Stockwatch review of 2020: part 1

It’s been such a busy year, our equities analyst has split his review of this year’s tip into two parts.

The year is closing at record levels of global optimism for stocks and the economy. Hopes for growth and corporate profits are at a 20-year high, with two-thirds of fund managers reckoning we’re in an early-stage recovery, not recession. Not only will profits rise, but also the multiples investors are prepared to pay.  

Last November, analysts at Bank of America characterised this as “full bull” after which prices continued to rise, then met some profit-taking in December.

Stimulus has helped buoy a variety of asset classes

This is the first time in years that my annual review of stocks I have discussed includes none that have gone seriously wrong. My self-deprecating conclusion is that this shows how financial anaesthesia from central banks has masked possible underlying weaknesses, while market prices have risen regardless. 

Showing how it pays to be flexible and pragmatic, “growth” and “recovery” investing styles have both worked well. Ultra-low interest rates mean growth stocks will probably retain attraction to buy when the market drops. Enough investors are prioritising firms with the best prospects of growth in long-term cash flows. There is talk of a rotation to “value” but the prospect of early 2021 lockdowns make it equally tricky to entertain cyclicals.  

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Given 2020 has been characterised by two major market events – the March/April plunge roller coaster, then November’s rally in response to Covid vaccines – I am splitting my review into two parts, so as to characterise the differences. 

Starting with the small cap “loser,” albeit simply on January’s price than underlying issues: 

Metro Bank (MTRO)

I drew attention as a ‘speculative buy’ at 207p given a 70% discount to net assets around 700p a share, making plain the prospect of stock volatility. High risk was underlined by Metro (LSE:MTRO) having agreed £350 million of debt for regulatory needs in October 2019 at a 9.5% interest rate. Yet a new chairman and CEO meant radical action, and the market realised it had let the stock fester later this year after the CEO bought 1.5 million shares at 59.3p. This triggered a rebound to 128p during November, which dropped to 111p then has recovered to 138p after selling a £3 billion mortgage portfolio to NatWest (LSE:NWG).  

I believe this drop reflects justified concern for lending while the UK economy is constrained by Covid-19, and also a potential hard Brexit. Domestic bank stocks are sensitive to both constraints, as are their operations to demand for credit. 

Metro can be viewed as a spicier alternative to Lloyds Banking Group (LLOY), the blue-chip play on domestic banking. Both stocks have trended 2020 according to UK macro expectations, initially Covid-19 then Brexit trade talks. Now, both factors are in the spotlight and the duration of tier restrictions is a genuine concern. I continue to retain my 24 November, longer-term Buy stance on Metro and Lloyds. 

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Big cap: 

Apple (AAPL) and Microsoft (MSFT)

These Nasdaq-listed stocks are prime examples of the growth paradigm, on excess valuations. 

Back in August 2012, when I drew attention to Apple (NASDAQ:AAPL) at $17 (adjusted for various stock splits) on the basis of its diversification potential from the iPhone, its trailing price/earnings (PE) ratio was 12.5x and the yield 3%. Last January at $77 equivalent, I thought that “if Apple is now in a sweet spot it could continue beating expectations for a few years and justify a premium” – the question being, what extent? 

Apple’s trailing PE had doubled since 2013 and its price/earnings-to-growth (PEG) ratio was 2.3 i.e. the market was accrediting over twice underlying earnings and valuing Apple at the top of the FAANG stock league. 

I thought iPhone upgrades continued to offer plenty of scope and Apple was evolving well towards services, hence a ‘hold’ stance was merited and ‘buy’ on a share price drop. March saw a drop to $67, followed by a terrific rally to $125 when in August I shifted stance to a ‘take profits’ – though not outright ‘sell’ – stance given Apple’s trailing PE was 38x and the dividend yield 0.7%. 

I also turned cautious towards Microsoft (NASDAQ:MSFT) at $203 in July due to a 35x forward PE, 20x sales and a sub-1% yield. This compared with a sub-9x PE when I originally drew attention at 20.75 in May 2011. Then, it seemed a classic contrarian play on “the big unpopular company”. 

Growth stock advocates will say both reflect strong market positions in essential technology, and ultra-low interest rates, but can they really deliver anywhere near such returns over the next decade? 

For now, both stocks are edging higher since vaccines provided another market surge: Apple to $128 and Microsoft to $223. At such levels, you are essentially judging herd sentiment. Hold, but warily. 

Royal Dutch Shell (RDSB) 

This was a conservative ‘buy’ pick at around £10 on 17 March, having plunged from nearly £23 in the New Year. Oil prices were down from nearly $60 to below $23 a barrel, but I thought it would recover once nations were tempted to add to strategic reserves. Curtailed production would also build in a price spike once demand resumed. A rebound briefly to over $50 has also likely been driven by Asia’s economic recovery. 

