Ideas Farm: Sorting wheat from chaff

When a rising market lifts all boats, it can feel like an opportunity to exit poorly performing positions that have proved a source of misery in the recent past. However, such action only really makes sense if it is based on a level-headed reassessment of the investment in question. Our emotions run riot when markets are volatile and it is often hard to view such situations with a coolly.

The tables we produce in the ideas farm offer some objective clues to whether a stock may be a good or bad bet. Unfortunately, these simple screens can’t in themselves provide answers, but they can provide the basis of more intelligent questions.

Take this week’s tip recommendation that readers exit AA (AA.). Naturally, our view could prove wrong and the company may find a way to address its debt and pension issues while reinvigorating growth. There would certainly be plenty of potential valuation upside if it did, but our opinion is that this is unlikely and the risks in the opposite direction are currently unpalatable. 

Helping to inform the question about the group’s prospects are the objective clues from both our table of most shorted stocks and broker downgrades. While AA shares have been significantly more shorted in the past, short interest has ticked up over the last month, although as can be seen in the shorts table, not the last week. Meanwhile, at a time when a number of companies are seeing brokers become more positive on their pandemic prospects, AA continues to see forecasts slide. Neither of these signals are in any way conclusive or incriminating either together or on their own. However, they provided us with a good prompt to re-examine the investment case and we don't like what we see.

Our other sell tip this week, Victrex (VCT), can also be found in our short table and has seen a small uptick in short interest over the last week. That said, the quality of this company’s balance sheet and operations are in an altogether different and superior category to that of AA. Our view here is based more on our concerns about over optimism in the trading outlook.

Fashion retailer Joules (JOUL), a purveyor of bright-coloured wellies and trendy florals, is another case where our tables nave hinted that something interesting may be happening. Last week the company appeared as having experienced strong broker forecast upgrades over the prior month. This followed significant downgrades when lockdown began. Importantly, the company’s business model looks good, the balance sheet looks robust, and the valuation looks attractive should it reclaim anything near its former glories.

The recovery from coronavirus offers both risks and opportunities and the best returns are likely to come from those situations where it is hardest to distinguish whether risk or reward is the bigger factor. We hope the “outside view" offered by the ideas farm tables can help readers decide where the balance may lie in for individual companies in addition to helping guide our own analysis as an investment magazine.

Click here to view the tables in PDF form

Source: FCA

Source: S&P Capital IQ

Source: S&P Capital IQ

Click here to view the tables in PDF form