Big high-quality winners

Valuation was quite an important factor in determining returns from last year's screen. The table below, which shows the performance of all the stocks that made it through the screen last year, demonstrates how volatile the highly rated shares (PEs over 20) were. Our only sub-10 PE share, Astra Zeneca, did outperform the index but underperformed the average.

*August 2011-August 2012. Source: Datastream

We also ran the screen in December 2010, and this is how that portfolio is doing:

With this year's screen we've honed the focus on selecting shares that boast a mid-range valuation – ie, not so expensive that there is little room for upside and not so cheap that there is probably something wrong. We've insisted our shares come from outside the bottom or top quarter of share valuations based on forecast PE adjusted to take account of a company's net cash/net debt.

■ A return on equity (RoE) of 17.5 per cent or more over the past 12 months and over the company's last three financial years.

■ Operating margins of 15 per cent or more over the past 12 months and over the company's last three financial years.

■ Operating margins in the company's last financial year above the level of two years earlier.

■ Forecast EPS growth of 10 per cent or more.

■ Gearing of less than 75 per cent or net debt of less than 2 times cash profits.

■ Member of the FTSE All-Share index (no Fledgling or Aim shares)

Only four stocks met all of our criteria on fundamentals and also passed the valuation test; these are summarised below. The table at the bottom shows the four stocks that met our 'high-quality' criteria but were deemed too expensive to cut the mustard.

Next

Clothing retailer Next commands a premium rating compared to peers, but its track record merits that tag. Like-for-like sales on the High Street have come under pressure, but strong cost control, clever management of expectations and a thriving online and catalogue business have more than offset that. It's also used strong cash generation to fund share buybacks, which have helped keep earnings per share rising - according to broker Shore Capital, in the five years to January 2012, Next's earnings per share increased by 71 per cent despite operating profit rising by just 10 per cent. And Numis Securities thinks investors can count on an 'EPS kicker' of about 4 to 5 per cent a year for the foreseeable future. Last IC view: Hold, 3,501p, 3 Aug 2012

Source: S&P CapitalIQ

Shire

For years, Shire was the only large-cap growth story in the UK pharmaceutical sector. But at the time of its half-year results, its managers said they were scaling back growth targets because of falling royalty revnues and sooner-than-expected generic competition for its attention deficit disorder (ADD) drug Adderall. Vyvanse, another ADD treatment, is not yet filling the gap generic competition is likely to leave. The company is cutting investment in the business in an attempt to meet full-year EPS expectations, but things look more uncertain now for Shire and the shares have slipped from highs of 2,316p in February this year. The track record should provide some encouragement for the longer term, though. Last IC view: Hold, 1948p, 1 Aug 2012

Paypoint

Over the years Paypoint has proved itself very adept at getting extra revenues from the network of cash-payment making-and-taking machines that it has installed in convenience stores across the country. TThese allow customers to pay bills and top up mobile phones, and newer revenue channels are more than compensating for slower growth from mobile payments. Examples include CollectPlus, which allows online shopping to be delivered to and picked up from local stores with Paypoint terminals. There's also been overseas expansion, for instance in Romania. The shares aren't cheap, but the company has a good track record. Last IC view: Hold, 633p, 24 May 2012

Jardine Lloyd Thompson

Insurance broker Jardine Lloyd Thompson is the only stock from last year's screen that has also made the grade this time around. The company has been benefiting from its investment in staff and the pace of hiring shows little sign of letting up, with 400 new people joining the group in the first half. And despite relatively modest premium rate increases in the types of insurance it covers, prospects look good, especially in developing economies where increased affluence is boosting demand - the group's operations in Asia and Latin America accounted for 18 per cent of its first-half sales following strong growth in the regions. The impact of sales growth on the bottom line is also being helped by decent margin improvements. Broker Panmure points out that the company's valuation represents a discount to its US peers based on both yield and earnings multiple, despite its potentially better prospects. Last IC view: Buy, 726p, 30 Jul 2012

Too expensive...