Ideas of the Year 2023

Ideas of the Year? When did the buy-and-hold advocates at the Investors’ Chronicle decide 365 days was the optimum holding period for a stock, rather than Warren Buffett’s preferred duration of “forever”?

The (admittedly mealy-mouthed) answer is that we didn’t. Historically, we have specified if our ideas are based on a company or fund’s short, medium or long-term prospects. But though we have never defined these periods, neither do we typically present them as the kind of opportunities a trader might target. Our aim is always to frame an investment case in terms that stretch beyond the immediate moment’s news cycle and market sentiment.

In other words, although we open our annual coverage of financial markets with stock ideas – and then review them 12 months later – we freely admit that this is a construct.

Still, a new year is as good a time as any to look at the investment opportunities out there. So as far as constructs go, we think it’s a useful one, which explains why we’ve kept it for decades. Two years ago, however, we changed our annual ideas format, from a series of individual stocks to five portfolios of 10 stocks that capture what we think are some of the most interesting opportunities for stockpickers.

This year, we have again tweaked the focus of several of the portfolios, to reflect the new market reality facing investors in 2023, and to highlight what to our eyes look like valuation anomalies and important trends.

In keeping with our 2021 and 2022 pieces, each portfolio is accompanied by a write-up of one stock and includes some of the ideas that have featured in the weekly ideas section in recent months. Metrics on each of the portfolio stocks are included in the portfolio introductions below, although online readers can also download a spreadsheet, with lots more financial data to pour over, here:

Global Horizons

Some of the biggest victims of the past year’s market sell-off have been grand narrative stocks. Those companies, often but not always associated with the technology sector, that until recently could put no foot wrong in their conquest of the markets exposed to the world’s megatrends.

For much of 2020 and 2021, it seemed that these companies’ future earnings potential and market valuations could only go up. And then, bang: share prices succumbed to economic gravity, and the dizzying expectations placed on the companies and sectors started to unwind with our assumed ability to forecast beyond the next year.

Granted, if you have no idea where interest rates or inflation might be in three months’ time, then price discovery becomes a lot trickier, further blurring what might be on the horizon. But that doesn’t mean we should stop thinking about the companies shaping big global change.

Take North Carolina-headquartered chemicals group Albemarle (US:ALB), one of the largest lithium producers on earth. At several points in 2021, its shares traded at more than 50 times forward earnings, as investors went delirious for anything connected to electric vehicles and battery storage. Since then, its valuation has collapsed along with risk sentiment, even as its profits and sales explode alongside ballooning demand forecasts.

An acknowledgement of the dirty work required to build a cleaner future is a theme for several other Global Horizon stocks, including industrial gas giant Linde (US:LIN) and energy major Total (FR:TTE). We think these stocks’ cheapness disguises their defensive qualities, and their growing attractiveness to investors who recognise that the future will not be built by Silicon Valley alone. And yet even among global technology leaders such as Alphabet (US:GOOG) and TSMC (US:TSM), valuations now look enticing.

Key idea: 

Climb the lithium ladder with Albemarle

Yield Leaders

The stars may just have aligned for fixed income in 2023. With short-term US government bonds yielding 4 per cent, any investor who expects interest rates and inflation to peak and then fall in the coming year has a chance to bank both income and capital gains.

And while stock markets are often seen as lead indicators of a recession, no-one has a clear idea how long or deep the looming economic contraction could be. As a result, equity investors are likely to be nervy, unsure of the moment or the necessary conditions to take on risk. Those stocks that manage to grab investor attention, therefore, may need to be bond-like: unspectacular, lower-risk and high yielding.

To tick these boxes, we have highlighted stocks with dividend yields of at least 6 per cent, and a mix-and-match approach to balance sheet strength, positive historic returns on equity and margins, and earnings growth. The result is a portfolio oriented to proven but out-of-fashion cyclicals, such as housebuilder Persimmon (PSN), iron ore giant Rio Tinto (RIO), multi-line insurer Direct Line (DLG) and care home landlord Target Healthcare Reit (THRL).

The portfolio is also more comfortable with financial services companies than many investors have been in recent years. Its featured pick, General Accident 8.875% Prefs (GACA), amounts to a play on the ongoing stability of Aviva (AV.) – an increasingly lean and financially solid group that trades below its tangible book value despite posting a two-year total return of 52 per cent.

