Shares for the future: 70% of these stocks are now in my ‘buy’ zone

Companies analyst and investor Richard Beddard explains how his emergency button is different to others, and why he buys and sells shares to his own rhythm.

Reading an article by data scientist and environmentalist Hannah Ritchie recently, I was struck by its main point: that reducing her impact on the environment often requires her to do the opposite of what feels right.

The ‘natural fallacy’

Hannah Ritchie knows that living in the city is better for the environment than living in the countryside, that nuclear energy is more environmentally friendly than a wood burning stove, that often local food is no better for the environment than food from afar, and that a microwave is the best way to cook food.

But still she resists because of what she calls “the natural fallacy”: If it seems natural, it must be good for the environment.

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I was thinking about this article when I was responding to an email from Larry, a regular and much valued correspondent.

Larry writes: “I appreciate your belief in slow decision making and waiting for annual reports. It seems to me that in certain circumstances there is a case for overriding this approach.”

He says he would have sold shares in XP Power (LSE:XPP), for example, when on 24 March a jury in California found it had stolen trade secrets.

We are still waiting for the judge’s ruling on the verdict and XP Power’s response, but as things stand the company will pay financially, reputationally, and strategically.

Emergency button

Larry advocates, “an emergency button so to speak,” because prices usually decline for some time after shocks like these, and often more bad news follows. “There’s no smoke without fire”, he says, and he invokes the well-known stock market adage that profit warnings come in threes.

What could be more natural than an emergency button, a decision to sell shares when something potentially awful happens?

What Larry is describing is natural. It is the herd instinct.

When someone yells fire, everybody heads for the exit. If the danger is real, the herd instinct saves lives, and even if it is a false alarm the cost may not be high.

That is probably true for traders, who make decisions very quickly based on anticipating the direction of the share price.

For buy and hold investors things are more complicated. We focus on businesses and how their strategies will deliver returns many years in the future. We have one share price prediction for all our shares: They will go up and down, but in 10 years time they will be a lot higher than they are today.

The only bad news that matters is news that undermines the company’s long-term prospects.

To get back to XP Power, the court's verdict will have an impact. As things stand there are damages to pay and the company is forbidden to use the technology the jury says it stole.

I do not think that necessarily makes XP Power a bad investment.

As the facts change...

In a nutshell, the theft of trade secrets relates to new products that have not contributed to the company’s past growth, and took place, I believe, in a business that was acquired.

If it turns out to be an isolated incident, I expect the company to get over it, but if subsequently we discover more skeletons in XP Power’s closet, I would probably take a different view.

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XP Power had just released its annual report when the court reached its verdict and, since I scored the company soon after the verdict, we have an example of how the scoring system copes with bad news.

I reduced XP Power’s score to 6 out of 9 in April, which took it out of the ‘buy’ zone (a score of 7, 8 or 9 out of 9) and reflected my newfound uncertainty.

A score of 6 told me not to buy or sell the shares until we know more, which seems sensible.

Speeding up to slow down

Larry is right though. The annual reappraisal cycle can be slow. This time, the timing was fortuitous. Previously, I have had to act quickly to prevent a travesty in the Decision Engine rankings.

Before the pandemic, investment case busting news was rare for the kind of stable businesses I follow. But the closure of airports and restaurants meant great companies such as Jet2 (LSE:JET2) and Churchill China (LSE:CHH) were unable to operate.

Their high scores and cratering share prices propelled them straight to the top of the Decision Engine table, which was untenable. They had become the most speculative of investments because their prosperity and maybe even their survival depended on the course of the pandemic, something I had no insight into.

The herd instinct led investors to sell these shares, but I did not. I removed them from the Decision Engine, put them in a separate table and refused to trade them until I could make a considered decision.

It turns out I do have an emergency button after all, it can be invoked as quickly as Larry’s, but it works the opposite way.

Instead of liquidating holdings it freezes them until I can make a considered decision (or give up trying). Instead of making me react to events, it stops me reacting to them until I know more, and I have time to devote my full attention to the share (when I score it).

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I have a mechanism for bringing sell decisions forward too. Once a month I think about trading. You can read about those trades in the Share Sleuth portfolio update that always follows a week after this Decision Engine update. If I have doubts about a business, I have the option of reappraising it then.

This means I buy and sell shares to my own rhythm, instead of being cowed by fear and buoyed by greed. It does not work all the time, but a portfolio of 30 good companies can absorb the poor performance of ones that turn out to be not so good, and over the long-term it has worked for me.

The slowness is deliberate. It is so ingrained, I almost never think about it.

Being forced to explain, though, has been a most uncomfortable experience because my process is complicated in comparison to following the herd. Like living in the City or microwaving our food, it does not feel natural.

As I drafted this article, a voice inside my head kept asking, “why not just score companies again every time there is news?”

If I were a master of the universe, I would. If I had limitless time, energy, knowledge, and perfect foresight, I would update all my scores in real time.

But since I am only human, I pace myself.

There is an opportunity cost to evaluating companies more than once a year, and that is that I would not be able to evaluate as many companies. Since the Decision Engine is a comparison machine, the comparisons would be less valuable if they involved a smaller set of shares.

The Decision Engine

Since the last update, I have scored Cohort (LSE:CHRT), Games Workshop Group (LSE:GAW) and Goodwin (LSE:GDWN). As usual, 40 shares are listed in the table. It is ranked from highest to lowest score.

The scores are made up of five factors described in the FAQ linked below, and documented for each share in the articles linked from the company names in the table.

I think all of the companies in the Decision Engine are probably good long-term investments, but the higher the score, the more confident I am.

Shares marked with an asterisk (*) are more speculative.

• Scores and stats: Richard Beddard. Data: SharePad and annual reports
• Shares marked with an asterisk* score less than 5 out of 6 for Profitability, Risks and Strategy or are likely to be re-evaluated. They are more speculative
• Click on a share's name to see a breakdown of the score (scores may have changed due to movements in share price)

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

Richard owns shares in 30 of the companies listed in the Decision Engine, with most of his portfolio weighted towards the top of the table.

For more information about Richard’s scoring and ranking system (the Decision Engine) and the Share Sleuth portfolio powered by this research, please read the FAQ.

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