My strategy screen touches on a few of my key personal interests in monitoring the many different screens this column reviews. Firstly, the screen works on the premise that well-defined investment styles are likely to come in and out of favour. Secondly, the screen plays on the idea that when trends emerge, they often remain established for a considerable length of time. Indeed, the strategy screen is effectively an attempt to apply the concept of momentum investing to investment styles as opposed to individual stocks.
It looks as though last year's screen was conducted at a particularly opportune moment. Resources stocks had recently started their stellar rebound, meaning their performance influenced the screen's selection of top-performing metrics. A 'value' investment style had also just started to outperform 'growth'. These trends continued to play out throughout the course of the year.
The 21 stocks selected by the screen in 2016 produced a total return of 43.4 per cent compared with 22.0 per cent from the FTSE All-Share.
2016 PERFORMANCE
| Name | TIDM | Total return (22 Mar 2016 - 6 Mar 2017) |
|---|---|---|
| EnQuest | ENQ | 175% |
| Anglo American | AAL | 130% |
| Cambian | CMBN | 127% |
| Glencore | GLEN | 112% |
| Stobart | STOB | 104% |
| Punch Taverns | PUB | 86% |
| HSBC | HSBA | 60% |
| EI Group | EIG | 53% |
| Premier Oil | PMO | 34% |
| Speedy Hire | SDY | 32% |
| FirstGroup | FGP | 31% |
| Premier Foods | PFD | 29% |
| Drax | DRXG | 28% |
| Equinity | EQN | 21% |
| Communisis | CMS | 17% |
| Lamprell | LAM | 4.4% |
| Petropavlovsk | POG | -10% |
| HSS Hire | HSS | -11% |
| Trinity Mirror | TNI | -17% |
| Flybe | FLYB | -22% |
| Lonmin | LMI | -27% |
| FTSE All-Share | - | 22% |
| Strategy Screen | - | 43% |
Source: Thomson Datastream
What's more, this was the screen's fourth year of outperformance since I conceived it in 2013. During its short life, the screen has managed a cumulative total return of 129 per cent, compared with 40.0 per cent from the index. If I factor in a 1.25 per cent annual charge to represent the notional cost of switching from one portfolio to the next each year, the cumulative return drops to 117 per cent.
Stategy screen vs FTSE All-Share
WINNING STRATEGIES IN 2017
The screen starts out with an assessment of what factors have been most successful at predicting performance over the past three months. Measures of 'low' and 'high' are based on whether a stock is in the most attractive fifth of FTSE All-Share constituents on the given stock analysis metric (when the metric in question cannot be calculated for a stock it is excluded). This is how the nine basic measures of valuation and quality I assess for the screen have done over the past quarter:
Strategies over the last three months
The next step in the process is to construct a screen based on the top three factors, which in this case are: low price-to-book-value (P/BV), low price-to-next-12-month-forecast-earnings (forward PE) and high forecast average EPS growth over the next two financial years (forward EPS growth two-year average). No FTSE All-Share stocks are in the most attractive fifth of those screened on all three measures. Therefore, as with previous years, I've looked for stocks that qualify based on the most influential factor over the past three months (low P/BV) and one of the other top-performing factors. On this basis, the screen identified 24 shares that are listed in the table below, which is ordered by lowest to highest P/BV. I've also provided write-ups of the stock with the lowest P/BV and the one with the lowest forward PE.
