Eight Neff picks

Having a foot in both camps served Mr Neff extremely well during his career. During his 31 years at the helm of the Windsor Vanguard mutual fund he returned 13.7 per cent a year versus 10.6 per cent from the S&P 500. In fact, while my screen based on his approach has a much shorter track record of six years and selects far fewer stocks each year than his fund held, the current outperformance of the index looks even more impressive. Factoring in a 1 per cent annual dealing charge, the compound annual total return from the screen stands at 21.3 per cent based on stocks fulfilling the screen’s full criteria and 17.3 per cent for stocks meeting a weakened criteria. That compares with a compound annual 9.2 per cent return from the FTSE All-Share index – the index the screen is conducted on – over the same period.

In all, the screen has produced a cumulative total return over six years of 239 per cent based on the highly concentrated selections of stocks meeting the full screening criteria, and 199 per cent based on the larger selections of stocks meeting the weakened criteria. I’ve had to resort to using a weakened criteria since 2015 due to the dwindling number of stocks that passed all the screen’s tests. Adding in the annual charge, the total return for the full-criteria stocks drops to 210 per cent and for the weakened-criteria stocks to 161 per cent. Over the same period, the FTSE All-Share has delivered a 69.5 per cent total return.

Having underperformed the market for the first time in the year to February 2017, the screen delivered some impressive outperformance over the most recent 12 months. The three stocks that passed all the screen’s criteria did particularly well, as detailed in the table below.

Source: Thomson Datastream

Key to Mr Neff’s stockpicking method was his use of a modified version of the price/earnings growth (PEG) ratio. Effectively Mr Neff factored dividend yields as well as earnings growth rates into the classic PEG formula as follows:

Price/earnings ratio (PE)  /  Earnings growth rate (EPS grth) plus dividend yield (DY)

In the Neff PEG formula for this screen, I use a historic PE and DY, while EPS growth rate is based on the average of the five-year compound annual growth rate (CAGR) and the average forecast EPS growth rate for the next two financial years.

Mr Neff’s investment approach centred on steady-as-they-go growth stocks. He did this by looking for good, but not too good, growth rates from stocks trading at low, but not too low, earnings multiples. He also was interested in several supporting factors to get assurances of the quality of a business. The criteria used for this screen are:

■ Historic PE ratio below the most expensive quarter of shares and above the cheapest quarter. A reader has pointed out that this test may be too stringent in avoiding very cheap stocks given Mr Neff’s stated penchant for low PEs. I regard this as a fair criticism. But this year no stock was excluded from the results simply because it had too low a PE.

■ A lower than median average Neff PEG ratio.

■ A five-year EPS compound annual growth rate (CAGR) of more than 7.5 per cent but below 20 per cent (excessive growth can fall away).

■ Average forecast EPS growth for the next two financial years of more than 7.5 per cent.

■ Rising EPS in each of the past two half-year periods.

■ Five-year turnover CAGR of 5 per cent or more (in the long term, earnings growth needs to be based on rising sales).

■ Positive free cash flow in each of the past three years.

Once again few shares passed all the screens test’s – only two. However, the relaxed screen criteria – based on stocks failing one test as long as it is not the Neff PEG test – produced a rather large (by the standards of this screen at least) number of results, with 18 stocks making the grade. To narrow down the list, I’ve eliminated any share that has had earnings forecasts downgraded over the past three months. That leaves a list of eight shares. I’ve taken a closer look at the two shares from the list that met all the Neff criteria. These shares are at the top of the table below, with the other stocks that failed one of the Neff tests listed in order of lowest (cheapest) to highest Neff PEG.

Jupiter Fund Management

Jupiter Fund Management (JUP) looks well positioned to benefit from the long-term trend for individuals to take a more hands-on approach to their savings due to increased financial freedoms and less pension security. The company has a strong brand and a lot of clout in the retail market. What’s more, the fund manager is benefiting from its efforts to diversify its fund range away from its roots in UK equities. Not only has this provided it with the opportunity to attract new funds, but it has also helped make the business more diversified and less prone to fickle investment trends.

However, the long-term positives of Jupiter’s exposure to retail investors cannot mask the shares’ susceptibility to shorter-term angst, and recent market ructions have provided a reminder of this. Indeed, while a focus on retail investors may prove a long-term positive, this money is considered far flightier than funds from institutional investors. Indeed, Schroders, the other asset manager that finds its way into this year’s Neff picks, typically commands a premium rating to peers due to having a large institutional bias. Some analysts are also a bit worried about the potential for Jupiter to attract regulatory scrutiny due to its higher margins.

But while Jupiter, like every other fund manager, will always face the challenge associated with the unpredictability of markets and changing regulation, its track record and forecast growth look attractive. Indeed, the business attracted £5.5bn of net inflows during 2017. Factoring in gains from asset growth, that meant assets under management were up by £9.7bn in the year, or 24 per cent, to £50.2bn. Not only is this driving impressive earnings growth forecasts, but better than expected inflows during the past 12 months have also meant the shares have benefited from a string of broker upgrades (see chart).

Strong trading should help underpin the hopes of income investors given the company regularly pays a special dividend. Last year’s 14.7p regular dividend payment was topped up with a 12.5p special payout that arrived with shareholders along with the final dividend for that year. Broker Numis forecasts the total payment (regular plus special) for the recently completed financial year, which is due to be reported on 27 February, will hit 31.1p, followed by 33.1p for the current year. That’s equivalent to a yield of 5.6 per cent, rising to 6.0 per cent.

RPC

After being lauded for its strategy of acting as a consolidator in the European plastic packaging sector, investors had an abrupt change of heart about RPC (RPC) a year ago. The market was put on edge due to the sheer number of large deals RPC had undertaken in a relatively short space of time. So when last spring analysts from Northern Trust Capital Markets publicly questioned whether the deals were eroding the quality of the business, the shares were quick to de-rate. Indeed, the trend shown by the group’s reported return on capital employed provides some ballast (see graph), although Northern Trust’s gripes went beyond just this.

A more recent reason for negative sentiment towards the company has been a toughening global stance towards plastic waste. Of significance is an environmental push by China, which used to be the destination for much of the developed world's unwanted plastic. A curb on imports means many countries may have to think harder about ways to reduce the amount of plastic used. Recent strictures from both the UK and EU have played to this theme. RPC’s environmental credentials may help it win market share against a tougher regulatory backdrop, but the bigger issue could prove a reduction in overall demand for packaging.

A third-quarter update has reassured that recent trading has been solid and cash flows are in line with expectations. Meanwhile, RPC’s track record has been strong with underlying EPS rising from 36.9p in 2013 to 62.4p last year. If brokers are right, there should be more growth to come and consensus forecasts have experienced modest upgrades over the past 12 months.

Furthermore, healthy free cash flow is predicted, with Numis’s forecast suggesting the shares offer a free cash flow yield of 5.7 per cent for the current year to the end of March, rising to an attractive 7.6 per cent next year. And the current earnings multiple based on next-12-month forecasts of 10.5 is almost at the bottom of the five-year valuation range (the bottom 2 per cent), although the shares traded at a lower valuation for most of the five years that preceded that, a period that included the credit crunch. All in all, while there are undeniable grounds for angst, if the company can deliver on analysts’ expectations and prove the doubters wrong, there is a clear value case.