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British momentum comes unstuck

The Best of British momentum screen we have run with great success since 2011 has finally come unstuck
August 31, 2016

Five years ago, we started our Best of British stock screen as a retort to certain government ministers' proclamations that the national economy was broken. In a refrain which may once again feel familiar, the future of the country's financial health was apparently bleak, UK plc included. George Osborne - then chancellor of the Exchequer - freely compared Britain's borrowing levels to a Greek sovereign debt crisis which in the summer of 2011 was threatening the very foundations of the eurozone. In response, the screen's underlying premise was simple: there are plenty of domestically-focused British companies which are in fine fettle. And because markets always end up gravitating towards quality, sentiment would prevail over doom-mongering and UK stocks with momentum would carry the day.

Since we last ran the screen last October, Mr Osborne may have departed office, but a lot of sentiment in UK companies' earnings and the broader national economy has decidedly soured. Indeed, as has been the case in several recent stock screens, Brexit has weighed particularly heavily on stocks selected for their exposure to the UK. In fact, our Best of British screen selection - which only looks at companies with at least three-quarters of revenue from the UK - slid by 22 percentage points in the two days following the vote to leave the European Union. In total, the screen delivered a total negative return of 8 per cent, against 11 per cent for the FTSE 350 from which the stocks are drawn.

Best of British 2015 picks

NameTIDMTotal Return (6 Oct - 25 Aug 2016)
JD Sports FashionJD.33.2%
DunelmDNLM4.1%
PaypointPAY3.2%
Telecom PlusTEP1.6%
BookerBOK0.5%
BellwayBLWY-3.1%
PersimmonPSN-3.1%
Howden JoineryHWDN-4.6%
Moneysupermarket.comMONY-8.0%
WhitbreadWTB-10.9%
MarshallsMSLH-11.3%
Ted BakerTED-17.7%
Restaurant GroupRTN-39.5%
Sports Direct InternationalSPD-60.6%
FTSE 35011.1%
Best of British--8.3%
Top 5--0.4%

Source: Thomson Datastream

 

That's a significant reversal in the screen's long-term trend - even after including this year's poor performance it has more than doubled in five years, if reinvested each year, compared with a 58 per cent total return from the benchmark index. As we have said previously, investing in the five stocks which showed the highest three-month share price momentum in each year's screen has proved an even more successful strategy. After including a 1.5 per cent annual dealing charge each for reinvesting the screen, the top five shares would have returned 154 per cent - ever so slightly down on last year's running return.

 

BEST OF BRITISH CUMULATIVE RETURN

 

That tactic has also played well for a screen that focuses on momentum over quality - demonstrated by the fact that reinvestment has worked better than buying and holding shares from any individual screen dating back to 2011.

 

BUY AND HOLD STRATEGY (TOTAL RETURN)

YearFTSE 350Best of British
201157.8%121.6%
201239.5%69.2%
201319.5%12.6%
201413.6%46.4%
201511.1%-8.3%

Source: Thomson Datastream

 

It should be noted that prior to the referendum, the screen was already underperforming the FTSE 350 for the period, thanks in part to a terrible year for Mike Ashley's Sports Direct International (SPD) and Frankie & Benny's owner Restaurant Group (RTN). That was despite bullish earnings forecasts for both stocks and high valuations, although the latter matters little to a screen chiefly concerned with solid return on equity, low volatility and a track record of growth.

This year, none of the stocks that passed the key earnings and momentum tests could claim to have at least 75 per cent of revenue from the UK. Setting the bar slightly lower for stocks with the required amount of UK sales revealed 17 shares which passed all of tests bar the requirement for a better three-month share price momentum than the FTSE 350. That should hardly come as a surprise, given the market's preference for index constituents with a lower exposure to sterling since the EU referendum. There is also still a fair degree of pessimism baked into the market's outlook for the UK economy, which explains why the vast majority of the shares that made the screen this year have underperformed the benchmark index since June.

Of the 17 companies that made the grade, we have included write-ups of the five companies with the highest three-month share price momentum, the rest of which are in the table at the bottom of the article. Although none of this year's shares passed the second test, the complete criteria for the Best of British screen is as follows:

■ At least three-quarters of revenue from UK.

■ Three-month share price momentum better than the FTSE 350.

■ Return on equity of more than 10 per cent.

■ One-year beta of less than one.

■ Forecast EPS growth in this and the next financial year.

■ Better than average five-year compound annual growth rate (shorter periods used where a full five-year record is unavailable).

■ Net debt of less than 2.5 times cash profit.

