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Great Expectations for 2018

My top-performing Great Expectations stock screen, which has produced a four-fold return over the past six years, has found three new shares that pass all its tests.
January 16, 2018

When I tallied up the performance of all my regular screens for my yearly review, published last week, the Great Expectations screen came out on top. This screen, which I am re-running in this column, boasted a stand-out cumulative annual total return of 27 per cent since I first ran it, compared with an 11 per cent cumulative annual total return from the FTSE 350 index. Over the six years I’ve run the screen, that equates to a better than four-fold return.

The performance of the screen over the past 12 months was a big contributor to securing its place at the top of the stock screen podium. In fact, the strong showing in 2017 came as an antidote to a lousy 2016 for the screen. Indeed, the screen underperformed quite significantly in 2016 as it was conducted while the resources sector was still in meltdown. The screen’s focus on momentum meant it eschewed this part of the market and missed out on the huge rally in the sector that started in February and powered the market that year. The screen’s 5 per cent return during that year represented a 16 per cent underperformance of the FTSE 350 index. But when a market trend persists, as the resources recovery has, momentum investors will catch up with it in the end. And for the Great Expectations screen it was the resources stocks it picked out at the start of 2017 that really underpinned the fantastic gains enjoyed over the past 12 months.

 

2017 Great Expectations performance

NameTIDMTotal return (10 Jan 2017 - 8 Jan 2018)
FerrexpoFXPO138%
GlencoreGLEN34%
ElectrocomponentsECOM30%
AshteadAHT30%
JD Sports FashionJD.5.9%
RPCRPC-12%
FTSE 350-12%
Great Expectations-38%

Source: Thomson Datastream

 

While 2016 was a bit of a horror show, in five out of the six years I have run this screen it has done very well. So even after the poor run in 2016 the screen boasts a cumulative total return (based on switching from one portfolio of picks to the next each year) of 319 per cent, which represents a massive outperformance of the FTSE 350 – the index the screen is conducted on – which has delivered an 89 per cent total return over the same period. If I factor in a 1 per cent annual charge to account for notional dealing costs, the total return drops to 295 per cent.

Great Expectations by year

 FTSE350Great ExpectationsOut/underperformance
201216.3%29.9%12%
201316.4%52.2%31%
20145.5%11.6%6%
2015-4.9%31.4%38%
201624.5%4.8%-16%
201711.6%37.9%24%

Source: Thomson Datastream

 

The Great Expectations screen is unlikely to be to all readers' tastes because it roundly ignores something that is an absolute must for many investors: valuation. Instead it focuses on stocks that have been experiencing earnings upgrades. The idea is that it is very hard for analysts to forecast earnings and they therefore understandably often base their forecast on certainties of what has been rather than the uncertain future. When a virtuous trading trend develops for a company, this can mean analysts spend many years constantly playing catch-up with earnings forecast upgrades. While these trends are often long-running, the market’s expectations tend to be tethered to the forecasts that are in the market, meaning share prices can respond strongly to upgrades even when they’ve become a given. As well as looking for forecast upgrades, the screen looks for forecasts of decent EPS growth and lots of share price momentum. As well as the ability of price momentum to predict more of the same, a key reason this screen looks for momentum is as an indicator that the market is still excited about the earnings upgrades coming through. The full screening criteria are:

■ EPS forecasts for each of the next two financial years upgraded by at least 10 per cent over the preceding 12 months.

■ EPS growth of 10 per cent or more forecast for each of the next two financial years.

■ Share price momentum at least double that of the market over the past year and better than the market over the past six months, three months and one month.

Only three stocks passed all the screening criteria this year and I have provided short write-ups of these companies below. However, given three results makes for fairly feeble pickings, I have used the tactic I’ve employed in other years and included in the stock selection below those companies that have passed all but one test, as long as it isn’t either of the key upgrade tests these stocks have failed. The list is ordered by strongest to weakest three-month momentum with the three fully qualifying shares at the top. While this screen does not take account of valuation, and momentum-focused strategies are often associated with the purchase of expensive stocks, sometimes strong momentum develops in recovery plays that are still relatively cheap. This is the case with several of the stocks picked by the screen this year that herald from the resources sector.

 

