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The growth share hitting all the right notes

Only one share has managed to embrace the zeitgeist to pass a growth-focused strategy screen this year
The growth share hitting all the right notes

In the long-running debate over the death of 'value' as an investment style, many proponents of traditional value strategies have suggested this investment approach would really shine during a sell-off. While it could still be early days in the current crisis, value has certainly not shined. This is reflected in the direction my strategy screen is taking this year. The screen looks to the most successful investment approaches of the past quarter to divine a way ahead for the coming 12 months. Spoiler alert: it's all about earnings growth.

A year ago, the three top strategies highlighted by the screen were high forecast earnings growth, earnings  upgrades and high return on equity. It proved a winning mix (two of the strategies are also in this year’s top three). Even with the FTSE All-Share tanking and delivering a negative total return of 16 per cent over the last three months, the six stocks that passed all last year’s tests racked up a positive total return of 16 per cent. Takeovers prior to the big market sell-off helped this bumper result as the way I monitor screen performance assumes any cash returned from takeovers sits on the sidelines until the screen is run again. A larger version of the screen that used weaker criteria to boost the number of ideas also delivered a creditable (in the circumstances) negative 3.9 per cent total return.

12-month performance

NameTIDMTotal return (13 May 2019 - 1 May 2020)Criteria met
Sophos SOPH79%Full
Kainos KNOS30%Full
HuntsworthHNT21%Weak
United Utilities UU.19%Weak
Aveva AVV11%Weak
Ashtead AHT8.4%Full
Oxford BiomedicaOXB7.1%Full
Jtc JTC6.0%Full
Electrocomp.ECM-3.8%Weak
PhoenixPHNX-4.8%Weak
SDLSDL-13%Weak
JD Sports FashionJD.-13%Weak
GCP Student LivingDIGS-16%Weak
Macfarlane MACF-19%Weak
Clipper LogisticsCLG-23%Weak
PagePAGE-24%Weak
4Imprint FOUR-28%Weak
Drax DRX-34%Full
Cineworld CINE-77%Weak
FTSE All-Share--16%-
Strat Screen--3.9%-
Full criteria only-16%-

Source: Thomson Datastream

Since I started  to run this screen in 2013, it has racked up a cumulative total return of 99 per cent compared with 26 per cent from the FTSE All-Share over the seven years. These numbers are based on the weakened criteria I’ve resorted to using over the last two years (or three years including this outing) to boost the paltry number of screen results. Based only on the stocks passing all criteria, the cumulative total return is 141 per cent. 

The screens run in this column are considered a source of ideas for further research rather than off-the-shelf portfolios, but if I make an annual adjustment of 1.5 per cent to account for notional dealing costs the total return drops from 99 per cent to 83 per cent.

This year’s outing for the screen has some added interest as we will be regularly featuring data on how different investment styles are faring on our new 'Ideas Farm' pages in the magazine. The 'style' performance data is based on an aggregation of the different strategies followed by this screen lumped into buckets of 'value' (price/book, enterprise value/cash profits, dividend yield and price/forecast earnings), 'momentum' (forecast earning upgrades and three-month share price), 'quality' (return on equity, return on invested capital and operating margin) and 'growth' (five-year EPS growth, forecast EPS growth and PEG). The screen monitors the performance of the most attractive fifth of FTSE All-Share constituents based on each factor. 

Because not every stock in the FTSE All-Share is screenable for every factor, each mini-screen captures between 12 and 19 per cent of index constituents. This, and the fact the results are assessed on an unweighted basis, means it is possible for most or even all strategies to either underperform or outperform the index at any one time. 

Based on the performance of the strategies over the past three months, the clear winners have been those focused on finding companies with strong earnings growth (see graph). Even the strategy among the top three that I classify as momentum – forecast earnings upgrades over the last 12 months – has a growth element to it. Likewise, the one growth strategy that has underperformed is based on searching for shares with a low price/earnings growth (PEG) ratio, which some would argue is more akin to a value strategy. 

The success of growth-focused strategies over the last three months dictates that this year’s screen is an all-out growth screen. What’s surprising in this context is that the only stock to pass all of the screen’s test is in a fund management group; a sector where earnings are notoriously sensitive to market ructions.

This year’s strategy screen simply demands stocks are in the top fifth for five-year earnings compound annual growth, two-year average forecast growth and earnings upgrades over the last 12 months. In some ways it seems a little odd that forecasts have helped highlight stocks that have held up well to the sell-off. This is because events mean earnings predictions are currently having to be massively revised. But on the basis that on aggregate all companies are in the same boat in facing forecast downgrades, there should still be some value in focusing on companies with the highest expected earnings growth.

As only one share passes all the screening criteria, I’ve increased the number of results to 10 by also including shares that pass the test based on the best-performing strategy of the past 12 months (five-year EPS growth) and one of the other two strategies. The list of stocks highlighted by the screen can be found in the table and I’ve taken a closer look at the one stock passing all the tests.

