Four quality 'Best of British' stocks

Oh, Blighty. To the outside observer, this country must look like a strange place sometimes.

A year and a prime minister since the credibility-extinguishing 'mini' Budget, the current administration’s approach to investment still lacks coherence. Stating as much doesn’t make you a partisan. Whatever you make of the HS2 situation, a lack of consistency acts as a negative multiplier for companies, sapping confidence in any capital spending decision.

A financial journalist would say that, though, wouldn’t they? We’re simply too negative. According to the Financial Conduct Authority’s director of market oversight, Clare Cole, the press needs to share the blame for creating a hostile atmosphere for business in the UK.

Not one to miss a trick, THG (THG) chief executive Matthew Moulding weighed in on LinkedIn, in one breath praising Cole’s comments while darkly alluding to the regulator’s co-option by “wealthy hedge fund[s] or City donors”. Could this be the true root of our curiously directionless business environment: a Square Mile locked in its own self cannibalisation?

I’m not so sure. When your company’s shares are down 92 per cent in less than three years of trading, pointing fingers and entertaining conspiracy theories may seem like reasonable responses. Those at the FCA or LSE calling for a campaign of market boosterism need to be careful what they wish for. You don’t always get the spokespeople you need.

Of course, the subject of Britain’s diluted animal spirits may run deeper. Does our national cynicism trump our entrepreneurialism? Or are we simply too prone to self-reproach and diffidence?

I’d like to venture another suggestion: that the whole debate might just be missing the point.

Yes, ailing prestige leads to lost pride. But part of the complaint with UK capital markets is a delayed recognition of the country’s sub-scale role in the world. If the kind of global business we consider 'our own' – a Diageo (DGE) or a Shell (SHEL) – were to list today, it’s doubtful whether they would select London as their primary trading venue.

Indeed, the narrative of managed (or mismanaged) decline often overlooks the truly intense gravitational pull of the US. That can’t be helped. But recognising that the entire market capitalisation of the FTSE All-Share Index is less than Nasdaq’s largest firm, Apple (US:AAPL) is step one to seeing how skewed the global stakes are. IPO competitiveness isn’t only a UK-specific issue, but one affecting all stock exchanges outside of America.

What’s more, national pessimism is peaking at a time when market conditions the world over have become much tougher.

Sure, even when times are tough, the starriest equity market stories will inevitably be over-represented in the US (think AI play Nvidia (US:NVDA) or weight-loss wunderkind Eli Lilly (US:LLY)).

But none of this should obscure the fact that the UK possesses plenty of quality mid-sized companies, including many that are entirely focused on a UK customer base. Capturing market-beating returns from this group is the aim of our Best of British screen, which has now been in service for 12 years.

In focusing on company fundamentals, the screen also shuts out all the noise surrounding UK equity markets. While sentiment of course matters, over-analysing its ebbs and flows, causes and victims, is often a second-order consideration in the job of putting money to work.

Sometimes, that’s easier said than done. The last time we refreshed the Best of British screen, it was amid a true nadir in investor sentiment toward the UK. The pound was trading near an all-time low, the gilt market had just suffered the equivalent of a heart attack, and the domestic-leaning FTSE 250 had lost 16 per cent in the space of two months.

Fortunately, by sticking to its rules, the screen managed to produce a handsome 21.4 per cent total return, almost eight percentage points ahead of its benchmark, the FTSE 350.

To say this outing was welcome is an understatement: the year before, the screen lagged the index by some 30 percentage points, erasing much of its historic cumulative outperformance. After a better 12 months, the total return for a version of the screen focused on each year’s top five picks now stands at 242 per cent, while the total return from all the screen’s selections stands at 160 per cent. Factor in an annual dealing charge of 1.5 per cent, and those returns dip to 185 and 117 per cent, respectively, versus 123 per cent from the FTSE 350.

Methodology

The screen, which draws its selections from the FTSE 350 (every constituent of the FTSE 100 and FTSE 250 indices), is principally focused on quality and momentum factors. Where it differs from other high-quality large-cap methodologies is its focus on firms whose sales are largely domestic in nature.

Last year, I described this defining test as both arbitrary and potentially risky, arguing that it acts as a limit to growth prospects, and heightens exposure to sterling and a single, potentially inflexible end-market. Ideally, an investment portfolio would seek greater diversification.

If only to play devil’s advocate, I’m now going to suggest that this test might not be so bad after all. Put simply, there is nothing stopping a company which makes all its money in the UK from expanding abroad, if its home market is saturated or management believes better returns on capital are available in an expanded geographic footprint. A strategic push overseas may even add momentum to an investment case.

A neat example of this arrived this week in the shape of Sports Direct owner Frasers (FRAS), which has acquired German chain SportScheck in a bid to replicate its British retail model overseas.

The full criteria for the screen are as follows:

■ At least three-quarters of revenue from the UK.

■ Three-month share price momentum better than the FTSE 350.

■ Return on equity of more than 10 per cent.

■ One-year beta of less than one.

■ Forecast EPS growth in this and the next financial year.

■ Better-than-average five-year compound annual growth rate (shorter periods used when a full five-year record is unavailable).

■ Net debt of less than 2.5 times cash profit.

This year, four stocks passed every test. Alongside from Frasers, they include back-from-the-dead retailer Marks & Spencer (MKS), poultry and pork hawker Cranswick (CWR) and online car marketplace Auto Trader (AUTO). This therefore makes for a distinctly consumer-focused selection of stocks, in keeping with past years.