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10 red hot stocks

My Monsters of Momentum stock screen enters its 10th year having delivered a threefold return over the first nine
October 22, 2019

The Monsters of Momentum screen is the longest-running of all the screens that I’ve devised for this column. This is its 10th outing, which means that in 12 months time it will have a 10-year track record. A 10-year record is something that, for highly debatable reasons, the investment world gives cachet to. For those who buy into the significance of 10-year performance stretches, if the screen can continue the run it has established in its first nine years, it will have something to shout about in a year’s time. 

That said, so far the market has failed to provide the variety of terrain that one may hope for to really test an investment strategy. Indeed, it is rather remarkable that the screen has not had to negotiate a serious bear market yet. Momentum strategies, which involve backing recent market winners, are often regarded as particularly vulnerable to market downturns. But the stocks selected by the Monsters of Momentum screen for the current year perhaps offer some suggestions of how momentum can prepare for challenging times (more on this later).   

The screen itself works by looking at momentum from several angles. It looks for stocks with rising prices that are also trading ahead of key moving averages, seeing increased trading volumes and are also expected to grow earnings at a clip. The full criteria are:

■ Price momentum: A share price rise in the top 10 per cent of shares screened over the past three months, in the top 25 per cent over six months, and in the top 50 per cent over a year.

■ Trend: The 10-day moving average must be above the 30-day, which in turn must be above the 100-day.

■ Earnings growth: Average forecast earnings growth for the next two financial years must be among the top quarter of all stocks screened.

■ Volume: Average daily volumes over the past three months must be above the level from a year ago.

Last year the screen beat the FTSE All-Share (the index from which shares are selected) once again. This means it has outperformed in seven of nine years I’ve run it (see table) with only one year of really poor performance – the market's shock at the outcome of the EU referendum played a noteworthy role in this. Given the high-octane character of this screen, the consistency of outperformance looks better than I personally would expect, which leads me to think, to an extent, that the screen has just got lucky.

 

Seven out of 10 ain't bad… Perhaps it's too good?

Year to Nov/OctFTSE All-ShareMonsters
2011-2.9%4.1%
201211%19%
201322%44%
2014-1.1%13%
20154.3%30%
201613%-13%
201713%29%
2018-0.5%-2.9%
20196.5%9.1%

 

2018 performance

NameTIDMTotal return (5 Nov 2018 - 16 Oct 2019)
Puretech HealthPRTC61%
Energean Oil & GasENOG47%
The Renewables Infr. Gp.TRIG20%
Greencoat UK WindUKW19%
HG Capital TrustHGT19%
BH MacroBHMG14%
LXI ReitLXI12%
Bluefield Solar Inc.Fd.BSIF11%
Std.Lf.Priv.Eq.Tst.SLPE8.3%
Tate & LyleTATE5.9%
Schroder Eur.Reit.Tst.SERE5.8%
Telecom PlusTEP-0.8%
Sqn Asset FinanceSQNX-10%
Civitas Social HousingCSH-16%
DraxDRX-24%
AG BarrBAG-27%
FTSE All-Share-6.5%
Monsters of Momentum-9.1%

Source: Thomson Datastream

 

On a cumulative basis the screen is well ahead of the index, boasting a total return of 212 per cent compared with 83 per cent from the FTSE All-Share. While the screens run in this column should be considered to offer ideas for further research rather than off-the-shelf portfolios, if I attempt to inject a bit of realism into the performance figures by applying an annual 1.5 per cent dealing charge, the cumulative total return drops to 172 per cent.

Momentum strategies do have a reputation for getting slammed during bear markets and it’s useful to see the returns generated by this screen in the context of the long bull market during which the performance has been generated. That said, momentum strategies can adapt quickly to changing market moods. And there does seem to have been a shift in the market’s mood recently with 'value' plays (cheap shares) enjoying a brief period of good performance and the market’s erstwhile heros – 'quality' (shares in companies with a competitive advantage) and 'growth' (shares in companies with high profit growth) plays – suffering setbacks. The character of this year’s screen reflects this. As a whole, the shares highlighted by the screen may actually be not too far out of step with an investor trying to position themselves semi-cautiously. 