2020’s strategy pick… and nine nearly-there’s

NameTIDMMkt capPriceFwd NTM PEDY5Y EPS CAGRAv 2yr Fwd EPS grthFwd EPS up/downgrade3-mth momentumNet cash/debt (-)Test failed
Liontrust Asset ManagementLSE:LIO£590m1,070p192.5%30%12%1.9%-19%£29mNone
SeverfieldLSE:SFR£211m69p94.2%65%4.4%-2.6%-20%£10mFwd EPS grth
Games Workshop LSE:GAW£2.0bn6,020p302.1%62%0.7%-2.0%-9.6%£5mFwd EPS grth
SSELSE:SSE£13bn1,250p146.4%52%9.9%-21%-17%-£10bnUpgrades
Spirent CommunicationsLSE:SPT£1.5bn241p221.8%30%6.8%18%8.1%$150mFwd EPS grth
Ultra Electronics HoldinplcLSE:ULE£1.4bn1,971p162.7%29%5.6%4.2%-14%-£155mFwd EPS grth
FDMLSE:FDM£817m748p214.9%24%2.9%-2.9%-27%£14mFwd EPS grth
QinetiQLSE:QQ.£1.7bn304p162.2%24%0.8%-1.8%-15%£173mFwd EPS grth
SafestoreLSE:SAFE£1.5bn719p242.4%22%6.0%-0.2%-12%-£444mFwd EPS grth
4imprintLSE:FOUR£526m1,878p183.6%21%4.7%-4.4%-43%$39mFwd EPS grth

Source: S&P Capital IQ

 

LIONTRUST 

The profits of fund managers are notoriously sensitive to wider market movements. This is because many of their costs are fixed – such as plush offices and expensive staff – and the income they generate is based on the value of the assets they manage. When markets fall sharply, as they have done recently, the value of assets tends to fall sharply, but costs don’t budge. 

The drop in assets under management (AuM) happens for two reasons. Firstly, and most obviously, the market simply puts a lower price on the assets managed. Secondly, when markets are weak, investors tend to withdraw money from funds rather than using it as an opportunity to buy more at lower prices – as the saying goes, the stock market is the only market that when things go on sale all the customers run out of the door.

Liontrust (LIO) has done a very impressive job in countering these negative forces during the crisis, but especially the latter. Put simply, Liontrust’s funds have performed well, and against the odds, its two key strategies continue to capture the imagination of investors. 

The company’s AuM has also benefited from an acquisition late last  year, which helps explain why forecasts are marginally up over 12 months. That said, this 12-month view masks some noteworthy downgrades in 2020, but in recent weeks brokers have made some modest upgrades.

The recent upgrades are a reflection of a very impressive trading update last month. Indeed, even as markets tanked in the first three months of the year, Liontrust attracted £492m of net inflows. It reported a further £132m net inflow for the first nine days of April, too. This is even more impressive considering just over four-fifths of assets under management belong to retail customers who are conventionally considered more flighty during volatile times. 

The net inflow in the three months to the end of March was not enough to offset the £3.5m drop in investment values, but assets under management are still up strongly over the last 12 months from £12.7bn to £16.1bn. This includes the £2.7m of assets from Liontrust’s acquisition of Neptune Asset Management for which it has paid £35m plus a possible £5m contingent on growth in AuM. There is also expected to be a very hefty £16m reorganisation cost associated with the deal.

While the Neptune deal broadens the fund manager’s specialisms, Liontrust’s success is currently built on two key areas: sustainable investment, which accounted for 32 per cent of assets under management (AuM) at the end of September, and its economic advantage strategies. The popularity of these approaches has seen the group pull in strong inflows for a number of years, even as the tide has moved against active managers to passive funds (see graph).

Liontrust only moved into sustainable investment three years ago when it acquired part of Alliance Trust Savings’ business. Importantly, despite Liontrust being a relative newbie in this fast-growing field of investment, the team it acquired from Alliance is very experienced, having worked together for two decades. Just as importantly, these managers are generating very strong returns, with eight of Liontrust’s 10 sustainable funds boasting top-quartile performance over five-, three- and one-year periods. Weaker performance has come from the two sustainable bond funds. This division’s AuM has doubled in size since the acquisition, reflecting both how well it has bedded into the group and the canny timing of the deal. 

Liontrust’s long-established economic advantage strategy focuses on investing in companies with a strong and durable competitive advantage that makes them able to produce high returns. This very much fits with the enthusiasm investors have shown for 'quality' stocks over recent years, which has been accompanied by the substantial re-rating of many shares that fit the bill. The four funds Liontrust runs that employ this strategy all boast top-quartile track records since launch as well as one, three and five years (one of the funds has not been around long enough to have a five-year record).

A encouraging feature of the two key investment approaches employed by Liontrust is that their attractions may actually be strengthened because of the current crisis. The approaches are also relatively hard for passive funds to mimic. While it is very difficult to judge how the crisis will ultimately play out, there is much talk that there could be an increased focus on sustainability as the world seeks to 'rebuild better'. Meanwhile, the dire plight of 'value' as an investment style during the recent crisis has demonstrated the importance of strong balance sheets and business models of the kind targeted by the economic advantage team. That said, the high valuations that continue to be associated with quality shares, even after the recent crash, represents a potential risk. 

Despite having recently made an acquisition, the balance sheet looks strong and the company may even stick by its progressive dividend policy. While Liontrust's shares are pricey compared with peers, the inflows achieved in the first three months of the year suggest a premium rating is very well deserved. As an asset manager, the shares are liable to be very sensitive to any further serious market declines and the anticipated size of the Neptune reorganisation charge is somewhat unsettling, but overall the business looks impressive and a very attractive proposition in the space.