Buy the best of British

The 16 shares selected by the screen last October have substantially outperformed the FTSE 350, from which they were selected, delivering an average total return of 14.9 per cent compared with 11.4 per cent from the index. And the five shares with the most momentum that we highlighted in our article have risen 20.5 per cent on average over the period (see below).

Source: Datastream

While we have to endure many commentators talking down the British economy, there are still reasons to be keen on domestic plays for those minded to focus on the country's obvious strengths. In fact, the market has recently been embracing this story, judging by recent strength in UK consumer-focused plays. So, while the going is tough, it's become increasingly clear which stocks are suited to such conditions. Meanwhile, the credit crunch has bought home the virtue of having our own national currency that can be printed at will, although global economic history suggest fears of inflation and ultimately currency debasement should not be ignored. Even with interest rates on the floor, the Bank of England is using the country's monetary flexibility to find innovative ways to try to inject a bit of life into the economy through schemes such as 'Funding for Lending'. The UK can also borrow money for a song at the moment, and the country's debt maturity profile is reassuringly long term. So, while growth is illusive and day-to-day borrowing needs remain high, Britain nevertheless displays some alluring characteristics compared with rivals.

But could domestically focused British companies really be one of the best games in town? The competition certainly doesn't look that tough at the moment. After all, China's stock market is in the doldrums and its economy is slowing, which has elevated fears about possible bubbles in its massive economy. Investors are also nervously waiting to see how these chill winds will be felt in other emerging markets. Meanwhile, the eurozone crisis continues and austerity is proving a major economic burden. And while the US provides a brighter spot, structural issues relating to its borrowings and current account deficit remain an elephant in the room.

At its core, our Best of British screen is a momentum strategy. We are looking for FTSE 350 stocks that generate at least three-quarters of their revenues from the UK and have outperformed the index over the last three months. The other characteristics stocks must display are:

■ Net debt of 2.5 times cash profits.

■ A beta (which measures a stocks volatility in relation to the wider market) of less than 1.

■ Return on equity of 10 per cent or more.

■ Earnings growth of at least 20 per cent over the last five years and forecast earnings growth over the next 12 months.

The best of British

Source: S&P Capital IQ

THE FIVE FASTEST RISERS

Dunelm

Home furnishing store Dunelm was one of the strongest contributors to last year's Best of British screen. The company's roll-out of a tried-and-tested retail formula into the south of the country has been producing excellent results. In the first quarter of its current financial year, like-for-like sales were ahead 3 per cent, in what broker Panmure Gordon believes to be a declining market, while overall sales grew 13.8 per cent. The shares have been buoyed by a raft of broker upgrades, news of a return of capital and a rising rating on the shares. The expansion story could have further to run, although the valuation has begun to look a bit rich and we advised taking profits last month.

*Based on consensus forecasts for the next full-year results

Source: S&P Capital IQ

Last IC view: Sell, 661p, 20 Sep 2012

Restaurant Group

The track record of earnings and dividend growth boasted by Restaurant Group, all funded from its own cash flows, is the envy of many of its industry peers. The shares have recently been buoyed by the strong performance of the Travel & Leisure sector in general but have more going for them than just this. The company has recently begun to roll out a new restaurant format called Coast to Coast which should underpin its ongoing growth potential. However, analysts believe it will generate more money than it needs to fund investment plans and continued dividend growth which, coupled with a strong balance sheet, means cash could be returned to shareholders.

Last IC view: Buy, 331p, 3 Sep 2012

Capita

The outsourcing market in the UK has had a tough time since the coalition government came to power, but recently it has been showing signs of life. At the half-year stage Capita looked set to return to organic growth. A £274m fundraising earlier in the year is also helping the group fund growth through acquisition and Capita's competitive position is still considered to be strong. That said, margins have been a growing concern for investors and the recent loss of Capita's CRB contract with the Home Office could prove a further strain on profitability. Still, following an Olympic-induced hiatus, contract approvals could be set to step up as the year draws to a close which would help newsflow and sentiment.

Last IC view: Hold, 705p, 25 Jul 2012

KCom

Hull-based telecoms company KCom, which was formerly known as Kingston Communications, has had its shares knocked since we ran our screen. In fact, its recent trading update, which reported slowing business sales, highlights the risks associated with the lacklustre growth in the UK economy. However, the company still has its attractions and is performing well compared with peers. It is benefiting from national expansion and growth in higher-margin business-to-business sales. KCom is also rolling out superfast broadband in and around Hull, which should help demand. So, despite the recent disappointment, management is confident enough about prospects to stick by a promised 10 per cent dividend increase this year, which means a 4.4p a share payout for 2013 and a prospective yield of over 5.6 per cent at the current price of 79p (the price quoted in our table is accurate as of the time of the screen). The rating is also far from challenging on an earnings basis based on Oriel Securities' post-update EPS forecast of 7.4p.

Last IC view: Buy, 71p, 22 May 2012

WH Smith

Stationery, news and book retailer WH Smith has already told the market that it expects to smash expectations with its full-year results on Thursday 11 October (after we have gone to press). The strong track record the group has built over recent years is focused on cost-cutting to mitigate declining trade on the high street, coupled with expansion of its outlets based in major travel hubs in the UK and, perhaps most promisingly, internationally. Cash generation is strong and the board has already said it plans a further £50m-worth of share buy-backs using surplus cash. The challenge management faces is to continue to feed the City news of more cash generation while pursuing successful expansion elsewhere.

Last IC view: Buy, 598p, 24 Aug 2012