2018 Great Expectations picks

NAMETIDMMarket capPFwd NTM PEDYPEGFwd EPS growth FY+1Fwd EPS growth FY+23-month momentumNet cash/debt(-)12-month upgrade FY+112-month upgrade FY+2Test failed
KAZ MINERALSLSE:KAZ£4.2bn937p10-0.33171.0%3.1%15.7%-$2.4bn156%145%-
VESUVIUSLSE:VSVS£1.6bn592p152.8%1.8324.1%10.7%0.3%-£322m31%35%-
B&M EUROPEAN VAL.RET. (DI)LSE:BME£4.0bn398p201.5%1.4519.2%16.1%0.2%-£584m12%17%-
ANGLO AMERICANLSE:AAL£24bn1,700p104.2%1.1742.4%-9.3%21.8%-$5.5bn35%56%FY+2 EPS grth
EVRAZLSE:EVR£5.4bn375p95.9%---21.2%-$4.2bn56%97%FY+2 EPS grth
FERREXPOLSE:FXPO£1.8bn300p71.6%0.5585.6%-23.5%19.1%-$481m81%79%FY+2 EPS grth
INTERMEDIATE CAPITAL GP.LSE:ICP£3.2bn1,158p192.3%--14.2%9.5%19.0%£407m10%13%FY+1 EPS grth
INTL.CONS.AIRL.GP.(CDI)LSE:IHG£8.8bn4,697p254.9%2.0413.7%12.7%15.7%-$2.0bn23%25%FY+2 EPS grth
COMPUTACENTERLSE:CCC£1.4bn1,192p181.9%2.0618.9%2.7%15.7%£137m14%15%FY+2 EPS grth
RENISHAWLSE:RSW£3.9bn5,365p341.0%3.2118.6%4.2%13.0%£52m26%22%FY+2 EPS grth
GLENCORELSE:GLEN£58bn405p141.3%-171.8%-8.6%11.5%-$28bn60%68%FY+2 EPS grth
IBSTOCKLSE:IBST£1.1bn267p142.9%1.631.7%12.9%10.4%-£160m10%15%FY+1 EPS grth
VICTREXLSE:VCT£2.3bn2,666p212.0%3.359.6%3.8%9.7%£120m15%11%FY+2 EPS grth
REDROWLSE:RDW£2.3bn645p83.4%0.9011.2%8.3%2.8%-£73m34%36%FY+2 EPS grth
ANTOFAGASTALSE:ANTO£10bn1,015p191.3%2.19110.1%-7.6%2.7%-$860m135%81%FY+2 EPS grth
BELLWAYLSE:BWY£4.4bn3,580p93.4%1.0512.2%5.7%1.4%£16m20%24%FY+2 EPS grth
SPIRAX-SARCO ENGR.LSE:SPX£4.2bn5,670p251.3%1.9724.4%8.6%-2.2%-£114m12%18%1 yr mom
PERSIMMONLSE:PSN£8.3bn2,673p115.1%0.9722.9%4.2%-4.7%£1.1bn33%33%FY+2 EPS grth

Source: S&P CapitalIQ/Thomson Datastream

 

KAZ Minerals

It’s not too difficult to see the moving parts that have propelled shares and earnings forecasts higher for Kaz Minerals (KAZ). From a desperate position following the commodity market collapse, the copper and gold miner has massively boosted production while savagely cutting costs. All this at a time when the copper price has been rising fast, clocking up a 23 per cent rise over the past year. What’s more, the high level of debt held by the company has caused the benefits for shareholders to be exaggerated.

With cash now being thrown off by the group’s operations, the balance sheet has turned a corner too with net debt falling from $2.4bn to $2.2bn during the third quarter to the end of September 2017. When the company updated investors on third-quarter trading it also pushed up full-year production guidance, prompting forecast upgrades.

More recently Kaz has announced that it has gained approval to expand its Aktogay mine in Kazakhstan, increasing the long-term potential of its operations. Meanwhile, news in November that authorities had suspended operations at its Bozymchak* mine in Kyrgystan, was followed a day later by news that the suspension had been lifted.  Perhaps a reminder of the political risk Kaz faces, but not anything to get in the way of the shares' mighty ascent.

*mine name corrected from Bozshakol to Bozymchak

B&M European Value Retail

Value retailer B&M (BME) could hardly ask for a better trading backdrop than one of rising shopping prices coupled with economic uncertainty. This post-Brexit mix has caused UK consumers to become more price conscious and flock to B&M’s already busy stores. In the first nine months of the current financial year the group reported a 20.5 per cent rise in sales, including 6 per cent like-for-like growth in the UK – a performance that puts it alongside other high-street winners in the value retail space such as Aldi and Lidl.

Importantly, B&M seems to be doing everything it can to capitalise on strong trading. The company has invested in improving the efficiency of its operations in order to cut costs and improve sales. Meanwhile, it continues to open new stores, although the pace has slowed slightly of late as the company concentrates more on purpose-built shops from which it can generate higher returns. With 569 B&M branded stores in the estate at the end of September 2017 and a target to increase this to at least 950, there is plenty of growth potential. What’s more, the company looks to be in a strong position to fund opening while paying out handsome dividends given the average payback time on new openings is just 8.1 months, or 14.4 months if working capital is taken into account.

As well as opportunities in the UK, there is potential for the group to grow in Europe. B&M already owns a German value retail chain called JA Woll. While performance has been disappointing to date, new management has been drafted in and the on-the-ground experience B&M is getting through the JA Woll chain should prove valuable should the group go for an overseas push.

There are plenty of reasons for optimism about B&M’s future and the potential for upgrades to continue. Broker Liberum forecasts a five-year compound annual growth rate of about 14 per cent and thinks the shares will average a yield of about 4 per cent between now and 2020 based on the combination of regular and special dividend payments.

 

Vesuvius

The market’s excitement about the current rare period of synchronised global growth is palpable. Prime beneficiaries of this rosy economic backdrop are big industrial companies, of which steel making equipment specialist Vesuvius (VSVS) is one. But there’s more to the earnings upgrades the company has experienced over the past year than the tailwind from strong global economic conditions.

The demand outlook for Vesuvius’s products from China look very encouraging. A reinvigorated environmental drive following last October's 19th National Congress of the Communist Party of China means heavily-polluting steel producers are being shut down in favour of state-of-the-art mills that have need for Vesuvius’s cutting-edge kit. Demand from China is also being buoyed by its massive “belt and road” land-and-sea trade-route project. Meanwhile, there are predictions of soaring demand from India in coming years as the company increases steel production. Higher and more stable steel prices are also encouraging steelmakers to invest.

As well as encouraging prospects, Vesuvius is benefiting from a cost-cutting drive. Margins are already edging up and brokers forecast more to come.