16 shares for the future

Rarely has it been easier to buy good companies at cheap prices, so why is it so hard to do? Analyst Richard Beddard explains why and names his top stocks.

These are testing times. I mean that quite literally. My investment strategy is being tested. More specifically, the rules that determine the scores of the shares ranked by the Decision Engine are being tested. 

Never before have I seen so many of the businesses I have most confidence in rank so highly. In the table below, these businesses are highlighted in a bold typeface. It means I score them at least seven out of eight for profitability, adaptability, resilience and fairness:

Quality and value, ranked

Since a share's ranking is dependent on its score, you may be wondering why it should be remarkable the highest scoring companies are at the top.

There is a fifth factor, the shares have to be cheap at the current market price. If we, me and all the other people trading the shares, agree a company is a good business, it is unlikely to be cheap because we will all be buyers or holders of the shares. I'm used to seeing the bold typeface lower down the list.

Today, we disagree. Today I think shares like XP Power (LSE:XPP) and Trifast (LSE:TRI) are outrageously cheap, but most of the trading is selling and the Decision Engine is telling me to do something very difficult. It is telling me, in some cases, to buy shares that have fallen significantly in price. XP Power is down 41% since a high in July. Shares in Trifast have fallen 36% since April.

I cannot say for sure why other investors have lost confidence in these shares, although opinions are often driven by news, and the economic news is bleak, particularly for shares like XP Power and Trifast that export globally to manufacturers. Reportedly, the Chinese economy is decelerating, which is bad news because it is huge.

Neither can I say whether a global recession will happen, like people fear. There are too many chaotic variables, many of which I do not properly understand, for me to even attempt the analysis, or work out which of the many analyses put forward by economic pundits is true. 

All I can say is I chose the attributes I score companies by, profitability, adaptability, resilience and fairness, because I believe companies with them will prosper through thick and thin. More specifically, I expect their returns on capital to remain above about 8%, even if things get quite dark.

We will see if they do. That is what I mean when I say my investing strategy, to buy good companies at cheap prices and hold them for the long-term, is being tested. 

While the Decision Engine is throwing up more clear cut opportunities than usual, it is difficult to invest in them because it requires faith that our individual contrarian judgements will be proved right in the long-term while, in the moment, the sellers’ views are born out by events. Things have got worse.

Power cut

Last week, power adapter manufacturer XP Power released a trading update telling us how much worse, and set expectations for the 2018 financial year. When it publishes the results for the full-year in March it will report record revenue and almost certainly profit but there's a worrying trend in new orders.  

The numbers are complicated by two acquisitions. On a like-for-like basis (excluding the contributions of the acquisitions), XP Power took in 1% more orders in 2018, than it did in 2017. Momentum is in the wrong direction, though. In the final quarter of the year, October to December, order intake fell by 6% compared to the previous year in constant currency. The company did not disclose a like-for-like figure (which would exclude the revenue of Glassman, a business it acquired in May), but like-for-like the fall in new orders would be greater. 

The weakness in orders stems from one important customer group: semiconductor machinery manufacturers. They are probably experiencing less demand because smartphone manufacturers are reducing the volume of phones they produce. In the past, such reductions have been temporary, and dictated by the launch cycles of flashy new models, but the market may be maturing. 

Nevertheless, XP Power anticipates revenue growth in 2019. Unless orders pick up, it will be relying on a full year's revenue from Glassman to achieve this target. Glassman's revenues are not that significant compared to XP Power's total revenue of nearly £200 million in 2018. For the seven months XP Power owned it in 2018, Glassman contributed £7 million , crudely £1 million a month. Assuming Glassman's revenue is evenly distributed over the year and, like XP, it doesn't grow much, it might contribute an additional £5 million in 2019 (it will have contributed for five more months). Worst-case, therefore, XP Power is anticipating a £5 million like-for-like fall in revenue, which is 2.5%. 

That is not particularly scary. When I profiled the company last April, I scored it 2 for profitability, 2 for adaptability, 2 for resilience and 2 for fairness - a perfect 8, as far as the business is concerned. I am not inclined to change that verdict. 

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The power supplies are designed into the machines they power, so demand should recover when demand for the machines does, XP Power has many diverse customers, and long-term it believes those that make semiconductor machinery are becoming less dependent on smartphone manufacturers as machines in general become more "intelligent". 

The smooth, and the rough

News that Avon Rubber (LSE:AVON), the manufacturer of gas masks and milking equipment, has agreed a contract with the US Department of Defense (DoD) for the M69 Aircrew Mask demonstrates there is still life after the end of the contract that transformed the business, the 10-year sole-source contract to supply the US general purpose mask. 

Only one thing was holding me back from awarding Avon a perfect 8 for profitability, adaptability, resilience and fairness when I profiled the company earlier in the month, and that was the company's dependence on the DoD for 40% of its revenue. 

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The contract follows a "collaborative development programme with the DoD" and I think we can be confident Avon's close relationship with the DoD is a significant advantage. It is still the only supplier of the general purpose mask, and I have lifted Avon's score for resilience from 1 to 2.

Before the next Decision Engine update in March I will have dropped the two lowest scoring companies, Finsbury Food (LSE:FIF) and MS International (LSE:MSI), from the rankings because my attention is probably better directed at higher scoring companies and new candidates. They may include Electrocomponents (LSE:ECM), 4imprint (LSE:FOUR), On The Beach (LSE:OTB), and dotDigital (LSE:DOTD), which I believe are good businesses.

If the market keeps testing my strategy, they may also get cheaper.

Richard owns shares in XP Power.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.