The major caveat here is that many shares highlighted by the screen are in companies that have high debt. Indeed, it’s hardly as if this year’s Monster stocks are not high-risk, but many do serve relatively defensive end markets and are unloved value plays. Investors may feasibly seek solace in 'value' should the market turn given such shares have underperformed 'growth' and 'quality' plays for a long time. This is what happened when the dotcom boom turned to bust. That said, there’s no compelling evidence that 'value' offers any special protection in falling markets.

Only two stocks passed all the screen’s tests this year. This is actually an improvement on last year when no shares ticked all the boxes. Given the screen’s limited output, I’ve resorted to the tactic I’ve used in the past to bulk out the numbers which involves including stocks that fail one of the tests. 

The two stocks that passed all the screening criteria are listed at the top of the accompanying table. That aside, the stocks in the table are ordered by three-month momentum. One of the fully-qualifying stocks, Polymetal, was the subject of a recent share tip in the 30 September issue of the magazine, and there’s little I have to add to the analysis laid out there. I’ve had a look at the other fully-qualifying stock, Vodafone, below.

 

10 red hot stocks

NameTIDMMkt capPriceFwd NTM PEDYEV/salesEV/FCFFwd EPS grth FY+1Fwd EPS grth FY+23m upgrade/downgrade3-mth momentum6-mth momentumNet cash/debt (-)in £Test failed
VodafoneLSE:VOD£43bn162p224.8%1.61454%18%-26%14%-£27.4bnna
Polymetal IntLSE:POLY£5.4bn1,147p113.5%3.55614%22%-17%42%-£1.4bnna
Mitchells & ButlersLSE:MAB£1.8bn414p11-1.7467.3%4.2%0.1%40%53%-£1.9bnfcst EPS grth
ReachLSE:RCH£297m100p36.2%0.431.4%-5.9%-36%58%-£13mfcst EPS grth
CMC MarketsLSE:CMCX£374m130p141.6%--352%-24%24%32%57%£45mfcst EPS grth
CranswickLSE:CWK£1.7bn3,308p241.7%1.2--4.2%17%2.8%28%13%£6mfcst EPS grth
Avon RubberLSE:AVON£534m1,750p201.0%3.0398.8%8.6%13%26%23%£47mfcst EPS grth
BritvicLSE:BVIC£2.8bn1,052p182.7%2.3583.5%6.8%0.1%21%13%-£683mfcst EPS grth
Derwent LondonLSE:DLN£4.0bn3,572p321.9%2398-7.0%10%-15%9.9%-£1.0bnfcst EPS grth
AssuraLSE:AGR£1.8bn75p263.6%24486.7%6.0%-15%28%-£670mfcst EPS grth

Source: S&P Capital IQ

 

Vodafone

As a mature, capital-intensive business that faces significant competition in key market, Vodafone (VOD) hardly makes for the kind of racy growth play one may associate with a Monster of Momentum. But momentum strategies are ever adaptable to the market’s wants. The market’s excitement about Vodafone’s shares is likely to be at least in part a reflection of investors’ rekindled enthusiasm for 'value' stocks. Indeed, the challenges Vodafone faces are what have made the shares cheap, and so well primed for the rerating they have experienced from a 123p low in May.

 

The 'value' on offer from Vodafone’s shares is not immediately apparent from a glance at the forecast price/earnings (PE) ratio of 22 times in the accompanying table. But the high PE number is more a reflection of depressed earnings than a lofty share price. While all long-range forecasts need to be taken with a liberal pinch of salt, broker Numis, for example, forecasts that EPS could almost treble from last year’s 5.3¢ to 14.1¢ by 2022.

Given the asset-heavy nature of this business (the company only produces about 40¢ of revenue for every €1 of capital employed), price to book value (book value is also often known as net asset value or shareholder equity) provides a clearer indication of the share’s rerating potential. The chart below, which shows Vodafone’s price to forecast book value (Forward P/BV) over the past five years, illustrates that, despite a recent fillip, there’s room for further rerating upside.

As for what may cause sentiment to improve further, there seem two standout candidates: improved profitability and improved finances. Both are likely to move in tandem. The low returns the company has recently been making on its net assets – known as return on equity (RoE) – suggests there is certainly room for profitability to improve (see chart below). Broker’s earnings predictions suggest the same. Meanwhile, debt levels, measured by net debt to cash profit (net debt/Ebitda), look high enough to warrant concern. So any improvement here could be a big positive for the rating too. 

