Aggressive UK equity selections

Monday, 24th September 2012 10:55 - by David Harbage

More on individual stocks

In the previous week’s blog we took a close look at ten individual UK listed company shares which the writer considered to be defensive – by reference to the business activities being essential, the group being a strong leader in their industry (usually with global, rather than simply local, operations) and the equity being reasonably or attractively valued. Investors with a cautious perspective might appreciate such companies, which feature low sensitivity to the overall health of the economy, and take comfort in the thought that these stocks’ valuations were undemanding by comparison with the wider market.

Beyond lower risk-reward defensive company shares

As promised, this article seeks to construct a second list or portfolio of stocks which feature individual UK company shares which appear to be suited to the higher risk-reward, more aggressive, investor. This is based on two factors: that they exhibit higher levels of growth and secondly, equally pertinently, their equity is valued on a demanding premium rating. Added to that, some of these companies may possess greater exposure to weak areas of the domestic economic activity, such as discretionary areas of consumer expenditure, and less to the global economy which is currently enjoying a more impressive pace of growth.

Every investor should carry out their own due diligence

As applied to the first portfolio of defensive businesses, these stocks are not intended to be a suitable recommendation to any one reader but rather are for interest only which may prompt further investigation. Many of the following stocks are constituents of the FTSE100 index, but all are large rather than smaller companies and have a market capitalisation approaching, if not more than, £2 billion. A lack of space and time persuades for mention of only ten companies – as also appeared in the blog detailing the more cautious blue chip investments – whereas the writer would recommend that vital diversification should extend to a minimum of twenty businesses, across a wide range of industry sectors and geographic regions.

Valuing growth businesses

Clearly the key to having confidence in highly rated/growth company stocks, is a belief that the above average growth continues and will eventually drive the rating metrics (such as PE ratio and dividend yield) into more attractive and share price supportive territory. Although the PEG (comparison of PE ratio to earnings growth) is useful when studying higher growth businesses, this ratio only provides a ‘snapshot of a very short term prognosis. Assessing businesses by reference to their longer term potential naturally requires an estimation of future profit or distributed profit (dividend) growth; professional investors typically create mathematical models of such projected income, and then discounting the numbers back (by using an anticipated long term interest rate) to arrive at today’s (or a present) worth of such future cash flows. When the overall economic climate is more daunting, as currently applies, then clearly a higher degree of belief – that the specific individual selection possesses especial business merit, or perhaps contrarian characteristics - is required.

Aggressive Portfolio of 10 UK equities

BG Group - a world leader in natural gas, with operations in more than 20 countries on 5 continents, the company has a broad portfolio of exploration, production, transmission and distribution interests. However, the company is characterised by major upstream assets in Brazil and Australia which are due to come on stream over the next 5 years and will determine its medium term success. By contrast with many integrated peers, the group has a focus on growth (note low dividend payout ratio) with an impressive track record in finding and commercialising reserves. Short term headwinds surround a weak US gas price, which led to a major asset write-downs earlier this year, and the prospect of replacing a longstanding CEO who departs in June 2013. The consensus of equity industry analysts’ (of whom 21, of the 27 reviewed, rate the shares as a Buy, 5 say Hold and only 1 says Sell) anticipate:

Aggreko - is a global provider of rental power, temperature control and compressed air systems with operations in over 120 locations in 28 countries. Best known for its ability to respond quickly to the need for temporary power, the company has benefited from many high profile contracts to supply its portable generators to the World Cup in South Africa, the Olympics in London and in response to natural disasters – notably in lesser developed countries. This FTSE100 constituent company boasts an impressive track record of growing revenue and profits, its shares are tightly held by supportive loyal institutional investors but, like most of the stocks mentioned in this blog, the equity ‘prices in’ high expectations (and offers no or little scope for disappointment). This is borne out by the consensus of equity research analysts’ recommendations (of the 16 reviewed, 9 view the shares as a Buy, 7 say Hold and none say Sell) and whose numbers anticipate:

SAB Miller – originating in South Africa, but transformed over the past ten years by acquiring a number of major brewers beginning with the US group Miller, the company has become a world leader – possessing 200 brands (including Peroni, Grolsch, Miller, Coors, Urquell, Castle, Snow, Victoria and Tyskie) in more than 75 countries. The group also has interests in soft drinks and bottling for the likes of CocaCola. Traditionally, brewers are not highly rated stocks as demand and the industry’s dynamics are regarded as steady rather than growth. By contrast, SAB have sought to promote its global brands into new countries and markets, with additional success achieved from taking local branded beers into new territories. Growth has been both organic and via acquisitions; undoubtedly the premium valuation anticipates and is dependent on further acquisitive success. The consensus of equity research analysts’ (of whom 14, of the 32 reviewed, consider the stock to be a Buy, 16 say Hold and 2 say Sell) forecast:

Unilever – this Anglo-Dutch consumer goods group supplies a wide range of well-known branded food and household products, which includes Dove soap, Persil detergent, Liptons tea, Ben & Jerrys ice-cream. This business was viewed as undermanaged and somewhat dull, with a constant battle for pricing power with the retailers being a notable headwind. However, over the course of the past three years, its image has changed dramatically as investors have recognised management success in focusing on new markets in Asia and Latin America. The group now operates in 100 countries and sells into 190, with 11.5% revenue growth in emerging economies in 2011 demonstrating strong appetite in such higher growth nations to buy luxury branded supermarket products. A consensus of equity research analysts’ (of whom 8, of the 19 reviewed, consider the stock as a Buy; 9 say Hold and 2 say Sell) forecast:

