Join our community of smart investors

One stock to rule them all

Our strategy screen’s slog through the least-worst investing styles of recent months has found just one share in London’s 600-strong premium market
May 17, 2022

Our strategy screen, now entering its 10th year of service, was designed to take a momentum-like approach to investment style. By following whatever approach is working in the market – be it growth, value, quality, or momentum – it seeks to mix prevailing sentiment with the cheapest, fastest-growing, highest-quality or fastest-rising stocks at any given moment (or in practice, each time it is refreshed).

But what happens if no one style is working? Faced with this conundrum two years ago, when all but a couple of the approaches tracked by the screen had underperformed the benchmark over the previous three months, growth was correctly identified as a looming winner.

In truth, given the massive re-rating in the market between November 2020 and May 2021, the screen would have likely done well even if a different style had won out. The combined effect of vaccines, massive monetary and fiscal stimulus, and swelling investor sentiment in an economic boom acted as a tide that lifted almost every boat.

This week’s version of the screen strongly resembles 2020. Over the past three months, each of the 13 single factor filters the screen follows has lagged the FTSE All-Share, which has itself dipped 5.2 per cent. To battered sentiment, we can now add persistent concerns around inflation and economic contraction.

Last year, the strategy screen’s style barometer swung to cheap stocks in a big way. As we warned at the time, that left it with an unbalanced selection full of potential value traps, and so it proved. Although winners and losers were split fifty-fifty, big slumps from a grab-bag of super-cheap finance stocks erased most of the monster gains provided by Investec (INVP) and Shell (SHEL).

NameTIDMTotal Return (11 May 2021 - 11 May 2022)
ShellSHEL76%
InvestecINVP65%
AvivaAV.8%
M&GMNG5%
Premier FoodsPFD5%
BabcockBAB4%
Lloyds BankingLLOY-3%
KierKIE-10%
Micro FocusMCRO-18%
JustJUST-26%
Int'l Personal FinanceIPF-27%
TP ICAPTCAP-44%
FTSE All-Share-6%
Strategy Screen-3%
Source: Thomson Datastream

As a result, the strategy screen failed to match the returns from the FTSE All-Share for only the third time since we started running it in 2013. In that period, it has delivered a cumulative total return of 170 per cent compared with 71 per cent from the FTSE All-Share. Between 2018 and 2020, we weakened the criteria of the screens to reduce volatility and add some diversification. While we stand by this approach, as we discuss in greater depth below, doing so has downplayed the strategy screen’s stock-picking chops. Based on only those shares that fully qualify (five in 2018, six in 2019, and just one in 2020) the total return over nine years is some way better at 220 per cent. 

That is, of course, a somewhat theoretical return. While the screens run in this column are meant as a source of ideas for further research rather than off-the-shelf portfolios, if we add in a notional 1.25 per cent annual charge for dealing costs, the total return drops from 170 per cent to 141 per cent.

The way the strategy screen works is by assessing the three-month performance of 13 different 'buckets' of shares. The buckets represent the most attractive fifth of the FTSE All-Share constituents based on a given set of criteria (such as high forecast EPS growth, low price to book ratio). All the strategies and their performance over the past three months can be seen in the chart below. 

What has performed well recently? The short answer is nothing. A more elaborate answer is that across this poor performance, no one style has been discernibly worse or better than any other over the past three months.

Fortunately, this doesn’t alter the methodology. Rather than selecting stocks that meet the best-performing investment styles, the screen must instead hunt from the least-worst factors, which amounts to the same thing. Taking its cue from what’s been working better than anything else recently, the strategy screen’s next step is to look for stocks that can currently be found in all three of the 'top-performing' buckets: high dividend yields, high three-month momentum, and high forward EPS growth. 

For the purposes of our screen, that’s not wholly a bad thing. While all three of last year’s winning factors focused on cheapness, this year has produced a blend of value, momentum, and growth – which in theory makes for more rounded selections.

Alas only one company, profiled below, ticks all three boxes this year. As noted above, sticking to our guns and going all in on the fully-met criteria would have improved our returns by a full 50 percentage points over the life of the screen. That’s equivalent to just under two percentage points of alpha a year on average, but such concentration risk feels a little too dicey.

Instead, and in keeping with years past, we’ve included shares that pass the test based on the best-performing strategy of the past 12 months (high trailing dividend yields) and one of the other two strategies. That bumps up the full list to 18, and gives a distinct weighting to resources, utilities and real estate names. Further details can be found in the accompanying table and download below.

 

Glencore

The appearance of mining-to-commodities trading giant Glencore (GLEN) at the top of our strategy screen means its earnings are forecast to grow well, and that its shares are both cheap and supported by good momentum.

The latter characteristic will be familiar to regular readers of these pages, given Glencore’s appearance in our quarterly large-cap momentum screen two months ago. Since then, it has also bucked the trend among diversified mining peers Anglo American (AAL), Rio Tinto (RIO) and BHP (BHP) and clung on to its year-to-date gains.

But Glencore did better than match all three of our strategy screen’s best investment styles. It also made the grade on a further two value tests (low forward price/earnings and low price/sales ratios), one other growth metric (low price/earnings growth) and a final momentum measure (high earnings per share upgrades). No other stock in the entire FTSE All-Share index ticks this many quant-shaped boxes right now.