WINNING-STRATEGY SHARES
| Name | TIDM | Mkt cap | Price | Fwd NTM PE | DY | P/BV | Av EPS grth FY+1 and FY+2 | 3-mth mom | Net cash/ debt (-) | Extra test passed |
|---|---|---|---|---|---|---|---|---|---|---|
| Ei | EIG | £636m | 134p | 7 | - | 0.45 | 1.5% | 25% | -£2.2bn | Fwd EPS grth |
| Trinity Mirror | TNI | £300m | 109p | 3 | 5.0% | 0.52 | -5.9% | 24% | -£29m | Fwd EPS grth |
| Royal Bank of Scotland | RBS | £28bn | 239p | 13 | - | 0.58 | 74% | 9.2% | £82bn | Fwd PE |
| Barclays | BARC | £39bn | 227p | 11 | 1.8% | 0.59 | 5.7% | -3.6% | £100bn | Fwd EPS grth |
| Standard Chartered | STAN | £24bn | 744p | 18 | - | 0.62 | 372% | 13% | $90bn | Fwd PE |
| U+I | UAI | £222m | 178p | 16 | 7.8% | 0.65 | 24% | 3.5% | -£149m | Fwd PE |
| Soco International | SIA | £433m | 132p | 65 | 3.0% | 0.66 | 276% | -12% | $81m | Fwd PE |
| Drax | DRX | £1.4bn | 346p | 30 | 0.7% | 0.69 | 95% | 14% | -£94m | Fwd PE |
| St Ives | SIV | £75m | 52p | 4 | 15% | 0.69 | -17% | -58% | -£70m | Fwd EPS grth |
| Helical | HLCL | £372m | 318p | 19 | 2.6% | 0.71 | 20% | 7.1% | -£654m | Fwd PE |
| Mitchells & Butlers | MAB | £1.0bn | 245p | 7 | 3.1% | 0.72 | 0.2% | 5.9% | -£2.3bn | Fwd EPS grth |
| Debenhams | DEB | £644m | 53p | 8 | 6.5% | 0.73 | -11% | -8.4% | -£279m | Fwd EPS grth |
| Gulf Marine Services | GMS | £251m | 72p | 9 | 2.8% | 0.75 | -45% | 47% | -$413m | Fwd EPS grth |
| Premier Foods | PFD | £354m | 43p | 6 | - | 0.77 | -4.7% | -4.0% | -£557m | Fwd EPS grth |
| Royal Mail | RMG | £4.0bn | 404p | 10 | 5.6% | 0.77 | -4.3% | -13% | -£472m | Fwd EPS grth |
| HSS Hire | HSS | £115m | 75p | 32 | 1.5% | 0.78 | 17% | -15% | -£232m | Fwd PE |
| P2P Global Inv | P2P | £662m | 793p | 9 | 5.6% | 0.78 | 38% | 6.0% | -£161m | Fwd EPS grth |
| Countrywide | CWD | £404m | 187p | 9 | 8.0% | 0.80 | -20% | 3.9% | -£263m | Fwd EPS grth |
| Communisis | CMS | £106m | 51p | 9 | 4.4% | 0.84 | 9.9% | 34% | -£26m | Fwd EPS grth |
| Gem Diamonds | GEMD | £165m | 119p | 10 | 3.4% | 0.87 | -29% | 14% | $35m | Fwd EPS grth |
| FirstGroup | FGP | £1.5bn | 121p | 9 | - | 0.87 | 16% | 17% | -£1.6bn | Fwd EPS grth |
| Intl Personal Finance | IPF | £372m | 169p | 6 | 7.3% | 0.87 | - | -41% | -£579m | Fwd EPS grth |
| Vodafone | VOD | £54bn | 202p | 32 | 6.2% | 0.89 | 16% | 2.7% | -€42bn | Fwd PE |
| Virgin Money | VM. | £1.5bn | 338p | 9 | 1.5% | 0.89 | - | 8.7% | -£3.5bn | Fwd EPS grth |
Source: S&P Capital IQ
LOWEST FORWARD PE
Trinity Mirror
How low is too low for a forward PE? There's no precise answer to that question, but in the case of Trinity Mirror (TNI), priced at three times forecast earnings, it's fair to assume something lurks beneath the surface. Fortunately for our screen, that does not necessarily mean the shares won't perform well as small improvements in desperate situations can lead to major upside.
