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Four shares that should outperform

Their fast rising earnings and share prices put them top in our stock screen
February 14, 2012

While most popular stock screens have been back-tested by the people that devised them to judge and hone their effectiveness, the inspiration for the screen normally comes before the number crunching starts. US investment star James O’Shaughnessy turned this process on its head.

In his best-selling book, "What Works on Wall Street", Mr O’Shaughnessy set out the results from extensive number-crunching experiments aimed at finding what screening criteria would pick the best stocks. He came up with two screens, one of which was described as "conservative growth" and the other as "value".

We're focusing on Mr O'Shaughnessy's growth screen this week. A portfolio from a similar screen we ran a year ago modestly outperformed the market over the 12 months to 1 Feb 2012, falling 1 per cent on an ask to bid price basis (the price it would have cost to buy and sell shares in the market if the strategy were applied), compared with the FTSE All-Share's 5.3 per cent fall. The portfolio produced a yield of 3.2 per cent over the period compared with the current yield on the All-Share of 3.5 per cent and 2.9 per cent when we published the screen's results on 1 Feb 2011.

While this is hardly a result to get pulses racing, Mr O'Shaughnessy got significantly better results himself over the long term and was a strong advocate of sticking to a strategy over the good times and bad to get the best results. Indeed, between 1954 and 1996 he found the conservative growth strategy produced an average annual return of 18.5 per cent.

Our O'Shaughnessy conservative growth screen looks for:

■ A price to sales ratio of less than 1.5. In the case of this screen, the ends justifies the means, but the reason normally given for looking at PSR rather than earnings based multiples is that it is ultimately sales that determine profits, but sales are more likely to be overlooked due to the market's obsession with profits.

■ EPS growth over each of the last five years. We've used annual underlying diluted EPS to measure this, which is slightly different to our last screen and has possibly contributed to a reduction in the number of stocks passing this test – more of that in a bit.

■ 3-month share price momentum – the higher the better.

Mr O'Shaughnessy's method is based on buying a portfolio of the 50 stocks with most momentum. But despite the fact that we've screened all companies with market caps above £75m, we've only found 17 that pass muster. Of these, only eight have displayed positive share price momentum over the last three months and only four have outperformed the 7 per cent rise by the FTSE All Share. We look in more detail at these four stocks below, all of them boast a very impressive record of unbroken dividend growth as well as EPS growth over the last five years

CompanyTIDMMarket CapPricePSRForecast PE DY3-mth momentum5-yr av annual EPS Growth
Compass GroupLSE:CPG£11.9bn629p0.8153.1%11%29%
G4SLSE:GFS£3.9bn275p0.5123.0%10%11%
BunzlLSE:BNZL£2.9bn873p0.6132.8%9%7%
Restaurant GroupLSE:RTN£597m306p1.3144.2%9%18%
Mitie GroupLSE:MTO£926m262p0.5123.6%6%11%
Associated British FoodsLSE:ABF£9.3bn1,175p0.8142.3%6%8%
Hargreaves ServicesAIM:HSP£319m1,177p0.6101.5%4%37%
Serco GroupLSE:SRP£2.6bn522p0.6141.5%2%21%
May Gurney Integrated ServicesAIM:MAYG£195m290p0.3112.8%-2%11%
James Fisher & SonsLSE:FSJ£256m514p0.9113.3%-3%19%
Halfords GroupLSE:HFD£637m327p0.797.5%-4%12%
JD Sports FashionLSE:JD.£389m799p0.473.2%-4%39%
Wm. Morrison SupermarketsLSE:MRW£7.4bn295p0.4113.9%-5%123%
WH SmithLSE:SMWH£688m528p0.594.7%-5%16%
CapitaLSE:CPI£3.9bn635p1.4133.3%-9%15%
TescoLSE:TSCO£25.8bn325p0.494.5%-20%8%
FTSE All-Share3.5%7%

Source: CapitalIQ/Thomson Reuters

Compass Group

Catering giant Compass is benefiting from a trend towards outsourcing the running of cafes and canteens by organisations that are keen to save money. The trend is particularly prevalent in the US where the group generates nearly half its revenues and it is also enjoying strong growth in developing markets, such as Asia, where it has been expanding recently. The outlook in Europe and the UK is stodgier but its end markets are considered quite defensive. The group’s cash generation is strong, and after rebasing the dividend upwards last year – dividend growth has averaged 12.7 per cent a year over five years – the group has set aside £500m for share buy backs this year. A recent trading update has added to confidence about the group's growth prospects.

Last IC View: Buy, 613p, 19 Jan 2012

G4S

Shares in security giant G4S have been regaining their poise over recent months after losing ground in a aborted bid for building maintenance group ISS which was unpopular with shareholders. Canning the offer means the group remains focused on generating organic growth from its promising end markets in security services and also through small bolt-on acquisitions. Its contract for the 2012 Olympics could provide something of a fillip this year. However, developed markets are not looking in great health overall and there are expectations that margins could come under pressure in 2012. Nevertheless the long-term growth story looks intact and dividend growth has averaged a whopping 17.6 per cent over the last five years.

Last IC View: Buy, 233p, 19 Oct 2011

Bunzl

The term “conservative growth” seems very fitting for international packaging firm Bunzl. With the help of small bolt on acquisitions – it spent £185m on 10 businesses in 2011 – the group has established a track record of steadily growing the top line and its margins. Its end markets in food packaging, food services and hygiene are all relatively defensive. The group also has significant exposure to the US, where it generated 54 per cent of sales in 2010 and 59 per cent of profit, so the signs that that economy is picking up are reassuring. The company also has a strong record of cash generation. That has underpinned impressive dividend growth, which has averaged 8.3 per cent over the last five years.

Last IC View: Good value, 767p, 30 Aug 2011

Restaurant Group

Having a focus on UK consumer spending hardly looks like a recipe for growth in 2012, but Restaurant Group, which operates chains including Frankie & Benny’s, Garfunkels and Chiquitos, could be a company to buck the trend. The company’s focus on openning restaurants in places with high footfall, such as leisure parks and airports, saw it grow through the last recession. While like-for-like sales fell marginally in 2009 and 2010, the group’s store opening programme, financed through its strong cash flows, kept everything moving in the right direction. Like our other stocks it also boasts a strong record of dividend growth averaging 11.2 per cent over the last five years.

Last IC View: Buy, 289p, 12 Jan 2012