This time last year, I was updating readers on a storming 12 months for my big reliables screen; however, the year since then has proved much tougher going. Perhaps this should not come as too much of a surprise as this is a screen that focuses on 'quality' and does not pay any heed to valuation.
From the perspective of last year's screen, the issue with its quality-centric output was that the valuations being placed on quality shares looked strikingly high. Indeed, as highlighted at the time, the term 'bondification' was being bandied about to describe the phenomenon of money moving out of the highly priced bond markets in search of high-quality dividend-paying equities, which had in turn pushed up the prices of such stocks. Since then bonds have continued to get more expensive, but the same cannot be said for high-quality shares.
While valuation in itself is rarely a reason for share prices to fall, high valuations do add to potential losses caused by negative changes to sentiment, or worse still if trading disappoints. Last year's big reliable stock picks struggled both as a result of sentiment and specific trading problems. Standout losers include the once oh-so-reliable retailers Burberry and Next, which have fallen from grace as trading has soured and valuations have had to adjust. Meanwhile, the likes of easyJet have suffered due to investors' fears that market dynamics are moving against it (see the write-up below). In price terms, one would expect lowly rated shares to deal with such disappointments better than highly rated ones. What's more, even when last year's big reliables have outperformed the market, stretched valuations have arguably kept the lid on the gains achieved.
2015 BIG RELIABLE PERFORMANCE
| Name | TIDM | Total return (7 Jul 2015 - 14 Jun 2016) |
|---|---|---|
| WH Smith | SMWH | 6.6% |
| Booker | BOK | 5.8% |
| Telecom Plus | TEP | 3.2% |
| Moneysupermarket | MONY | 0.1% |
| PayPoint | PAY | -1.6% |
| easyJet | EZJ | -9.0% |
| Whitbread | WTB | -20% |
| Victrex | VCTA | -24% |
| Next | NXT | -28% |
| Burberry | BRBY | -30% |
| Average | - | -9.7% |
| FTSE 350 | - | -4.1% |
Source: Thomson Datastream
While it's rarely fair to judge a strategy over a period as short as 12 months, it is arguably particularly unfair to judge a strategy based on buying 'quality' over such a short time. Generally the tactic of focusing on quality is seen as the territory of long-term buy-and-hold investors. On that basis, it is encouraging that from a long-term buy-and-hold perspective the strategy has done well. Indeed, buy-and-hold has been more lucrative in the five years I've been running the big reliables screen than the result from switching between portfolios each time a new one is published, as represented by the five-year cumulative return in the table below.
BIG RELIABLE BUY-AND-HOLD PERFORMANCE
| To present from June/July | FTSE 350 | Big Reliable |
|---|---|---|
| 2011 | 26% | 77% |
| 2012 | 37% | 84% |
| 2013 | 1.3% | 41% |
| 2014 | -3.2% | 34% |
| 2015 | -4.1% | -10% |
| 5-yr cumulative | 26% | 54% |
Source: Thomson Datastream
While the five-year cumulative total return from the screen of 53.7 per cent versus 25.7 per cent for the FTSE 350 is decent, and would represent a top-quartile UK equity unit trust performance, it is not a knockout result. However, it is good enough to provide some vindication for running a screen focusing on quality above all else over the period. If I include an annual charge of 1 per cent to account for dealing costs the total return drops to 46.2 per cent.
Big reliables versus FTSE 350
The screen focuses on FTSE 350 constituents ('big' companies) and the broad measures of quality used by the screen to attempt to identify 'reliable' companies are:
■ 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 profit. ■ Cash conversion (cash from operations as a proportion of operating profit) of 90 per cent or more. |
Six FTSE 350 stocks passed all the screen's tests this year and I've taken a closer look at three of them below, with the rest included in the accompanying table.
SIX BIG RELIABLE SHARES
| Name | TIDM | Mkt cap | Price | Fwd NTM PE | DY | PEG | Fwd EPS grth FY+1 | Fwd EPS grth FY+2 | 3-mth mom | Net cash/ debt (-) |
|---|---|---|---|---|---|---|---|---|---|---|
| Berendsen | BRSN | £2.0bn | 1,190p | 18 | 2.6% | 3.4 | 6.8% | 6.3% | 0.9% | -£379m |
| Booker | BOK | £3.0bn | 168p | 23 | 2.7% | 2.3 | 10% | 8.9% | 1.1% | £127m |
| Dunelm | DNLM | £1.8bn | 884p | 18 | 6.1%* | 2.8 | 5.3% | 7.5% | -5.9% | -£29m |
| easyJet | EZJ | £5.5bn | 1,395p | 10 | 4.0% | 1.0 | 4.1% | 15% | -6.7% | £296m |
| Moneysupermarket | MONY | £1.5bn | 279p | 21 | 3.3% | 3.5 | 5.1% | 8.4% | -18% | £17m |
| Whitbread | WTB | £7.1bn | 3,908p | 17 | 2.3% | 3.0 | 3.8% | 8.2% | 0.2% | -£924m |
*Dunelm DY includes special dividend
Source: S&P Capital IQ