Almost a decade on from its merger with Xstrata, it is still useful to think of the FTSE 100 constituent as two companies in one. The larger half – in terms of profits and free cash flow generation – is the industrial division, which is home to many of Xstrata’s legacy producing assets. Unlike its listed peers, which have pivoted away from ESG no-no coal to concentrate on a handful of markets, Glencore produces lots of metal and energy commodities, including copper, cobalt, zinc, nickel, gold, and oil.

Like its peers, Glencore’s profits mainly rise and fall on the movements in those markets and the operational issues that all too regularly occur at its mines. In the first three months of 2022, during which time most commodity prices spiked following Russia’s invasion of Ukraine, production was hit by “geotechnical challenges” in the Democratic Republic of Congo and “Covid-19 absenteeism” in Australia.

An important reason why Glencore screens cheaply on a price-to-sales basis is the existence of its marketing division, which accounts for most of group revenue. These sales come from an array of services to producers and buyers of commodities, including storage, product finishing and financing. Plenty of money is also made from arbitrage, particularly in times of heightened price volatility.

Given the amount of capital the marketing arm absorbs, and the year-to-year vagaries of its profits, it has more in common with an investment bank or an insurer.

Investors often disparage this kind of black box-like earnings, particularly if they are the occasional source of serious regulatory headaches. For years, Glencore has guided for modest annual adjusted operating profits of between $2.2bn and $3.2bn (£1.8bn-£2.6bn) from the division, although this was easily surpassed in the pandemic-impacted years of 2020 and 2021 (see chart below).

This year the division is once again forecast to beat the upper end of guidance, suggesting it is becoming a more reliable source of profits. The first quarter, which saw “tight physical market conditions and periods of extreme volatility”, has put the group on track to “comfortably” exceed the annual goal. With war and the unfolding impact of widespread sanctions on Russia likely to persist into 2023, investors can probably extrapolate with a bit more certainty. These are ripe conditions for big traders.

In theory, the marketing arm should put Glencore in a better position than its diversified mining peers this year. Analysts at RBC describe it as an “inflation pass-through” business, as strictly speaking it is neither price taker nor price maker. By contrast, producing assets are forced to swallow cost inflation, which may be easier said than done if stalling economic growth hits sales.

For most of its time as a public company, Glencore has disappointed investors. Last month its share price hit 528p – just shy of the price it listed at in 2011, when commodity markets were riding a wave of unprecedented Chinese economic growth.

China’s engine may have stalled of late, a fact that will concern producers of industrial materials everywhere. But tight supply-demand dynamics in several commodities markets, coupled with unpredictable shifts in the global order, should help to underwrite positive returns for Glencore over the coming decade. Either way, it’s not like its future cash flows were priced highly to begin with.

 

2022 Strategy Picks

 NameTIDMMkt Cap (£mn)Net Cash / Debt(-)*PriceFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)P/SalesP/BVNet Debt / EbitdaEBIT MarginFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%Failed criteria
Alfa Financial SoftwareALFA               537£6m180p291%4%6.912.3-29%-1%3%4%10%Hi Fwd EPS grth
AntofagastaANTO          13,827£399m1,403p155%4%2.42.2-49%-5%4%3%16%Hi Fwd EPS grth
BAE SystemsBA          23,506-£3,245m745p144%6%0.93.21.3 x10%7%7%24%5%Hi Fwd EPS grth
BMO Real Estate InvestmentsBREI               228-£89m95p---10.20.85.7 x---5%-Hi Fwd EPS grth
CMC MarketsCMCX               776£180m270p115%-3.12.2--14%10%18%4%Hi Fwd EPS grth
ContourGlobalGLO            1,253-£2,833m191p229%17%0.88.15.0 x18%21%-2%2%34%Hi Fwd EPS grth
Diversified EnergyDEC            1,011-£756m119p1012%22%1.12.11.6 x46%--3%2%-31%Hi Fwd EPS grth
GlaxoSmithKlineGSK          88,461-£19,351m1,740p143%8%2.45.42.0 x22%7%8%7%5%Hi Fwd EPS grth
GlencoreGLEN          62,620-£23,183m476p511%19%0.32.12.0 x5%32%-29%14%64%-
HaysHAS            1,946£43m117p124%5%0.52.5-3%28%15%-20%6%Hi Momentum
Impact Healthcare ReitIHR               475-£98m123p165%-11.01.13.2 x-14%14%7%1%Hi Fwd EPS grth
InvestecINVP            3,054-£3,298m439p86%-0.70.9--8%9%-3%1%Hi Momentum
Kenmare ResourcesKMR               434-£60m457p37%29%1.60.60.4 x34%22%-21%7%11%Hi Fwd EPS grth
National GridNG          43,723-£41,141m1,199p184%-2%2.12.16.2 x19%6%7%9%3%Hi Fwd EPS grth
PayPointPAY               396-£21m574p107%13%3.24.91.3 x23%5%2%-14%1%Hi Momentum
SSESSE          19,656-£9,929m1,841p165%-1%2.23.26.3 x16%21%3%19%14%Hi Fwd EPS grth
Target Healthcare ReitTHRL               685-£184m110p176%-11.01.02.7 x-18%7%2%-6%Hi Fwd EPS grth
United UtilitiesUU            7,501-£7,807m1,100p264%1%3.52.87.2 x35%-11%13%3%-16%Hi Fwd EPS grth
Source: FactSet. *FX converted to £. NTM = next twelve months; STM = second twelve months (i.e. one year from now).