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14 cheap recovery plays

Algy Hall's Late Bloomers stock screen delivered a 16 per cent total return last year. This year he highlights 14 more stocks ripe for recovery
May 20, 2015

The Late Bloomers screen that I concocted a year ago - designed to capture stocks that still promised cyclical upside - has had a good run over the last 12 months. Following a slow start, the 19 stocks selected by the screen have generated a total return of 16 per cent compared with 6.5 per cent from the FTSE All-Share. This time around, 14 shares have passed the screen's tests.

On a share-by-share basis the performance from last year's screen was somewhat mixed, with some big losers as well as some big winners. Overall, nearly two-thirds of the stocks outperformed the market. The spread of performance should not come as too much of a shock because hunting for stocks on lowly valuations can be expected to highlight risky situations. Indeed, when a company has a low price put on its sales, it can be a sign of entrenched problems with profitability or other aspects of the business. That said, rewards outweighed those risks over the last 12 months.

 

NameTIDMTotal return (9 May 2014 - 12 May 2015)
GreggsGREG116%
SavillsSVS47.7%
GraftonGFTU36.1%
RankRNK31.4%
Speedy HireSDY27.5%
CranswickCWK27.5%
Robert WaltersRWA24.6%
Travis PerkinsTPK24.2%
PendragonPDG21.9%
SIGSHI11.5%
StagecoachSGC11.4%
KellerKLR11.1%
Morgan SindallMGNS5.2%
HeadlamHEAD-0.1%
BPBP.-3.8%
UK MailUKM-8.3%
Home RetailHOME-13.1%
NorcrosNXR-18.4%
Aga RangemasterAGA-48.8%
Average-16.0%
FTSE All-Share-6.5%

Source: Thomson Datastream

 

While my particular interest in creating the Late Bloomers screen last May was to spot 'late-stage' cyclical stocks, the screen can also be viewed as more of a general recovery screen. Indeed, the star performer from last year's screen, Greggs, makes a better fit with this 'recovery' theme than a 'late-stage cyclical' story. Given the length of time since the credit crisis, the recovery angle may now seem the most relevant way to think of the screen even though the weak and stuttering nature of the UK's recovery means some parts of the economy, such as construction, are yet to enjoy their time in the sun.

The key criteria the screen looks for is a price-to-sales (PSR) ratio of less than one. The usual explanation of why investors should pay attention to PSR is that it can often identify businesses that are going through a period of reduced profitability but are backed by sales that could be made to be much more profitable in the future. Given that the expectation of a return to profitability is a key reason for backing a low PSR stock, the screen also looks for companies that are currently generating operating margins that are substantially (one third) below the 10-year peak level. In addition, PSR needs to be a third below the 10-year peak, reflecting the concern that some stocks are persistently valued at a small multiple of sales because their businesses are inherently low margin.

The full criteria are as follows:

■ PSR of less than one

■ PSR at least one-third below 10-year peak

■ EBIT margin at least a third below 10-year peak

■ Net debt of 1.5 times cash profits or less

■ Rising year-on-year sales in the last six months

■ Positive free cash flow

NB financials are excluded from this screen

14 FTSE All-Share stocks passed all the screen's tests. The five of these stocks with the lowest PSRs are given write-ups below while the other nine shares are additionally listed in the table that follows.

 

14 CHEAP RECOVERY SHARES