Six shares with Great Expectations

By contrast, the index from which it draws its selections, the FTSE 350, has only averaged returns of 7.5 per cent a year including dividends.

Recent years have posed more of a challenge. The screen, which looks for companies with good projected earnings growth, improving analyst sentiment and market-leading share price momentum, has failed to beat its benchmark in three of the past five outings, and came badly unstuck in 2021 when its lockdown-winner-themed picks faced unwinding growth projections last winter.

Given the context – namely, monetary policy-induced volatility and investor scepticism around the reliability of earnings growth forecasts – its 2022 selections held up relatively well. But it was nothing if not a wild ride.

Two-thirds of its picks finished the year in the red. Most notable were falls in the share prices of asset managers St James’s Place (STJ) and Liontrust (LIO), which saw a sharp reversal in their markets, as well as luxury timepiece retailer Watches of Switzerland (WOSG) whose sky-high valuation softened on the back of a slight retrenchment in its own dizzyingly speculative market.

That the Great Expectations screen ended the year up 0.3 per cent, just 1.6 per cent below the value-driven positive return of the FTSE 350, is down to the stellar performance of its two successes, Anglo-African lender Investec (INVP) and pharmaceuticals group Indivior (INDV), which has rallied on repeated upgrades to the sales forecasts for its anti-opioid treatment, Sublocade.

For the screen to pick two stocks whose total returns exceeded 40 per cent in the past 12 months should provide some confidence that it is onto something. But if we needed a fresher sign that the screen continues to successfully identify in-vogue stocks, the past week delivered.

Last Thursday, just as we were running the numbers, First Abu Dhabi Bank confirmed a news report that it had considered a potential bid for the international lender Standard Chartered (STAN). Although the would-be acquirer ultimately decided against a pursuit, the FTSE 100 group ticked all the boxes for our Great Expectations screen.

In fact, as the results below show, the screen (and investors) have warmed to banks in a big way over the past year. As the storming performance of 2022 pick Investec shows, market momentum has followed the rapid increase in central bank rates around the world, and the sector’s ability to pass on higher borrowing costs at a faster rate than they pay out via interest rates on deposits.

How sustainable all of this might prove is of course up for debate, particularly if a loan book-damaging recession or sudden shift in monetary policy augur a reversal in analysts’ earnings expectations. However, while it’s important not to draw too much from one company’s strategic ambitions, the prospect of merger and acquisition (M&A) activity might be another way for that momentum to be reinforced further, as investors recast their impression of the sector.

Great Expectations stock screeen methodology

Our screens are best considered a source of ideas rather than off-the-shelf portfolios. However, by factoring in a 1 per cent annual dealing charge, the Great Expectations screen’s cumulative total return, based on annual reshuffles when new results are published, falls to 340 per cent.

While off the peak, that’s almost triple the 120 per cent return from the FTSE 350; a strong performance that belies an otherwise simple set of stockpicking criteria. They are as follows:

■ EPS forecasts for next financial year upgraded by at least 10 per cent over the preceding 12 months.

■ EPS forecasts for the financial year after next upgraded by at least 10 per cent over the preceding 12 months.

■ EPS growth of 10 per cent or more forecast for the next financial year.

■ EPS growth of 10 per cent or more forecast for the financial year after next.

■ Share price momentum in the top quartile of market constituents over the past year.

■ Share price momentum better than the market over six months.

■ Share price momentum better than the market over three months. 

■ Share price momentum better than the market over one month.

This year, just three stocks – InterContinental Hotels (IHG), StanChart and NatWest (NWG) – passed all eight tests. In the interest of diversification (and to reduce the 2023 picks’ overall sensitivity to the banking sector) I have admitted three more stocks – caterer Compass (CPG), HSBC (HSBA) and Drax (DRX) – which show positive momentum across each of the six, three or one-month momentum tests, even if this momentum isn’t above the median in one instance.

Compass is an interesting example of the screen’s insistence on a pattern of rising earnings growth optimism, shared by both analysts and investors. By pinning hopes on Compass’s ability to rebuild sales lost during the pandemic, it is fair to say that the market has been surprised at the degree to which generalised staff shortages and high food costs would feed into outsourcing demand.

Though Compass and the other stocks named above are drawn solely from the FTSE 350, this year I have also screened the FTSE All-Small and Aim All-Share indices to throw up some small-cap Great Expectations ideas for readers. Although these stocks won’t count towards the performance of the main screen in 2023, I have included any Aim or All-Small company that passed at least seven of the eight tests in the table below.

Among the 13 smaller companies to make the cut are three of the 10 companies that made up the Small Cap Value portfolio in last week’s Ideas of the Year cover feature: drilling services provider Capital Limited (CAPD), ten-pin bowling alley operator Ten Entertainment (TEG) and internet services outfit CentralNic (CNIC).

Finally, a programming note: owing to an oversight on my part, the long-term performance data in the main table of last month’s 2022 Stock Screen review did not line up with the screen names. The online version has been corrected and can be found here, but any print readers who would like an electronic version of the table please email me at alex.newman@ft.com.