All-weather stock picks

Arguably, a case in point at the moment is value investing. For many investors, it has long been an article of faith that over time a value approach will outperform the wider market. However, for over a decade growth, as measured by the MSCI World Growth index, has markedly outperformed value, as measured by the MSCI World Value index. Indeed, the 10-year net total return for growth currently stands at 202 per cent compared with 136 per cent for value and 168 per cent for the broad MSCI World Index – all measured in US dollars.

Many reasons are given for why value may have endured such a long spell of underperformance. Some point to the extremely loose monetary policy since the credit crunch as having prevented the creative destruction needed to trigger a reversion to mean in the market (a key concept value investors pin their colours to). Others point to a new paradigm created by capital-light industry disruptors, such as Facebook and Amazon. Meanwhile others point to the fact that some key valuation metrics, such as price-to-book, may no longer be fit for purpose.

Most probably, we’ll never get the kind of clear narrative most investors crave to explain why value has spent such a long time underperforming. But perhaps the more pertinent question is whether we should really see a prolonged spell of underperformance from an erstwhile successful strategy as all that odd, even if the length of the underperformance is unusual?

In fact, rather than seeing a period of underperformance as a black mark against an investment strategy, it could be argued that it is something investors should very much expect, and should even hope for. Indeed, it is the fact that the more flighty proponents of such strategies are quick to throw in the towel that creates opportunities for diehards, who are the ones left to reap the rewards when their chosen approach finally hits a purple patch. After all, if everyone is following the same approach, the advantage that originally made the approach attractive is likely to disappear. A given type of investment will quickly become overpriced if everyone wants in, and the pain caused by a reversal in sentiment is likely to prove that much more severe. For investors prepared to stick to their knitting and focus on a long-term time horizon, the shake-out provided by a healthy bout of volatility may be regarded as a welcome thing. Meanwhile, enduring the fretful uncertainty associated with such painful periods can, in many ways, be seen as a way disciplined investors actually 'earn' their outsized returns.

My Screen for all Seasons, which I first ran last year, is an attempt to bring together strategies with different characteristics that could possibly prove well suited to playing off each other, with some outperforming when others are underperforming to smooth the bumps in the investment road.

Given the recent travails of value investing, it is interesting to note that last year the only individual screens that outperformed were the ones that paid no heed to valuation. The performance of the screen overall was not particularly impressive (a 6 per cent total return compared with 7 per cent from the FTSE All-Share), but neither was it a disaster. And one year does not provide much scope from which to draw a judgement. The full details of how the screen performed can be seen in the table and chart below, along with details of the criteria of the six screens used and the latest stock picks.

The screen works by selecting the most attractive 10 stocks from six different screens. The screening criteria are set out below. The stocks that passed are presented in the accompanying table. The shares are separated by screen and, within this, are ordered from most-attractive-first based on the additional filter used by the screen. For several of the screens, fewer than 10 stocks pass all the criteria, with the remainder made up of stocks that have failed one of the tests but passed the rest.

THE SCREENS

Great Expectations

■ 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.

Additional filter

■ The 10 most attractive shares based on a combined ranking of EPS upgrades and three-month price momentum.

Screen source: Thomson Datastream

Big Reliable

■ EPS growth in each of the past five years.

■ Return on equity (RoE) of 12 per cent or more in each of the past five years.

■ Forecast earnings growth in the current financial year and the year after.

■ Gearing of less than 50 per cent, or net debt of less than two times cash profits.

■ Cash conversion (cash from operations as a proportion of operating profits) of 90 per cent or more.

Additional filter

■ Ten largest market caps

Screen source: S&P Capital IQ

Neff

■ Historic price/earnings ratio (PE) below the most expensive quarter of shares and above the cheapest quarter.

■ A lower than median average Neff PEG ratio:

Neff PEG is calculated as the price/earnings (PE) ratio divided by EPS growth (an average of the five-year compound average growth rate and average forecast for the next two years) and historic dividend yield.

Neff PEG = PE / (EPS grth + DY)

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

■ 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.

Additional filter

■ For stocks passing on weakened criteria the most attractive seven have been selected based on combined ranking of Neff PEG and the EPS growth rate used in the ratio.

Screen source: S&P Capital IQ

Safe Yield

■ Dividend yield of at least 3 per cent.

■ Dividend cover of at least two times.

■ Interest cover of at least five times.

■ Dividend growth in each of the past three years.

■ Forecast earnings growth in each of the next two financial years.

■ An average return on equity over the past three years of at least 12.5 per cent.

■ Cash conversion (measured as cash from operations as a percentage of operating profit) of over 100 per cent.

■ A market capitalisation of at least £250m.

■ Beta of 0.75 or less.

Additional filter

■ For stocks passing on weakened criteria the most attractive eight have been selected based on combined ranking of dividend yield and forecast average EPS growth over the next two financial years.

Screen source: S&P Capital IQ

EV/Sales Recovery

■ EV/Sales of less than 1.

■ Five-year compound average annual sales growth rate of 7 per cent or more.

■ Forecast sales growth in each of the next two financial years.

■ An average operating profit margin of at least 10 per cent over the past five years.

■ Positive free cash flow.

■ Gearing of less than 50 per cent, or net debt of less than two times cash profits.

Additional filter

■ For stocks passing on weakened criteria the most attractive eight have been selected based on combined ranking of EV-to-sales and historic operating margins.

Screen source: S&P Capital IQ

Cape screen

■ Market capitalisation of more than £100m.

■ Net debt less than 2.5 times cash profits.

■ Average five-year operating cash conversion of more than 100 per cent or average 5-year free cash conversion of more than 90 per cent.

Additional filter

■ Top 10 shares (due to three stocks tying for ninth place, 11 stocks actually qualified for this screen) out of the 50 lowest-CAPE shares are selected based on their combined ranking for CAPE and 5-year average return on capital employed

Screen source: Sharepad

Stocks for all Seasons

Source: S&P CapitalIQ/SharePad (CAPEs)