25 world-beating 'Geico' income stocks

The method is unique in three ways. First, in screening the constituents of the MSCI World Index, it is the only approach in these pages that looks across multiple exchanges. Second, it is the only stockpicking process we follow that is derived from an active management team working in the market today, namely that running Guinness Global Investors’ Global Equity Income fund (IE00BVYPNY24). Third, and in line with the Guinness fund’s focus, it is the only screen that considers 10 years of trading data.

Calling this the ‘Geico’ screen also allows me to make a not-too-subtle nod to the US auto insurer of the same name, one of the most famous companies in investing history.

Founded in 1936 by a husband-and-wife business team, in 1948 it was majority acquired by a coalition of investors led by the doyenne of value investing, Benjamin Graham. Three years later, the company’s consistent growth through rocky markets, sector-leading profitability, dividends and expansion prospects were all cited by Graham protégée Warren Buffett in an article for The Commercial and Financial Chronicle titled ‘The Security I Like Best’. Forty-four years later and still a fan, Buffett would acquire Geico as chief executive of Berkshire Hathaway (US:BRK.B).

Last year’s selections got off to an inauspicious start, as equities around the world sold off heavily in late September 2022 amid the chaos in the UK gilt market and rising fears around a global recession. Since then, the 25-stock portfolio has marched ahead of both its benchmarks. On a total return basis, the Geico screen finished the year up 10.5 per cent, compared with 7.9 per cent from the MSCI World index and 6 per cent from the GEI fund, which was included in our Top 50 Funds issue last week.

In fact, having watched the screen’s rolling return hit 15 per cent on four separate occasions, I feel a pang of disappointment that returns weren’t higher. However, the price of a concentrated portfolio is often the double-edged sword of higher volatility. Judging by the results so far, it’s been worth it, even after accounting for double-digit declines in five 2022 Geico stocks since the end of July.

Looking at the past year’s performance in greater detail, a few observations jump out.

First, just seven of the 25 stocks posted a negative total return, which should be considered a good hit rate in any year. Second, removing the only UK names in the portfolio – Schroders (SDR) and St James’s Place (STJ) – would have added two percentage points to the portfolio. Third, the fact those two companies were both once-prestige asset gatherers but are now struggling for momentum highlights a key risk with the screen: that long-term consistent returns on equity can always run out of road.

That’s not a brilliant omen for this year’s sole UK selection – retail investment platform provider Hargreaves Lansdown (HL.) – whose return on capital is now almost half its 10-year average. While this might still seem high at 35 per cent, it is amplified by Hargreaves’ light asset base. Indeed, for some sectors and businesses, the screen’s requirement for 10 unbroken years of 10 per cent returns on capital employed is easily surmountable.

This goes some way to explaining why 10 of last year’s selections made the cut this time round. Encouragingly, the average total return from these stocks was 12.2 per cent, while all but three have posted a positive total return in the past year.  

Among this year’s new entrants is Novo Nordisk (DK:NOVO-B), which this month supplanted 2022 Geico stock LVMH (FR:LVMH) as Europe’s largest listed company. The Danish pharmaceutical giant has seen its shares leap more than 40 per cent so far this year on the back of surging sales of its diabetes drug Wegovy, which has been hailed as a cure for everything from obesity to heart disease.

Other debutants include the building products groups Geberit (CH:GEBN) and Watsco (US:WSO), the investment managers SEI Investments (US:SEIC) and Partners Group (CH:PGHN) and supply chain group Fastenal (US:FAST).

Methodology

The reappearance of several of last year’s stocks is by design, rather than a bug in the methodology. Indeed, the managers of the Guinness Global Equity Income fund team like to hold stocks for at least three years, making an annual review a decent point to re-evaluate holdings and either ‘sell’ or ‘add’ stocks according to their pass rate.

The Geico screen criteria, which is applied annually to the constituents of the MSCI World Index and loosely map the Guinness team’s rules, are as follows:

Given all but 1 per cent of MSCI World constituents have a market capitalisation of at least $1bn, only the size test is somewhat redundant. The capital budgeting test, the only one that compares companies with one another, acts as a set filter rather than a determinant of quality attributes. It was the most common test failed by 2022’s selections.

Of the remaining five, while the aggregate outlook for free cash flow growth has improved and dividend payments are once again more ubiquitous, the proportion of stocks failing the valuation test more than doubled and balance sheets appear more leveraged.

That leaves the return test, which is still the toughest. I said above that some capital- or equity-light businesses and sectors find it easier to score highly on this measure. For most blue chips, however, an unbroken track record of at least 10 per cent returns on capital over a decade is hard to achieve.

Below are the stocks in full, as well as a downloadable spreadsheet showing a much wider range of operational and valuation metrics.