Mention the names Buffett or Bolton and most investors will know who you're talking about. But the name John Neff is more likely to produce some head-scratching, despite the fact that he boasts one of the best track records of any US fund manager. At the helm of the Vanguard Windsor fund, he produced average returns of 13.7 per cent a year over 31 years, compared with an average of 10.6 per cent from the S&P 500. Mr Neff's lack of profile fits with the kind of stocks he liked to buy for his fund.
As a fund manager, he was a contrarian investor focused on buying relatively dull but fundamentally sound stocks that were being overlooked by the market. In his view, stocks that are already unloved have less downside risk and plenty of room to re-rate. What's more, dull businesses are far more likely to have their fundamentals overlooked and are far less likely to attract competition.
The approach espoused by Mr Neff involves buying stocks with low price-earnings (PE) ratios – but not rock-bottom ones, which he believes suggests a company has serious problems. He also puts a lot of emphasis on the role of dividends in determining returns, looking at valuations based on total return. He also looked for steady earnings growth but not high earnings growth that was more likely to fizzle out and disappoint further down the line. Sales growth is also important to his approach as earnings growth based on sustained margin expansion will inevitably run its course at some point.
This is how all these ideas fit into our screen, which encompasses the FTSE All-Share, the FTSE All-Small and the Aim All-Share.
■ PE: We have eliminated the most expensive quarter of all stocks based on forecast PE for the next 12 months and have also eliminated the cheapest quarter. Stocks with zero or negative forecast PEs or no forecasts have been excluded from the screening process altogether. This left us with 331 stocks with PEs ranging from 8.1 times predicted earnings to 16.4 times.
■ Growth: (i) We are looking for stocks with average underlying EPS growth over the past five financial years of 7.5 per cent or more and a similar level of earnings growth forecast for the next 12 months. However, average historic EPS growth of 20 per cent or more is considered excessive.
(ii) In addition, average sales growth over the past five years must be more than 5 per cent.
(iii) EPS must be above that of the previous year in each of the last two half-year periods, suggesting a company is moving in the right direction and therefore more likely to re-rate.
■ Cash: All companies must have positive free cash flow in each of the last three years. Mr Neff believed signs of cash generation were important to make sure companies were not employing accounting tricks to create profit rises.
■ Value: Mr Neff believed good dividends were often ignored by investors despite the fact that they are often critical to performance. His valuation method adds together yield and earnings growth (we've used the average of the past five years and the forecast EPS growth rate) to get a measure of total return (TR). This is then divided by the forecast PE. This is a similar idea to Jim Slater's well-known price-earnings-growth (PEG) ratio, but taking dividends into account. The higher the value of TR/PE, the cheaper the stock is. The shares in the table below have a TR/PE of twice the median market average, which is 0.88.
| TIDM | Name | Market Cap | Price | Dividend yield | Total return (TR) | PE +1 | TR/PE |
|---|---|---|---|---|---|---|---|
| LSE:INF | Informa | £2.3bn | 381p | 3.7% | 42% | 10 | 4.3 |
| LSE:ADN | Aberdeen Asset Management | £2.7bn | 238p | 3.8% | 29% | 13 | 2.2 |
| LSE:BWNG | N Brown | £653m | 233p | 5.3% | 19% | 9 | 2.2 |
| LSE:LSE | London Stock Exchange | £2.4bn | 874p | 3.1% | 21% | 10 | 2.2 |
| AIM:AN. | Alternative Networks | £142m | 295p | 3.4% | 27% | 13 | 2.1 |
| LSE:ADM | Admiral Group | £2.5bn | 909p | 3.6% | 21% | 11 | 1.9 |
| LSE:GFS | G4S | £3.8bn | 269p | 2.9% | 21% | 11 | 1.9 |
| LSE:CPI | Capita | £3.9bn | 646p | 3.1% | 24% | 13 | 1.9 |
| LSE:SVS | Savills | £385m | 312p | 2.9% | 21% | 11 | 1.9 |
| LSE:DPH | Dechra Pharma | £347m | 520p | 2.3% | 25% | 14 | 1.9 |
| LSE:MRO | Melrose | £1.4bn | 360p | 3.9% | 23% | 12 | 1.8 |
| LSE:DPLM | Diploma | £423m | 377p | 3.2% | 23% | 12 | 1.8 |
| LSE:ATK | WS Atkins | £665m | 678p | 4.3% | 15% | 9 | 1.8 |
| LSE:XTA | Xstrata | £31.6bn | 1,078p | 1.5% | 16% | 9 | 1.8 |
| LSE:SYR | Synergy Health | £481m | 869p | 1.8% | 25% | 14 | 1.8 |
| AIM:MAI | Maintel | £37m | 345p | 2.5% | 23% | 13 | 1.8 |
Source: S&P CapitalIQ
Here's a closer look at five of our Neff stocks.
Savills
The market has good reason to take a dim view of Savills given its exposure to the highly cyclical and fragile property market. However, the posh estate agent has shown a remarkable ability to weather the storm. Indeed, it has produced very strong results recently due to its exposure to buoyant parts of the market, especially prime London residential property which foreign buyers have been clamouring to buy, and East Asian property. The group is also building a facilities management business, which it hopes will help mitigate the inherent cyclicality of the estate agency business.
Last IC View: Good value, 319p, 19 August 2011
Capita
Outsourcing group Capita's share rating certainly makes it look deeply out of favour compared with the many years when it would routinely trade at 20 times forecast earnings or more. Indeed, since the coalition government came to power growth appears to have slowed as outsourcing work has dried up. The jury remains out on whether this represents a temporary hiatus while national and local government gets to grips with austerity or whether something more fundamental has changed. The group did report some encouraging contract wins last year, though, and it has also been expanding through acquisitions, which should help growth prospects.
Last IC View: Buy, 714p, 16 September 2011
Admiral Group
Once a stock market darling thanks to a fantastic record, Motor insurer Admiral now sports some major dents in its fender. Investors have taken issue with the amount of business that the company passes to reinsurers, which affects profits but also limits risk. Premium rate rises are also expected to moderate, which would hit numbers. There was also a warning from the company in the autumn about an unexpectedly large number of bodily injury claims, although if this is not an aberration rates should rise to take account of it. The final bitter pill shareholders have had to swallow was news that referral fees, which accounted for about 6 per cent of the group's car insurance profits, will be banned. However, underlying this is a business that has been impressive in the past and could yet make a comeback.
Last IC View: High enough, 1,437p, 24 August 2011
Alternative Networks
Alternative Networks' end market in business communications shows little sign of growth at the moment, and that's hardly the type of prospect to get investors scrabbling for a company's shares. However, the group is growing nonetheless through a combination of market share gains and margin expansion. Acquisitions have also helped the group make progress despite the uninspiring trading environment. The company is clearly confident that it can continue to move things forward as dividend increases of 10 per cent or more have been put on the cards until 2013.
Last IC View: Good Value, 283p, 6 December 2011
London Stock Exchange
The market reacted negatively to the news that the London Stock Exchange would be paying £450m for the remaining 50 per cent of its FTSE International joint venture with Pearson (the owner of this magazine). But while the price of 17 times cash profits looked high on the face of it, FTSE International is a fast-growing business that will give the LSE an opportunity to launch new indices and derivative products. For the rest of the business, nervousness about the global economy is an issue, but the group performed strongly across all of its divisions in the first half and the shares are far from expensive.
Last IC View: Fairly priced, 842p, 16 November 2011