Key idea: 

Insure your portfolio with General Accident prefs

Small Cap Value

Few corners of the stock market have been more badly beaten up than small caps. The Aim All-Share – a composite index of the junior market’s 750 or so companies – had been one of the winners of the post-pandemic recovery, more than doubling from peak to trough in the 18 months to September 2021. Since then, it has fallen more than a third, wiping out more than six years of gains in the process. The Aim 100, the market’s own blue-chip index, has fared even worse.

A couple of reasons explain the drop. First, the junior market has a greater weighting to big-promise growth shares and pre-revenue companies than its larger counterpart. Second, its dividend streams are sometimes perceived as lacking the resilience of big corporates, which can be a turn-off in a time of economic crisis.

However, with many small caps now trading at multi-year valuation lows, there are signs that some of the sell-off has become indiscriminate. Across Aim and the lower reaches of the FTSE All-Share, active stockpickers have a large hunting ground to venture into.

The names in our Small-Cap Value portfolio show that currently, there are plenty of solid sub-£1bn listed businesses that boast good free cash flow yields, returns on equity and stable or improving earnings. Despite avoiding aggressively leveraged companies, we have not struggled to find stocks trading at or below book value or on single-digit forward earnings multiples.

Our highlighted idea, drilling services outfit Capital Limited (CAPD), is a case in point. Despite posting share price gains in every calendar year since 2017, its valuation fails to reflect its prospects, track record, defensiveness or cash generation.

This table was corrected on 6 Jan 2023.

Key idea:

Capital limited in name only

UK Stars

The footballer-turned-pundit Alan Hansen was fond of saying that “form is temporary, but class is permanent”. To lots of investors, the observation is also true of companies, given the propensity of some firms to consistently generate above-average returns on equity for years or decades.

As with footballers, the trouble with stocks whose class appears permanent is the price tags they can attract. The shares highlighted in our UK Stars portfolio, several of which were included in our Best of British basket a year ago, are not cheap when priced against their current earnings. But their qualities – commanding market positions, high returns on equity, pricing power and a track record of continual reinvestment and innovation – should provide comfort when the economic or financial waters are rough and help to more than justify their price tags over the long run.

A lot of the coverage in this magazine involves banging the drum for the many quality UK-listed companies out there. Despite its reputation as a graveyard of dividend dinosaurs, the London Stock Exchange is home to dozens of world-class businesses full of highly talented people and serving global customer bases. Often, if UK investors don’t bang the drum loudly enough, then someone else – in the shape of a foreign buyer – will.

Key idea: 

Convatec's recovery remains on track

Unloved ITs

A year ago, we complemented each of our mini portfolios with a fund whose investment strategy mirrored each investment theme or style. At the start of 2023, however, we believe investment trusts need highlighting as a theme all on their own.

For one, prices are cheap. Indeed, if you thought individual stocks had a rough year, then have a look at professional investors’ portfolios. In the year to mid-November, the average investment company discount to net asset value (NAV) widened from 3.6 to 14.3 per cent, according to industry body the Association of Investment Companies.

Given many of these funds are portfolios of heavily marked-down quoted shares or other heavily discounted trusts, the so-called “look-through” price cut on the underlying assets of many funds is even greater than the market price implies. And while some of these discounts will be warranted – as in the case of highly geared portfolios or trusts stuffed with illiquid assets – many appear to be the victims of dour market sentiment.

Nor do trust managers lack options to close the discount gap. Many are authorised to buy back their own shares to cancel them, to limit the extent of any discount. All can liquidate holdings into cash if it can improve prices further.

Second, there’s reason to believe investment trusts should be in vogue. However strong an investment idea or theme, some investors will always prefer to delegate playing it to teams of seasoned, well-resourced stockpickers. Some trusts’ investment styles, like that of AVI Global (AGT), as we explore in fuller detail below, are highly differentiated.

The trusts and funds we have highlighted in the portfolio below all trade at a discount to NAV. None – bar the puzzlingly overlooked US equity fund Pershing Square (PSH) – uses much debt, and all – bar colossally discounted early-stage investor Molten Ventures (GROW) – pay a dividend.

Key Idea: 

AVI Global Trust looks to be a bargain

Find out how our ideas of the year for 2022 performed here.