Whitbread – this FTSE100 constituent is no longer a brewer, but rather a leading domestic leisure company via its ownership of the budget hotel chain Premier Inns, its leading Costa Coffee shops and various restaurants (notably Beefeater). While discretionary spending for the embattled UK consumer has come under pressure, astute management has positioned the group in areas of relative strength where it has been able to take advantage of secular growth trends: companies have reduced overnight budget expense (Premier Inn) and, on the High Street, low ticket treats (Costa) have been the order of the day. The extent, to which new outlets can be profitably added, perhaps overseas rather than at home, is key to future success or maintaining high hopes implied in the valuation. The consensus of equity research analysts’ (where, of the 22 reviewed, 10 consider the stock as a Buy; 9 say Hold and 3 say Sell) predict:

ASOS – describing itself as a global online fashion and beauty retailer, the offering is primarily aimed at the 15-35 year old female audience with its ‘As Seen on Screen’ reasonable price replication of high fashion. The group’s low cost-base, website retailing has extended from the UK to target the US, France, Germany, Spain, Italy and Australia with local sites, as the proposition has extended to menswear, footwear accessories, jewellery and beauty products. The smallest of the companies we feature in this blog, with an equity worth of £1.7 billion, but perhaps the fastest growing business as well as the most expensive stock valuation. ‘Me-too’ sites represent a real threat, but the ASOS brand shows no immediate prospect of slowdown despite a tougher economic environment. According to the consensus of retail analysts (where, of the 18 reviewed, 15 consider the stock as a Buy and 3 say Hold) further growth is predicted:

ARM Holdings – designs critical technology (micro & graphics processors, video engines, cell libraries, connectivity, peripherals, development tools, and embedded memories) that powers advanced digital products: from wireless, networking and consumer entertainment solutions through to security, imaging, automotive and storage devices. A major beneficiary of rapid development in new technology – think smart phones and 3D & HD TV – future success is dependent on further progression and the group maintaining its technological edge. Investors’ affection (per the stock’s high rating) also reflects an absence of other big IT companies in the UK and an expectation that it is a prime takeover target. This popular expectation of growth is evident from the consensus of equity research analysts’ (of the 32 reviewed, 21 view the shares as a Buy, 9 recommend a Hold and only  2 say Sell) whose numbers anticipate:

Randgold Resources – the largest listed pure gold miner within the FTSE100 index, operating 3 mines in Mali (with deposits of circa 20 million ounces) and a 4 million deposit in the Ivory Coast, one in the Congo due to produce in 2013 and developing other exploration projects in Africa. As a major owner of gold, with the prospect of more discoveries to come, this stock has been a major beneficiary of a rising price in the precious metal. Although possessing mines in more than one location, the continent of Africa represents a higher risk-reward investment - via volatile politics, labour relations, uncertain regulation & taxes and corporate governance. The outlook for the gold price, helped by the prospect of increasing money supply and low interest rates, is reflected in the consensus of mining analysts’ views (of the 24 reviewed, 14 view the shares as a Buy, 7 recommend a Hold and only 3 suggest Sell) and their forecasts :

Shire – a relatively young pharmaceutical company, founded in 1986 and coming to the stock market in 1996, it has grown strongly via its specialism in behavioural health, gastro-intestinal conditions, rare diseases and regenerative medicine and is best known for its attention deficit disorder treatment Adderall and Vyvanse. Unlike many of its peers – large and small - the business has managed to deliver impressive growth in its revenue and profits, as well as develop a pipeline of products, over the past five years. While the shares are a favourite amongst institutional investors and the Sell-side industry analysts (of the 31 available recommendations, 25 view the shares as a Buy, 6 recommend a Hold and none proffer a Sell), they are also regularly touted as a likely takeover candidate. This may account for some of the stock’s premium (relative to the wider health sector) rating, as evident in the same analysts’ consensus forecasts:

Experian – demerged out of the GUS group in 2006, this is a global business services company which is probably best known for its credit checking operation that enables consumers to see their credit score and protect against identity theft. However its prime function is to provide data and analytical tools to help businesses manage credit risk, prevent fraud, target marketing offers and automate decision making. The company’s premium rating has been built on its strong reputation for growth which, despite coming under pressure during the early part of the banking/financial crisis, it has regained over the past three years. Unusually, the consensus price target of equity research analysts covering the stock is lower than the current share price (by almost 10%), but nevertheless of the 19 broker reports available, 14 view this stock as a Buy, 4 recommend Hold and only 1 says Sell, as they forecast:

In conclusion

One could have selected yet higher growth and rated companies from within the FTSE100 – such as the oil explorer Tullow Oil (instead of BG). It could be argued that last week’s Defensive portfolio selection of the i shares S&P Commodity Gold Producers exchange traded fund could also have qualified in this list – in place of Randgold Resources - by reference to its very low (reinvested) income. Focusing on larger businesses was a deliberate policy, in recognition of the greater availability of information and research views (which suggests, but certainly does not assure, more reliable outcomes surrounding shareholder experience), but the writer could also make a case for medium sized companies, rather than the largest – perhaps for another article.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.