 

Domino's Pizza

Domino's Pizza's (DOM) Michigan roots hardly puts it among the most blue-blooded of British companies, but the nation's love of motorcycle-delivered cheese products is one constant set to endure any potential Brexit-linked economic stagnation. In July, the company posted its 11th successive quarter of double-digit comparable sales growth for the UK, helping the company to a 17 per cent half-year growth in sales to £495m. And while acquisition costs and investments have edged the business into net debt, Domino's is throwing off enough cash for a recently announced £15.3m share buyback and dividend hike.

Last IC view: Buy, 388p, 29 Jul 2016

 

Cranswick

Out of the pizza oven, into the frying pan. Another British company whose shares confidently shrugged off a small Brexit sell-off is meat product specialist Cranswick (CWK), which makes a return to the screen after a year off. In its year off, the company has been busy investing in chicken; first, through a doubling of capacity at Benson Park, the producer it acquired in 2014, and second, through the £40m purchase of Crown Chicken in April. That led analysts at Liberum to upgrade their expectations for adjusted pre-tax profit of £73.4m in the year to March 2017 and adjusted EPS of 117.9p.

Last IC view: Buy, 2,307p, 24 May 2016

 

Next

Like Cranswick, Next (NXT) failed to make last year's screen despite being a permanent Best of British constituent since 2012. And with the lowest forward PE ratio of the retailers to make the screen, it is clear that Next's excellent long-term track record of earnings growth has come in for questioning in the last year. Indeed, investors' main concern is whether the group can offset rising costs via price increases and effectively pass the pain on to its loyal customer base. If it can't then margins look set to be punished in order to protect profits, although the continued rise of its online operation and a well-placed currency hedge for the year to January 2017 provide useful protection from any dip in high street sales over the crucial autumn and winter months.

Last IC view: Hold, 5,321p, 4 Aug 2016

 

JD Sports Fashion

High street retailer JD Sports (JD.) has been this stock screen's standout constituent for the past two years, so despite the lofty valuation we wouldn't bet against the prospects of another strong showing. That will be predicated on a slightly different tack, given that most of the group's future growth is planned for Europe, with 38 more stores added to the continental store estate during the last financial year. In March, the group purchased two brands in Netherlands which were on the brink of administration, making JD the largest operator in the region. If the early trading signs are positive, the company's net cash position means there is plenty of scope for further growth.

Last IC view: Buy, 1,179p, 14 Apr 2016

 

Rightmove

Although the online real estate group technically has the fifth best momentum, jitters around the domestic property market means Rightmove's (RMV) shares have actually lost ground in the last three months. But the company is confident that its subscription model and brand power will help it deliver on heady expectations for earnings per share of 138p this year. In setting that target, analysts at Numis can point to the 1.1m UK homes listed on its site - 40 per cent more than any other property portal - as well as the company's recent success in squeezing more cash out of estate agency customers.

Last IC view: Hold, 4,089p, 28 Jul 2016

 

Best of British 2016

NameTIDMMkt capPriceFwd NTM PEDYPEGFY EPS gr+1FY EPS gr+23-mth momentumNet cash/debt (-)UK rev
Domino's PizzaDOM£1,871m377p272.0%2.4114.1%11.1%6.6%-£11m94%
CranswickCWK£1,163m2,332p201.6%2.9911.5%5.1%3.3%£18m98%
NextNXT£8,042m5,625p132.8%####0.5%1.9%2.1%-£903m91%
JD Sports FashionJD.£2,563m1,317p180.6%1.7516.2%11.9%1.3%£209m77%
RightmoveRMV£3,954m4,219p291.1%2.2622.3%8.9%-0.5%£13m100%
BookerBOK£3,162m179p222.6%2.5610.3%8.4%-0.6%£127m100%
WhitbreadWTB£7,611m4,175p172.2%4.142.4%6.9%-4.3%-£924m97%
MarshallsMSLH£621m315p182.2%1.1123.8%13.2%-6.0%-£14m95%
DunelmDNLM£1,813m900p182.4%3.865.0%4.6%-6.1%-£29m100%
ITVITV£8,089m202p123.2%8.753.3%0.5%-6.9%-£793m79%
GreggsGRG£1,051m1,047p172.9%2.835.2%7.7%-7.4%£35m100%
Moneysupermarket.comMONY£1,644m300p203.1%3.805.7%7.5%-7.8%£11m100%
WH SmithSMWH£1,788m1,602p162.5%2.539.1%5.2%-8.9%-£1m94%
Howden JoineryHWDN£2,857m461p162.3%3.455.2%4.4%-10.6%£183m98%
PendragonPDG£482m34p84.2%1.424.3%4.9%-18.1%-£47m100%
Galliford TryGFRD£946m1,150p96.3%0.7111.7%15.7%-20.0%-£109m100%
Crest NicholsonCRST£1,217m480p74.7%0.5627.4%6.2%-22.9%-£26m100%

Source: S&P Capital IQ