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How to seek solid, stable and growing businesses

Harry Nimmo tells Leonora Walters why he prioritises investing in stable and growing businesses over valuations
July 9, 2020

In times of economic uncertainty, smaller companies can run into difficulty because they may not have the financial strength or dominant market positions that some of their larger counterparts have. However, so far this year, Standard Life UK Smaller Companies Trust (SLS) and ASI UK Smaller Companies Fund (GB00BBX46183) have held up relatively well. Their manager, Harry Nimmo, puts this down to their investment process, which he has had in place since 1997.

“We focus on quality, growth and momentum, and have a screening process for helping us to pick companies that feature [these attributes],” he explains. “In the bear markets of February and March this year, the key point, in particular, was quality. Quality companies tend to be more resilient and fall less. One of the measures we use to measure quality is called ‘Altman Z-scores’. Edward Altman was a bond analyst who developed this to try and [determine] whether a company was likely to go bust. We try and spot such companies so that we can avoid them. All our stocks have good Altman Z-scores so tend to be resilient, high quality and fall less in a bear market.”

When assessing quality, Mr Nimmo and his colleagues are particularly focused on visibility and predictability of earnings.

“How much of, let’s say, next year’s revenues has a company already got?” aks Mr Nimmo. “We prefer companies that have multi-year contracts that provide, for instance, a service revenue. They get paid before they provide the product or service rather than the other way around. That makes for much better cash flow and visibility, and deep, long-term relationships with customers. [We also] like a very stable management team and founder-run businesses – we don’t like change in the people running a business.”

Examples of such holdings include video game developer Team17 (TM17), whose chief executive officer is its founder Debbie Bestwick. This company has been performing well and since the coronavirus outbreak has experienced increased demand for its games. Mr Nimmo has recently added to it. "Emergencies accelerate change, so I think it will continue to do well," he says. "Quite often changing behaviours spawned by something that has happened, such as Covid-19, don’t suddenly go away."

Another existing holding that has been doing well is Gamma Communications (GAMA), a provider of cloud communication services to small- and medium-sized enterprises, which has benefited from the home working trend. Meanwhile, multi-utility Telecom Plus (TEP), which provides services including landline calls and broadband, has enjoyed a substantial share price rise since March.

Computacenter (CCC), which advises organisations on IT strategy and technology, and manages infrastructure, is also benefiting from the home working trend.

But it has not been plain sailing for all of Mr Nimmo’s UK funds’ holdings, in particular travel-related stocks such as Dart (DTG), which owns airline Jet2.com

"A number of our companies are struggling," admits Mr Nimmo. "But I think [they] will be able to [make] it through to the other side because they have the balance sheets – or at least the ability to raise money to strengthen balance sheets – to see it through. A good example of this is Jet2.com [which has been] voted Britain’s favourite airline and is a very customer-focused operation. It struggled in the first quarter and [Dart's] shares came off very sharply, but it's raised [approximately £172m], so could not fly anybody until April next year, and still stay afloat. But it is opening for business." 

Trainline (TRN), which sells train and coach tickets online, has also been hit by reduced demand and its share price plunged in March, although it has since recovered quite a lot of the fall.

"It’s only operating at a fraction of capacity," says Mr Nimmo. "But this company has a business in the UK and Europe, and is the go to place for buying tickets for travel. And I think we can assume that there will be a time again when [people] will be happy to travel by train or bus. Trainline has enough balance sheet strength to be able to survive for many months [and I think] that after this there will be an acceleration towards ticketless systems where Trainline dominates. Emergencies accelerate change, and it should be in an even stronger position when things open up."

A holding that has experienced a sharp share price fall recently for a reason other than the coronavirus pandemic is clothing producer and online retailer Boohoo.com (BOO). The company has been accused of using a supplier that pays its workers illegally low wages. Mr Nimmo held the stock in his funds because it was trading strongly and he thought it was benefiting from people increasingly shopping online, a trend that the coronavirus outbreak has accelerated.

Following the allegations, Mr Nimmo says: "Boohoo has performed strongly in recent years, but its share price has been rocked by allegations about conditions at one of its suppliers' factories. We are speaking to management about the situation and the actions they’re taking."

When selecting companies, Mr Nimmo and his team screen 13 factors, including measures of stock price and earnings momentum. They also look at growth factors – “mainly earnings per share and dividends per share growth”.

However, they consider valuations to be of secondary importance.

“We do measure prospective and future valuation – it’s not completely ignored,” says Mr Nimmo. “But it doesn’t lead our stock selection, and we don’t have price or valuation targets. Markets are dynamic – everything is getting better or worse – and we want to get on board with the momentum of change. We don’t tend to buy loss-makers, or blue-sky companies that have no earnings or revenue. We much prefer solid, stable and growing businesses with momentum.”

 

Harry Nimmo CV

Harry Nimmo is manager of funds, including Standard Life UK Smaller Companies Trust and ASI UK Smaller Companies. He has worked at Standard Life, now called Aberdeen Standard Investments, since 1985 when he joined as an investment analyst. He became a senior investment analyst with responsibility for larger UK-quoted companies funds in 1990 and investment manager responsible for UK-quoted equity smaller company funds in 1993.

He was global head of smaller companies at Aberdeen Standard for 27 years until he stepped down in February.

Mr Nimmo has a MBA degree from the University of Edinburgh.