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10 Big Reliable shares

My Big Reliable stock screen has delivered big long-term returns every year since I started running it in 2011. Ten stocks make the grade this time around.
July 8, 2015

Investors have recently been piling into high-quality stocks to such an extent that a term has been coined for the phenomenon: "bondification". My Big Reliables stock screen, which focuses solely on quality with no regard to valuation, has been a beneficiary of this trend, with the nine stocks chosen last year producing an excellent 28 per cent total return compared with 3.3 per cent from the FTSE 350.

 

2014-15 performance

NameTIDMTotal return (17 Jun 2014 - 3 Jul 2015)
Micro FocusMCRO69.8%
WH SmithSMWH49.1%
TelecityTCY38.4%
BookerBOK34.8%
HalmaHLMA29.4%
WhitbreadWTB21.9%
BT GroupBT.A21.5%
DunelmDNLM18.3%
Weir GroupWEIR-33.5%
FTSE 350-3.3%
Big Reliables-27.8%

Source: Thomson Datastream

 

The Big Reliables screening strategy tries to embody an investment approach that views quality as the key determinant of long-term outperformance and considers valuation principally as a short-term distraction. For me, this is a strategy that intuitively goes against the grain, but my near-20 years of experience as an investment writer has provided many examples of the quality-focused buy-and-hold approach producing excellent long-term returns.

From the perspective of the Big Reliable screen, the long-term performance is very impressive from each of the screens I've run since I started running the strategy in 2011. The 2011 portfolio now boasts an 83 per cent total return, compared with 34 per cent from the market, the 2012 portfolio has returned 92 per cent versus 46 per cent, and the 2013 portfolio is 26 per cent ahead compared with 8.1 per cent (see charts below). On a cumulative basis - based on switching between portfolios each time a new screen is run - the screen has produced a 73 per cent total return compared with 34 per cent from the FTSE 350

 

Big Reliable 2014 v FTSE 350

 

Big Reliable 2013 v FTSE 350

 

Big Reliable 2012 v FTSE 350

 

Big Reliable 2011 v FTSE 350

 

Old Reliables cumulative total return v FTSE 350

 

While past performance has been good, there are now fears in the market that valuation will soon assert itself as the dominant factor in determining the trajectory of 'quality' stocks. From a historical perspective, valuations do look high in this part of the market. The worry is that the overheating of the bond market has caused bond investors to buy 'bond-like' equities in their hunt for decent yields, which in turn has pushed up prices. Some commentators think this situation has caused the price of quality stocks to become linked to the price of bonds - hence the term 'bondification' - meaning that when bond prices fall, quality stocks will suffer too.

While there is some compelling rationale behind this view, it's not the only convincing argument about the current interplay between bonds and bond-like stocks. Another way to look at the issue is that as bond markets fall, money seeking refuge from an overpriced bond market will actually be more incentivised to move into quality equities as a safe haven. As for the concerns about the high ratings being placed on quality stocks, if there is one thing events in the bond market over recent years should remind us, it is that prices can carry on rising long after valuation arguments have lost any serious credibility.

Big-picture stuff aside, the Big Reliable screen focuses on a number of classic measures of quality, such as return on equity and earnings growth, and attempts to find companies that have looked attractive on these measures for several years. The screen also looks for companies with strong balance sheets and good cash conversion, and when combined with the other screening criteria, this means the stocks highlighted by the screen often have good dividend track records and a history of returning capital to shareholders. The screen is confined to FTSE 350 companies and the full criteria are as follows:

■ EPS growth in each of the past five years.

■ RoE of 12 per cent or more in each of the past five years.

■ Forecast earnings growth in the current financial year and the year after.

■ Gearing of less than 50 per cent, or net debt of less than two times cash profits.

■ Cash conversion (cash from operations as a proportion of operating profits) of 90 per cent or more.

Ten stocks passed all the screen's tests this year. I've looked at five of this year's Big Reliables in more detail below, the remainder of the stocks are listed in the table that follows.