Trading Strategies: pick these stocks for your ISA not cash

Given the UK stock market’s lacklustre performance over recent years, many investors may wonder whether they should hold cash and avoid shares in their ISA. Indeed, the FTSE All-Share index has risen at an annualised rate of just 1.9% over the past decade. Even when a dividend yield of 3.7% is factored in, the prospect of a total annual return amounting to 5.6% is competing with cash ISAs, some of which currently offer interest rates in excess of 5%.

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However, the past is never perfectly repeated in future. Cash ISAs may seem appealing today, but their returns are likely to have already peaked. Inflation declined to 3.4% in February and, due to fast-paced price rises from spring 2023 dropping out of the annual measure over the next few months, the rate of inflation could reach the Bank of England’s 2% target quite soon. This is already prompting widespread calls for interest rate cuts that could mean the return on cash ISAs falls significantly over the medium term.

Capital growth potential

By contrast, falling interest rates are likely to boost the stock market’s performance. Not only will they encourage investors to ditch cash in favour of shares, thereby raising demand for stocks, they will prompt consumers to increase their spending as the cost of debt falls. This should have a positive impact on economic growth, with the UK’s ongoing recession likely to prove short-lived, and provide improved operating conditions for FTSE All-Share constituents.

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Given that the index’s past performance has been somewhat disappointing, many of its members currently have attractive market valuations that equate to significant scope for capital growth. And with the FTSE All-Share index’s profits being partly derived from abroad at a time when interest rate cuts are also on the near-term horizon in Europe and the US, investing in the index now could mean investors generate far higher returns than cash ISAs in the coming years.

Managing risk

Of course, stocks and shares ISAs are inherently riskier than cash ISAs. Unlike cash, no investment in any company can ever come with a zero risk of capital loss. However, investors can significantly reduce the impact of permanent capital loss on their ISA by diversifying across a wide range of companies, geographies and sectors. This process is made easier by relatively low commission costs now available online, while the FTSE All-Share index’s international focus means it is straightforward for UK-based investors to gain access to a wide range of geographical regions.

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Buying high-quality companies can also reduce the risk of permanent capital loss. For example, buying businesses that have modest debt levels and which can afford to pay their interest costs several times with operating profits are less likely to struggle financially vis-à-vis highly leveraged firms. Similarly, companies that have a sustainable competitive advantage are better equipped to survive any future economic or industry-related challenges compared with their lower-quality peers.

A favourable risk/reward opportunity

Stock prices will undoubtedly prove to be volatile at times in future. Investors, though, can overcome this challenge by adopting a long-term outlook that is accepting of short-term fluctuations in the market value of their holdings. Moreover, investors should remind themselves that there is a great difference between share price volatility and the risk of permanent capital loss. A share price that moves erratically over a short time frame, for instance, does not necessarily mean the company is about to fold.

Indeed, the elevated volatility and heightened risk of investing in shares represents a fair trade-off when the stock market’s return prospects are factored in. The FTSE All-Share’s low valuation, improving prospects and the likelihood of interest rate cuts that reduce the returns on cash savings, mean that stocks and shares ISAs are hugely appealing at present.

Therefore, while it is understandable that cash ISAs may remain in high demand given today’s generous interest rates, buying a diverse portfolio of high-quality stocks, including those discussed below, is likely to be a far more profitable move.

Past performance is not a guide to future performance.

InterContinental Hotels Group

Falling inflation that prompts interest rate cuts is set to have a positive impact on consumer-focused firms such as InterContinental Hotels Group (LSE:IHG). It should bring the cost-of-living crisis to an end, with higher disposable incomes leading to greater demand for travel and leisure activities.

Furthermore, global airline passenger numbers are expected to finally return to pre-Covid levels this year after materially declining due to pandemic-related restrictions. Their recovery is set to equate to growing demand for IHG’s diverse range of hotels that encompass luxury properties and budget accommodation across a wide range of territories.

The company’s latest annual results showed it generated a 19% rise in sales, while operating profit increased by 25% versus the prior year. It benefited from a 16% increase in revenue per available room, as well as a 5% rise in its total number of hotel rooms. Further growth in both areas is likely as the world economy’s performance improves and the company’s pipeline of 297,000 rooms, which equates to 31% of its current estate, is delivered.

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The firm’s financial position means it is well placed to invest for long-term growth. While its net debt increased by 23% to £1.8 billion in the latest financial year, net interest cover of over 20 shows that it has ample headroom when servicing borrowings.

IHG also has an excellent market position due to the loyalty which its various brands enjoy. And while the company’s shares now trade on a forward price-to-earnings (PE) ratio of 24.5, its long-term growth potential, sound financial position and improving operating outlook mean it is a worthwhile purchase within a stocks and shares ISA.

AstraZeneca

Pharmaceutical company AstraZeneca (LSE:AZN) also offers long-term investment appeal. Despite its size, with it currently being the FTSE All-Share index’s second-largest member, latest results highlight the firm’s growth potential. Earnings per share rose by 15% versus the prior year, with the company forecasting a low double-digit to low teens percentage increase in the current financial year. This means that despite trading on a relatively rich PE ratio of 18.5, the shares offer good value for money.

With a net gearing ratio of 58% and net interest cover of 6.4 in its latest full year, the firm has sufficient financial strength to invest in its pipeline of new treatments. Indeed, it raised the amount spent on research and development by 13% in its latest financial year so that it now accounts for 23.9% of total revenue. This is up from a figure of 22% in the prior year. The company’s solid balance sheet also means it has the capacity to make further acquisitions following the recent purchases of rare diseases and cancer treatment specialists.

AstraZeneca’s long-term growth opportunity is highly attractive based on factors such as population growth and an ageing population. As a result, the prevalence of non-communicable diseases, which are those that cannot be passed from one person to another and include cancer and heart disease, are likely to increase. And while the company’s shares currently trade at the same level as they did two years ago, they are poised to post a markedly improved performance as the firm delivers a relatively high rate of profit growth over the coming years.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.