I am starting to look ahead to indentify stocks to add to my own ValuableGrowth portfolio and thought that it would be interesting to share the process that I follow ahead of making the decision to commit my capital.
What is ValuableGrowth?
Over the years I have developed a methodology focusing on five fundamental factors; price, earnings, growth, net debt and cash-flow, which help me follow Warren Buffet’s two rules of investing:
Rule 1: Don’t lose money.
Rule 2: Don’t forget rule number 1!
In addition, I overlay my views on macro-economic cycles in order to try to avoid the regular full scale market sell-offs where fundamentals are thrown out of the window and panic takes hold. This helped me avoid the carnage of 2007 to 2009, but it takes patience and the ability to ignore the consensus. It is also important to acknowledge that I may well be wrong, but that is a risk I am prepared to accept. Fear and greed govern market participants’ psychology and I am aiming to prevent myself being at the whim of the market by thorough research and analysis.
I am not looking for racy growth stocks, which are too risky for me. Nor am I looking for for ultra-safe dividend stocks, because, as we have seen there is no such thing as ultra-safe when investing, so something in the middle suits my personal style.
One thing to note is that although the FTSE 100 is back to the levels of 2000 and 2007, if you were heavily invested in the go-go sectors of the day (telecoms, banks) you could still be nursing heavy losses. If you lose 50 per cent of your money, you need to make 100 per cent return to get it back. That’s a lot of hard work.
My focus is on small and medium companies that are inherently more volatile and more prone to earnings setbacks. However, by focusing on the quality of earnings through cash-flow and companies with low debt and are thus less susceptible to rising interest rates, I think I can tip the odds in my favour slightly and find attractively-valued diamonds in the rough.
It should be noted that small caps are illiquid and at times can have a large spread. Small caps can also be subject to large price falls if too many investors head for the exit at the same time, but hopefully I can use this to my advantage. By being clear about what I am buying and why, I can differentiate between general market fluctuations and changes in a companies fundamental prospects.
SCISYS
The first stock to make the cut is SCISYS (SSY). SCISYS is a bespoke software and service company providing leading IT services to blue-chip and public sector businesses, with a particular focus on government & defence, media & broadcasting and the space industry. The company says that their “projects are usually critical to [their customers’] operational success” and that “80 per cent of their revenue comes from customer relationships greater than 5 years”.
SCISYS appears to be dependent on a small number of large customers but is also apparently good at the large complex software projects that it undertakes. This snippet from the company’s annual report illustrates this:
“Some good examples of delivery at the core of our customers’ needs in 2012 include:
•Arqiva: Successful completion of the UK digital television switch over project in time for the Olympics. SCISYS has supplied the monitoring and control system. The final area to switch over was London, where SCISYS Directors were invited to the Crystal Palace switch over event on April 18th
•European Galileo satellite navigation system: including satellite launch support from UK and Germany, and on time deliveries into the mission and ground control segments;
•Coal Authority Inferis System: Operational use of this complex mapping and geospatial reporting system that is used in 25% of all house purchases in the UK. The Inferis system won the Innovation and Achievement in Central Government award from the Association of Geographical Information.
•BBC: The framework contract continues to deliver further dira! radio playout and production systems, notably to the new Salford and West1 complexes. dira! Is supporting all of the BBC national radio channels, local radio in Manchester with London on the way, Radio News and World Service. The BBC successfully trialled dira! at local radio station BBC Radio Northampton, using a unique cloud based approach to delivering local radio at a fraction of the capital cost of onsite deployment. Known as ViLoR (Virtualised Local Radio), it won the technical innovation award at the 2012 Radio Academy Festival.”
SCISYS is moving away from lower margin activities and expanding its customer base as it grows through selective acquisitions. With a forward p/e ratio of 8.4 and earning per share forecast to grow 17% in 2013/4, SCISYS meets the ValuableGrowth criteria and a yield of 2 per cent that is more than 5 times covered doesn’t hurt either.
One key risk is that a disproportionate amount of revenues are dependant on the UK & European public sector, however the company states: “the acquisition of VCS AG (now SCISYS Deutschland GmbH) has reduced this risk by providing 50 per cent of revenues outside of UK public sector or regulated markets and in markets which are least affected by the Eurozone crisis. The strategy to further widen the Group’s non-public non-regulated sector client base will continue to reduce this risk.”
The share price is hovering around 70p currently and is not far from the highs of 72p set in April. Edison Investment Research has a price target of £1.00 which is close to my own price target. However, given my view that the stock market as a whole will suffer a correction over the summer, I do not want to chase the price at this time. Instead I will add SCISYS to my watch list and see how the share price performs over the summer and in the lead up to the interim results announcement on 26th September 2013.
Kerry Balenthiran is the author of "The 17.6 Year Stock Market Cycle, Connecting the Panics of 1929, 1987, 2000 and 2007. "
