit.
Richard Beddard is a freelance contributor and not a direct employee of interactive investor.
Richard owns shares in all six companies featured in this article.
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: email@example.com or on Twitter: @RichardBeddard
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