Its price swiftly rebounded to over £14.50, but from early June drifted back to 888p by end-October – then rallied to about £13.50, helped by vaccine news and soaring oil. Like any oil stock, dynamics of the commodity will dictate, and I would beware oil could be over-bought in the short run having breached $50. That’s against an average of $44 projected only last October for 2021. Shell (LSE:RDSB) has now dropped to £12.70. Hold. 

Mid cap: 

Pets at Home Group (PETS)

This is one of my favourite domestic mid-cap stocks, having been bullish from 125p in August 2018 when it was a short-selling favourite yet insiders were buying. Subsequently, a new CEO has honed the group, now capitalising on rising pet ownership during lockdowns and a transition to more working from home. Pets at Home (LSE:PETS) have to eat and be cared for, hence combining food/accessory sales with veterinary services makes sound strategic sense and implies dependable earnings – largely irrespective of Brexit. This was why at 155p I advocated it among five stocks for an ISA portfolio for the Brexit years.

Starting 2020 at around 300p, Pets was not immune to the March sell-off, but its CEO bought £250,000 worth at 204p in May. Trading updates in July and September updates led it to double to over 400p where they still trade. That puts them on a near 25x forward PE and 2% yield.

Benefiting from investors favouring defensive growth, Pets may stay relatively expensive. Mind that if unemployment was to rise enough in the medium term to compromise pet ownership, the growth halo could slip from current expectations. In which scenario you might want to consider taking some profits. Broadly: Hold.  

Small cap:

Sanderson Design Group (SDG) – formerly Walker Greenbank 

This is a £55 million maker of high-quality interior furnishings, especially wallpapers and fabrics. Despite initial disruption from Covid-19, it has enjoyed what could be a transformational year, elevating its brands at a time when people have diverted income to spending on the home. Reduction in stamp duty also gave the housing market a fillip, encouraging refurbishments.  

Since March 2019, there has been a highly experienced luxury goods professional as CEO, and the group should be capable of earnings per share (EPS) of at least 7p, it has achieved (and better) historically. 

Last August, I noted buying by directors and their associates in a 37p to 43p range, and a positive trading update warranted upgrading Sanderson Design Group (LSE:SDG) to ‘buy’ at around 45p. A latest update cites trading substantially ahead of management’s previous expectations after strong autumn sales during a key period. At 85p, I retain a long-term Buy stance.  

Goco (GOCO) – formerly GoCompare 

This price-comparison website has suitably diversified and should benefit from consumer price-consciousness as unemployment rises. Last April, I drew attention at 77p for its 25% return on capital and initiatives towards new areas of growth. I also liked its strong cash flow profile which raises the chance of a private equity bid.

A 21 April trading update anticipated positive cash flow under multiple stress scenarios and AutoSave, a service automatically switching subscribed customers to the cheapest provider, was enjoying 25% revenue growth this year. 

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Last November, digital publisher Future (LSE:FUTR) made a cash and share-based offer valuing GoCo (LSE:GOCO) at around £540 million, or 130p a share, hoping to exact synergies.

The story shows how takeovers are likely to continue, with mergers possibly a means to exact better growth. But I am wary this move is opportunistic by highly-rated Future, hence better to Sell Goco than become part of an enlarged group and its risks.

Reach (RCH) – previously Trinity Mirror Group 

I have drawn attention to Reach (LSE:RCH) shares as a ‘buy’ from 66p in early 2018 on the basis of turnaround taking shape, re-iterating ‘buy’ in May 2019 at 83.5p. The group’s strong cash flow profile was enabling debt to be cut and also acquire The Express and Star newspapers alongside The Mirror, which is now a digital success.  

Last February at 181p, having doubled in three months, I thought a ‘hold’ stance was warranted, given the PE on the 2019 results was still only just over 4x.

There was also £147 million of cash generated from operations last year (relative to a £565 million market cap) which offered scope to further cut liabilities and re-build the dividend pay-out. A low PE is explained party by a circa £200 million pension fund deficit from the Maxwell plundering years. 

The chief prize is whether Reach can achieve its growth target of 7 million digital customers by end-2022, up from sub-one million at end-2019, already the fifth biggest digital asset in the UK. The stock periodically swings between hopes for this and fears of ongoing print decline. 

It re-traced as far as 50p last August, then rebounded to 75p after September’s interim results and guidance for the full year ahead of expectations. I re-iterated ‘buy’ and it has recovered to 134p. If Reach’s cash flow combines with digital success, it can prove a medium-term winner. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.