Vodafone’s shares hit a low in May partly due to the group’s capitulation on its dividend. At €4bn (£3.4bn), last year’s annual dividend bill looked seriously out of whack with the group’s cash flows and €27bn net debt. The rebasing of the payment from 15¢ to 9¢ still leaves a 4.8 per cent yield in prospect for would-be buyers. More importantly, the payout level looks more credible. 

The reduction in the dividend payment will also go towards the company’s plan to reduce its net debt/Ebitda 'leverage' ratio toward the bottom end of its 3 to 2.5 target range. Indeed, the fact that Vodafone has arguably done a very sensible thing by reducing the payment may well have figured in the improving sentiment towards the shares over recent months. 

But the most noteworthy piece of good news investors have recently had from the company regards the potential value of its mobile-phone mast assets, which it announced it would consider selling last November. This July, Vodafone has said it had received approaches at prices equivalent to more than 20 times cash profits (Ebitda). The group's plan is to hive off  61,700 towers located in 10 countries into a separately-managed entity. This should be done by next May. The masts business is expected to have annual cash profits of about €900m. Selling the division is only one option for the spin off, and an IPO is also a possibility. The potential for a valuation of between €15bn and €20bn would be a shot in the arm for the balance sheet. 

Given that the remaining Vodafone businesses would need to pay for continued use of the masts being spun off, the overall implications of the transaction are tough to predict at the moment. Nevertheless, the valuation being talked about produced a 10 per cent share price boost when details of the plan was announced. That news accompanied a first-quarter update that also provided encouragement. Service revenue was ahead of brokers’ expectations. That said, the group’s core European markets were broadly in line with expectations, with the improvements coming from other regions. 

The European business operates in a tough environment. This was reflected in the €2.9bn impairment taken against the group’s Spanish business last year, which accounted for 10 per cent of group sales and 7.5 per cent of adjusted Ebitda. Vodafone also struggled in Italy (12.5 per cent sales and 15 per cent Ebitda) where a new entrant pushed down prices and where the structure of 5G auctions saw Vodafone fork out a hefty €2.2bn for space ('spectrum') on this new, faster network. The South African operation also disappointed in the second half of last year while the group's 45 per cent owned Indian joint venture (created from a spin out and merger of its Indian business last year) needed a €1.4bn equity injection to help it cope with fierce competition.

Vodafone is attempting to address the competitive pressures in Europe by cutting €1.2bn from operating costs in the region between 2018 and 2021. So far, cost-cutting is on track. The company is also trying to grow revenue from business customers, who currently account for 30 per cent of group sales. Most significantly, though, the company has made a bold move in its largest market, Germany (23 per cent sales and 29 per cent Ebitda), by acquiring Liberty Global’s German and Eastern European cable assets, which is expected to heap another €18.4bn onto the group’s debt pile. Such a large deal clearly represents a big risk, but Vodafone’s management reckons the improved broadband offering that results from the acquisition will make it a far more effective competitor to market leader Deutsche Telecom. Vodafone is looking to juice about €550m of cost savings a year by combining the Liberty business with its own cable operations.  

The Vodafone-Liberty deal could be the start of a period of consolidation in the hard-pressed European telecoms industry. If this proves the case, it could be significant for Vodafone's prospects because industry consolidation can often do a lot to reduce the ferocity of competition, including driving smaller players out of the market 

Another potential plus for Vodafone investors is that capital spending is expected to drop by 2021 once auctions for 5G spectrum are over. This should help with debt reduction plans. In June, Vodafone spent €1.9bn on German spectrum, having paid for UK, Spanish and Italian 5G spectrum last year and parting with €8.2bn in total in the five years to the end of March. 

So, there are several reasons to think life could get easier for Vodafone in the years ahead and there’s room for the shares to rerate further based on the potential for: asset sales; cost savings; balance sheet improvements; and a kinder trading environment spurred by industry consolidation. But none of this means the company has transformed into a high-quality business, or a growth play. The size of the Liberty acquisition also means the possibility that integration or trading prove tougher than expected represents a big risk. And despite the tentative grounds for optimism, the reality at the moment is that the group’s finances look stretched and the industry’s competitive dynamics are nasty. But 'value' plays are rarely pretty.