Stockwatch: Five ideas for 2018

Chief lessons from my review a year ago are, the best performers in the Stockwatch universe have continued to do so in 2017, but either peaked in the second half or consolidated, in need of fresh stimulus.

Momentum has given way to caution, which bulls will interpret as a positive sign that exuberance is not going unchecked, while bears may see it as an early sign of support breaking down.

I'd characterise several waves in recent years with different stocks in vogue. A market slump began mid-2011 over fears for the US debt ceiling, and, if you recall that December, predictions that the eurozone would implode and the US tip into recession. It proved the start of a second bullish wave since the 2009 crisis as monetary stimulus was unleashed; its actions/effects pronounced come 2013 by way of a big shift of capital into risk assets, with cyclicals/turnarounds benefiting most.

There was then a period of consolidation as investors sought proof from company results, with disappointments and stock falls in 2014. More recently, Stockwatch year-end reviews in 2016 and 2017 have shown the best performance deriving from growth plays; my ideas being restricted to those delivering real earnings growth, but there has been a massive up-wave in speculative growth stocks also. Cumulative years' monetary stimulus appears to be maturing.

Boohoo.com

I drew attention to AIM-listed online fashion retailer Boohoo.com at 33p in November 2015 and around 100p in July 2016, noting parallels with highly-rated ASOS, albeit with better growth dynamics – based on astute marketing with rapid response to new concepts via social media.

Exactly a year ago, at 137p, Boohoo traded on 73 times earnings for the year to end-February 2017, reducing to 60 times for 2017/18, yet upgrades together with momentum buying pushed the stock up to 266p mid-year.

The three months to end-May showed like-for-like revenue growth of 78%, with a slip in the gross margin from 56% to 54.2% as Boohoo's competitive offer intensified, although revenue growth for the full year to February 2018 was upgraded from 50% to 60%. At this point in early June, management opted to raise £50 million via a share placing at 220p – to fund warehouse expansion – while also enabling an additional 36.6 million shares to be sold by three founder directors.

Interims to end-August then showed a 41% advance in pre-tax profit, with earnings per share (EPS) up 24%, based on revenue up 106%, raising guidance for the full year while also maintaining the vague theme of "continuing to invest in the customer proposition", which could involve growing sales at the expense of margin.

But investors took a more cautious view, with clouds growing over UK discretionary spending (62% of revenues), buyer fatigue and profit-taking has meant a slide to 175p over two months or so, currently about 185p where, according to forecasts, the 12-month forward price/earnings (PE) is over 50 and there's no dividend. Holders may take heart that ASOS has sustained huge PE's over the years, although I see a parallel with various growth stocks over-cooked. Avoid.

Burford Capital

I drew attention to AIM-listed litigation finance specialist Burford Capital at 123p in 2015: a "special situation" since legal funding is independent of business cycles, Burford was evolving as a market-leader (principally a US-based firm), yet its shares were below-radar.

In a habit of nearly doubling annual profits, at 570p last December it appeared well-placed for 2017 and has maintained its soaring chart to a recent high of 1,244p. It's currently at 1,125p where it trades on a forward PE in the mid-twenties, yielding 0.8%. I'd expect consolidation from here, given the story is now better-known and new investors may not appreciate how lumpy litigation finance profits can be. There's also no meaningful yield despite progressive dividends, in support.

Yet, in the long run, Burford is prime-positioned in an international growth industry that's more stable than retail fashion or technology. Yes its stock appears to reflect animal spirits of a mature bull market, and it is exposed to a market slide, but then would be a priority to buy/add. The chief risk would be an extensive falling out among senior management, that fragments the firm with key talent leaving – but there's no such sign as yet. Buy on weakness.

IQE

I drew attention to AIM-listed supplier of advanced semiconductor wafers IQE for a wide range of microchip applications, at 23.5p in July 2016, and again at 30p that October as an update reinforced prospects.

End-December I suggested its rating could improve as operational gearing kicks in from its fast-growing photonics side, the company also perceived as being less cyclical after industry de-stocking of wireless components had previously hit profits.

The stock was then on a forward PE in the mid to low teens and, within 16.4% group revenue growth declared at the March 2017 prelims, photonics jumped 43%, infra red 19% and wireless 15%. This reflects wireless still dominant, but IQE's positioning in photonics caught the imagination of analysts and growth investors, its stock soaring as high as 179p recently. It's now 157p, which capitalises the business near £1.2 billion.

Frankly, I have not seen such a powerful tech stock re-rating since the likes of BATM and ARM Holdings in the 1999-2000 boom; IQE now on a 12-month forward PE of about 43 times.