There are two really big concerns for any investor in Trinity Mirror. First off is the massive pension deficit. Indeed, a forward PE adjusted for the £466m pension hole along, with the group's modest £30.5m net debt, comes in at 7.4 times, based on broker Numis's adjusted profit forecasts for 2017. This is still a low rating, but not as suspiciously low as the unadjusted number.
The other big problem Trinity Mirror faces is its core business - newspaper publishing. Circulations are in seemingly inexorable decline as more and more people turn to online news sources. Indeed, despite cover-price rises, underlying profit from this part of the business fell by 11 per cent last year. The pain has been reduced by cost-cutting and management further demonstrated its panache at making savings last year with the efficiency improvements it was able to find at acquired local news business Local World. Still, sales are falling at an alarming rate and there is only so far cuts can go to offset this. Impressive growth from Trinity Mirror's digital business does provide some encouragement, but this represents little more than one-tenth of revenue.
There's no getting around the fact that low PE ratio, huge deficit and structural issues in the industry shout 'value trap'. However, recent full-year results did suggest the company is doing well in dealing with the decline and, allowing for £40.7m of cash payments into the pension (top-up payments of £36m a year are scheduled until 2023 and potentially more depending on dividend growth rates), cash generation was impressive thanks to relatively low levels of capital expenditure. That means management's aim to grow the already tempting dividend by 5 per cent a year does not look totally outlandish and were there any signs of a serious abatement in top-line declines could prove very good news for the share price.
Last IC View: Buy, 110p, 28 Feb 2017
LOWEST P/BV
Ei Group
A number of the shares highlighted by the strategy screen this year are stocks that many investors have considered 'uninvestable' since the financial crisis. The banks selected by the screen, particularly RBS, are the clearest example of this, but pub company Ei (EIG), formerly known as Enterprise Inns, has arguably been tarred with the same brush - and for good reason.
The group has looked excellent value against its net assets since it became a high-profile victim of the credit crunch, which came after the group had spent several years loading up the balance sheet with 'securitised' borrowings. The trouble with the group's reported book value (assets minus liabilities and minority interests) is that on the liabilities side there is a gargantuan debt pile. Indeed, the group's £2.2bn net debt is equivalent to 3.5 times Ei's market capitalisation and 7.5 times cash profit. The outsized significance of borrowing in the overall funding of the group means lenders, rather than equity holders, have been firmly in the driving seat for several years.
The group has been attempting to deal with its balance sheet issues by selling off pubs. To this end it has managed to reduce net debt by a fifth over the past four years while sacrificing about 14 per cent of its cash profit, according to Numis's calculations. Ei has also been engaging with its disparate band of debt holders to see if it can soften certain loan terms in order to get a bit more wriggle room with how the estate is managed.
Progress has been made on this front and the group is now able to pursue a strategy of converting more of its leased and tenanted pubs into own-managed sites. It plans to take the number from 99 at the end of the last financial year to 800 by the end of September 2020. The early signs suggest this should boost performance, with the strategy being credited as helping boost returns on investment last year from 19 per cent to 22 per cent. The group is also converting property to sit in its commercial real estate arm and plans to grow this part of the business from 291 properties to about 400 in the current year. First-quarter like-for-like commercial property net income growth was 2.1 per cent.
The value of the estate also rose last year in another sign that management initiatives are paying off. Last year trading was also encouraging, with all regions and parts of the business moving in the right direction. A first-quarter update provided further reason for cheer, with the group reporting that the core leased and tenanted estate grew like-for-like net income by 1.6 per cent.
The huge amount of debt the company carries - so-called 'financial gearing' - has the effect of magnifying the impact on shareholder returns of trading and property value improvements. That means a little good news can go a long way for the share price. However, these potential rewards need to be seen against the substantial risks high debt brings, which is illustrated by Ei's very low fixed cover charge of 1.4 times (profit compared with annual interest costs and fixed lease payments, such as rent), as calculated by SharePad.
Last IC View: Buy, 107p, 8 Dec 2016
