Five of the world's best value shares

I first ran the screen a year ago and the results have been pretty good. Between them, the seven stocks selected produced a 26.2 per cent total return over the 12 months. But in the context of the 24.2 per cent total return delivered by the index from which the stocks were picked, the S&P Global 1,200, the relative outperformance was only modest (see graph). Still, the screen has shown some early promise and I'm revisiting it with a few tweaks to its stringent stock-selection criteria.

Source: Datastream

The screen is probably best regarded as focusing on stocks at the "safer" end of the value spectrum. This is in part because the S&P Global 1,200 is made up of large companies and these, on average, are less likely to deliver the kind of big surprises that small caps are well known for - both on the upside and the downside. The stocks also have to pass a number of fairly rigorous tests based on track record, forecast growth and balance sheet strength. From this perspective, it is encouraging to see that there were no real disaster stories from last year's screen, with all the stocks delivering decent total returns on an absolute basis, even if the two companies with connections to the energy sector (Statoil and AMEC) put in poor showings relative to the index (see table).

How last year's shares performed

Source: Datastream

The three guru investors who provide the intellectual underpinning to the screen are the legendary Benjamin Graham along with two much-celebrated US fund managers - John Neff and David Dreman. The principle valuation metrics the screen uses are Mr Graham's formula for intrinsic value and a variation on Mr Neff's favourite measure on value (see box). The variation to Mr Neff's valuation formula is a tweak I've made this year.

The screen

■ A discount to intrinsic value of at least 50 per cent

■ A GV ratio among the lowest two fifths of all stocks screened (below 1.03)

■ A return on equity of more than 10 per cent.

■ A current ratio (current assets/current liabilities) of more than 1.

■ Net debt of less than two times cash profits.

■ Five-year compound average annual EPS growth of 5 per cent or more.

■ Average forecast EPS growth over the next two reporting years of 5 per cent or more.

■ Five-year compound average annual dividend growth of 5 per cent or more.

■ A yield higher than 2.24 per cent, which is the median average of all stocks screened excluding non-dividend payers.

I've insisted that all the shares pass our two key valuation criteria. However, I've allowed them to fail one of the remaining seven tests (I would have drawn a blank if I hadn't). Ensco failed the five-year EPS growth test and all the others failed the higher-than-average dividend yield test.

FIVE OF THE WORLD'S BEST VALUE SHARES

Ensco

There are some signs of a turn in the negative market sentiment towards the oil services sector, which has weighed on shares in Ensco (US.ESV) recently. What's more, there are reasons for optimism about the prospects of Ensco itself which specialises in providing oil exploration companies with ultra-deepwater drilling platforms and high-quality "jack up" rigs. There are grounds to hope that deepwater drill rental rates have bottomed out and demand has also been better than expected in other parts of the market recently. Ensco also looks particularly well positioned to benefit from the global oil and gas industry's exploration plans over the next four years given its strong presence in Brazil. Meanwhile, the company's ongoing fleet expansion programme should also help drive earnings growth in the coming years especially as the average age of the global "jack up" fleet has started to look stretched. Indeed, Ensco's standardised "jack up" building method makes it look particularly well place to take advantage of any supply issues. The potential for earnings growth coupled with improved sentiment provides some good potential for the apparent value on offer from Ensco shares to be realised. Broker JP Morgan believes the shares are worth $70 based on long-term average cash profit multiples.

Source: S&P CapitalIQ

Macy's

US department store giant Macy's (US.M) served up an unwelcome surprise for investors in August when it revealed that second-quarter sales and earnings were short of analysts' expectations and that it would be revising down full-year profit targets. However, the poor quarter could prove to be a genuine blip. Indeed, over recent years, sales growth has been impressive and the company's quality offering is expected to continue to win it market share. Sales and margin improvements are also expected from the group's "omni-channel" strategy which involves taking advantage of its physical and online presence for the best possible result. Share buybacks should also continue to enhance the impact of improved profits when calculated on an EPS basis. Broker JP Morgan believes the strategy should drive double-digit earnings growth through to 2015.

Technip

Halloween proved a scary time to be holding shares in Technip (FR.TEC) as a third-quarter warning knocked over 10 per cent off the share price. But the bad news, which came from the group's subsea division, may be overshadowing some promising signs for the future. Technip, specialises in energy sector project planning, engineering and construction. The problems in its subsea division in the third quarter were put down to higher-than-expected start-up costs, currency movements and a one-off depreciation hit. But start-up costs should come down significantly next year helping boost the subsea division's performance. What's more, the group has reported strong order intake and has a bulging bid pipeline, which bodes well for the future. The company's high level of technical know-how also means it is particularly well placed to win work on the type of complex projects that are becoming increasingly prevalent in the oil and gas industry.

Japan Tobacco

"Abenomics" has been puffing up Japan Tobaccoo's (JAP.2914) trading and when it announced third-quarter results last month the group told analysts to increase their forecasts for the full year. A key reason for the better-than-expected performance was the positive impact of the weakening yen on reported overseas earnings (overseas cigarette sales account for almost half the group revenue). But it is developments in the domestic cigarette business (a third of the sales) that could provide the real excitement in coming years. The bad news for the group is that demand for cigarettes is declining as an ageing Japanese customer base wises up to the deadly nature of the horrid habit. However, JT's investment in state-of-the-art facilities should produce productivity improvements at the same time as the planned closure of several factories should cut costs elsewhere. There are also hopes that the group's strong brands could be used to bolster prices in the domestic market even though tax increases present headwinds. Broker JP Morgan puts a target price of Y4,200 on the shares based on them re-rating to a sector average PE of about 17.

Safran

Aerospace company Safran (FR.SAF) produced storming third-quarter results last month on the back of burgeoning, high-margin aftermarket sales. The group's aftermarket business is in a particularly good spot thanks to the age profile of its engines that are currently in use. Despite the strong numbers, the company is sticking with its full-year guidance, which means there is the potential for further positive surprises. One concern for investors is Safran's policy of capitalising a higher-than-sector-average proportion of its R&D, which has the impact of boosting reported profits when spending runs ahead of amortisation, as it is currently doing. That said, broker Deutsche Bank believes that after adjusting for capitalised R&D, the strong aftermarket sales coupled with scope for margin expansion in the equipment division and currency tailwinds will drive compound annual EPS growth of about 19 per cent to 2015.