Quite like at Boohoo, management has capitalised on this high share price, raising £95 million at 140p per share last November in order to "scale the business to capture multiple high growth mass market opportunities" – in particular, high demand for wafers in 3D sensing, consumer electronic applications.

Possibly, investors are perceiving IQE as "ARM Holdings Mark 2" since ARM was acquired by a Japanese conglomerate: I recall ARM trading for years on a PE over 40 times, if not 100 times amid the tech-stock bubble, although its operating margin was about twice IQE's 15%.

Also, like Boohoo, there was a locking in of gains in July when the chief executive sold £6.2 million worth of stock at 106p and the chairman £1.1 million at 105p, the market absorbing this in its stride reflecting strong bullish sentiment.

Probably the IQE story will indeed continue to strengthen, if impossible to define investment value nowadays. With 758 million shares issued, EPS isn't advancing like at Burford, partly because Burford has a lower 208 million issued. Symptomatic of a maturing bull market perhaps, some followers of IQE will say EPS and PE miss don't reflect a revolution underway. Yet technology markets can surprise both ways, hence it's wise to follow the bosses' example and lock in some gains. Take profits.

JD Sports Fashion

Mid 250 stock JD Sports Fashion has been the longest-duration winner since I drew attention at a pre-stock split equivalent price of 36.25p in August 2010; reviewed at 320p at end-2016 as continuing to present upside as international sales expanded, the stock then on 18 times projected earnings.

In the first three months of 2017, JD rose a further 42% to 456p, though I suggested at 450p in April this largely discounted prospects and to mind anything taking THE shine off the JD story.

The June AGM cited margin pressure creeping in; clothing imports (even from the Far East) are anyway usually denominated in US dollars, therefore a weaker pound implies additional cost. Yet September's interims were plenty strong: a 33% advance in pre-tax profit with EPS up 35.5% and the full-year outcome guided to the top end of expectations.

Notably, the stock has continued to drift to about 330p, most likely due to the UK context - as yet 70% of revenue – where discretionary spending is becoming constrained by inflation versus static wages, also credit appetite waning. Continental Europe constitutes 28% of revenue and it remains to be seen what trade deal Britain can wrest with the EU.

The stock's forward PE has moderated to about 13 times versus consensus of 19% earnings growth in the current year to end-January 2018, then 9.5%. Versus plenty of other retailers, JD's yield is only 0.5% yield, which is no support in case macro risks intensify.

JD is, therefore, in "no man's land", potentially losing its strong growth profile while lacking yield – if showing how in the retail sector at least, investors are cautious and reactive. But it's a well-run business with plenty long-run international potential to develop the JD brand; quite like Burford it's one to keep under scrutiny. Buy on weakness.

Disappointing: Go-Ahead Group

It's actually hard to find ideas that have gone wrong this year in the Stockwatch universe, and in self-deprecating manner I'll link that to the UK economy remaining robust and investor sentiment strong, after years of monetary stimulus. Privatised industry stocks have had a torrid time though.

After a spring-time fall from about 2,300p, I drew attention to Go-Ahead shares in June at 1,830p when directors bought into the mid-cap transport group at between 1,700p and 2,000p, the stock yielding over 5.5%.

The story was already messed by rail strikes, although bus revenues/profits supported dividend growth and a debt refinancing was set to cut finance costs. International operations were expanding in Germany and Singapore. Notwithstanding a risk of economic slowdown, I suggested "the balance of trading has shifted to buyers for income and a patient recovery."

But the stock has continued down to 1,485p, a four-year low, despite the yield now testing 7%, about 1.7 times covered by projected earnings and substantially more by cash flow. Yes, there have been downgrades, with a trend of declining earnings, but modest dividend growth of 4.5% is targeted for the year to July 2018.

On a macro view, the situation recalls 1999/2000 when less exciting but strongly cash-generative, mature industry stocks were shunned in favour of chasing high expectations in growth plays. There's political risk of re-nationalisation under a radical left Labour government, but, if this is the real reason privatisation stocks are out-of-favour, I think it's overdone.

Conservative investors - by which I mean those who for proof will want to see a chart bottom established, but on valuation grounds - buy for income and you might gain capital upside also, as and when less yield is exacted for perceived risk.

A concluding point I would make as a stock-picker surveying the corporate landscape, is that new stories are needed to inspire another leg to the bull market. This piece shows how some of the best performers of 2016 carried on doing so, but animal spirits need refreshing with new and dynamic firms.

Otherwise, like I describe, the past winners' charts are over-run, their stories have been multiple times around the block, leaving investors to guess whether or not to buy the dips. Where's the excitement?

Pundits in the US are saying the Wall Street rally means plenty of new issues are in the pipeline. We shall see of what quality, but they need to happen here, too.

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