Shares for the future: four more shares I think are good value

On a recent cycle commute, I heard strategist Richard Rumelt say something so wise I felt compelled to stop, pause the audiobook I was listening to, The Crux, and work out how to place a bookmark so I would not forget.

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The Crux is a sharpening and updating of Rumelt's earlier book: Good Strategy/Bad Strategy. That book was a major influence on the design of the scoring system that powers my Decision Engine. The sequel will probably inspire the first redesign of that system for many years.

Before I take the plunge, I want to explain why it is necessary to shake things up, and before that why I am running it by you first.

My scoring system underlies my research, which underlies my articles and my own personal investments. Judging by the performance of the Share Sleuth portfolio, it has been reasonably successful. Making changes, therefore, could backfire. It is a good idea to air them.

I have not told you what Rumelt said to me on that bike ride, bear with me. First I need to revisit the Decision Engine's design.

The Crux

I took Rumelt at his word, when he wrote in his earlier book that: “A strategy is a coherent mix of policy and action designed to surmount a difficult challenge.”

The questions I seek to answer, written in my template for every share are: “Risks: what could stop it (the company) growing profitably?” and “Strategy: how does its strategy address the risks?” The risks are challenges, and strategy is the policy and actions.

Rumelt's message in The Crux is unchanged, but it has emphasised to me that challenges and solutions are two sides of the same coin and strategy should be focused on the most significant challenge, the one that if addressed, offers the biggest payoff.

In mountaineering, Rumelt explains, the crux is a section of the climb that needs working out, a tricky sequence of hand holds and foot holds that move you on to the next stage.

Businesses face critical challenges too. Language translator RWS Holdings (LSE:RWS) is working out what to do about artificial intelligence, for example. It is a threat and an opportunity: machine translation is more efficient than human translation in some cases and becoming more reliable. Consequently, RWS has acquired capabilities in machine translation and is working out how best to marry them to its strengths. Whether this is enough to overcome the challenge will probably determine whether RWS is a good long-term investment.

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To overcome the crux, a climber, or a business, must focus their resources on critical challenges, but my system does not identify or reconcile them very well.

It requires me to identify the three biggest risks facing the company, whether they are critical or not, which probably means I am not focusing on what is most important.

Worse, if I believe a business is in a particularly competitive position, for example, I will give competitive risk a positive score, while also giving the strategy that achieved this a positive score.

For example, Howden Joinery Group (LSE:HWDN) has a dominant position in the UK fitted kitchens market and due to its trade-only policy I think it provides an unparalleled service to small builders. I score it positively under risks, because competitive risk is low, and then score it positively under strategy because its policy of only supplying trade customers is a good one.

This is double counting a challenge and strategy, and the strategy has already resolved the challenge, which was how Howdens would differentiate itself from other kitchen suppliers. The competitive threat is low because Howdens built a unique business by choosing to focus solely on the trade.

Instead of scoring the strategy of Howdens, how it will grow now it has achieved near blanket coverage of the UK with depots, I have scored a strength. Strengths are important but they are not strategy. Strategy builds on strengths and plugs weaknesses.

Now Rumelt has awakened me again, I realise there are other inefficiencies in the Decision Engine.

The first factor I score is: Does the business make good money? This scores profitability. Basically, I ask myself whether a company has been profitable in cash and accounting terms through thick and thin.

It is a proxy for whether the firm is already a good business, but it does not require me to explain what capabilities make it so, the reasons it makes good money in other words, and whether those capabilities explain its track record, as opposed to things outside its control.

I am also wondering about the fairness factor: Will we all benefit? Whether a company is enlightened in its dealings with employees, customers, and suppliers, whether it considers its impact on the environment and society, and whether executive pay encourages management to prioritise the long-term prosperity of the business, are critical but also integral to the business and its strategy.

Perhaps the fairness category is superfluous.

I think the design of my scoring system is flawed; it recognises important factors in the long-term success of a business, but not so well how they fit together.

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My proposal is to reconfigure it so that it evaluates a business, how it makes money, identifies preferably just one crux, AI for RWS and limits to growth in the UK for Howdens, and evaluates the strategy.

I have yet to consider how the scoring would work. At the moment I have an image in mind. It is the shape of an hourglass. The top section relates to the past. It contains information about the business and how it has made money. The neck is the Crux, it is a path to the future that must be opened, a bottleneck that must be overcome if the business is to flourish. And the bottom is what the company needs to do to get past the Crux, its strategy.

In scoring the business and its strategy, I will be seeking coherence. That the businesses capabilities explain its performance and in improving its performance the strategy builds on strengths and plugs weaknesses. The actions it is taking should support and reinforce each other rather than pull the business in different directions.

I had no need to bookmark the words that stopped me in my tracks on my bike ride, because I can hear their essence loud and clear. Rumelt said:

“You will have a much harder time dealing with a gnarly challenge if you have not distilled it down to a crux. No one solves a problem they cannot comprehend and hold in their mind.”

Understanding a business and its prospects is a gnarly challenge. Maybe I have been making things harder for myself and, I regret, for you.

30 shares for the future

I re-score each share in the Decision Engine once a year, after the publication of the annual report.

Since the last update a month ago, Auto Trader Group (LSE:AUTO), Solid State (LSE:SOLI), Marks Electrical (LSE:MRK) and D4t4 Solutions (LSE:D4T4) have been through the process. To see how I scored them, or any share, please click on the share’s name in the table below.

Oxford Instruments (LSE:OXIG), Latham (James) (LSE:LTHM), Games Workshop Group (LSE:GAW), Jet2 (LSE:JET2), Cohort (LSE:CHRT), and Goodwin (LSE:GDWN) have all published annual reports and are due to be updated.

Generally, I consider shares that score 7 or more out of 9 to be good value. This month there are 30, four more than last month (Cropper (James) (LSE:CRPR), Solid State, D4t4 and Softcat (LSE:SCT) are upgraded). Shares that score 5 or 6 out of nine are probably fairly priced.

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. They are more speculative.

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

Richard owns shares in most of the shares in the Decision Engine. He weights his portfolio so it owns bigger holdings in the higher-scoring shares.

More information about Richard’s investment philosophy and how he implements it.

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