Will these ten stocks make the Decision Engine?

Our stock analyst offers a sneak preview of candidates for future inclusion in his Decision Engine.

It’s eight shares for the future this month, one more than last time we published the Decision Engine’s rankings. The number is arbitrary, the number of shares that score seven or more out of ten, but it does tell us something. The dearth of high scoring shares means I am finding fewer obvious bargains.

Source: The author

The average score of the 30 shares in the list has dropped to 6.4, principally as a result of surging share prices, which has increased valuations and rendered the shares less attractive long-term investments (in aggregate). They have realised some of their long-term potential ahead of schedule.  

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The increase in valuations means returns from portfolios of shares selected from the Decision Engine today will likely be lower than returns from portfolios selected a year or two ago, which have been highly lucrative already!

I hasten to add, scores are a relative measure. Lower scores do not make these 30 shares bad long-term investments. They are all, in my estimation, shares in good businesses capable of prospering through thick and thin.

Their average earnings yield is 5%. The earnings yield is a theoretical yardstick measuring the return we would earn if a company paid all profit back to investors rather than investing some of it to generate new business.

Since all of the companies in the Decision Engine are investing some of their profit to grow, and they all earn a high return on capital (the average is 38%), I consider the earnings yield to be a baseline measure of investor return and expect better from my portfolios over the long-term. The short-term is another matter, unfathomable to me, so we must be patient.

Patience does not imply inactivity, though. As well as being less attractive investments than they once were, the balance may also have shifted between the 30 shares in the Decision Engine and the more than 2,000-odd shares listed in London that I do not rank.

That is why I am trawling the stockmarket for equally good companies at more attractive valuations. Companies that might one day join the Decision Engine. They are shares for further in the future, perhaps.

Shares for further in the future...

The table below shows ten new candidates for the Decision Engine. They have not been subjected to the same scrutiny as the 30 companies listed in the Decision Engine, and until they have received it, they will not be admitted.

They are ranked using the same scoring system as the shares in the Decision Engine so I know which shares to prioritise, but since I have not evaluated them fully the scores are more than usually informed by instinct and guesswork and I have chosen not to share them with you. Put a number on something, and it lends it credibility, and these prototypical scores do not deserve it. 

The columns show the performance, financial strength, and valuation of each company. Causes for celebration are highlighted in green, and causes for concern are highlighted in pink. 

Source: The author

Because most companies report their full-year results in the first half of the year, many in this list will be publishing annual reports relatively soon, which is when I will score them properly. The nearer a company is to the top of the list, the more likely I am to score it, although I hope to augment the list significantly over time, pushing shares near the bottom further down, or letting them fall off the bottom.

These shares have warts, of course, most companies do and if it’s apparent to everyone that a firm is flawless, then the share price is likely to be the wart.

Vitec (LSE:VTC), Strix (LSE:KETL) and Greggs (LSE:GRG) are top of the list. 

Warts ’n all

Vitec makes camera equipment for photographers and videographers, from film crews and broadcasters to “smartphonographers”. Its warts are perhaps minor and transitory. It will report slightly lower profits for the year to December 2019 than it did in 2018 due to prior overstocking by some of its customers and a fire in one of its factories, and it is quite heavily dependent on outside capital, the result of an acquisitive strategy that has seen it add numerous brands over the years.

At 13%, the company’s Return on Total Invested Capital at cost in 2018 was decent, so it’s likely Vitec has invested wisely, and while a dip in its performance may have encouraged traders to sell, an earnings yield of 8% implies good returns for those of us with a longer time horizon.

Strix dominates the global market for electric kettle controls, and it is transferring some of the technologies it has invented into other markets, like water purification. Strix’s warts have little to do with the business. As long as Strix can protect its intellectual property, the kettle controls business will probably grow slowly over the long-term as electric kettle use increases outside Europe, where pretty much everybody has one.

Newer initiatives may hasten growth, but Strix is very heavily dependent on outside finance. On the one hand the debt does not make Strix a bad business. The company’s cash flows indicate it would be self-financing, had its previous owners not floated it on the stockmarket loaded with debt. On the other hand, debt is not likely to fall as quickly as I would like because Strix is funnelling money into a new factory in China.

If you read last week’s article about Greggs, the sandwich shop, you know I would love to include this share in the Decision Engine. The only wart I have detected so far is the share price, which means the share has an earnings yield of just 3%.

Richard owns shares in most of the companies listed in the Decision Engine. He doesn’t own any of the shares in the list of candidates (yet).

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.