Considering Growth

Monday, 25th July 2016 09:51 - by David Harbage

Further to last week’s article, ‘Assessing Value’, which looked at an apparently undervalued sector within the UK equity market, this blog considers leading constituents of a domestic growth portfolio – by reference to the same metrics.

The Old Mutual Mid Cap fund endeavours to produce capital growth by investing in medium sized UK listed companies and seeks to beat the FTSE250, ex-investment trust, index. While underperforming its benchmark in the current year to date (by 5.5% to 30 June), the fund outperformed in the previous four years (by 12.7% in 2015, +5.4% in 2014, +3.4% in 2013 and +14.5% in 2012). The underlying portfolio is more concentrated than most of its peers, with the largest 10 constituents typically accounting for 40% - and the next 20 largest exposures another 40% - of the £2bn open-ended fund.

These are the fund’s ten largest exposures, as at 30 June 2016, by reference to the measures or factors mentioned in the previous blog – reiterated, at the end of the article, for ease of reference.        

1. Paysafe – 7.1% is invested in this £1,872m market cap financial payments business. In the year to 31 December 2017 brokers expect EPS of 31.5p, putting the shares (currently priced at 389p as at close of business 22 July 2016) on a forward looking PE of 12.4x, and a PEG of 0.8x as earnings growth of 15% is anticipated next year. The company is unlikely to pay a dividend, based on the forecasts of the 8 brokers that research the stock, but it is worth noting that consensus earnings forecasts have increased over the past week, month, quarter and year. Finally, all 8 rate the stock a Strong Buy.

2. Just Eat – 6.06% invested in this £3,204m market cap online food ordering and delivery group. In the year to 31 December 2017 brokers estimate EPS of 15.5p, putting the shares (priced at 474p) on a forward looking PE of 30.5x, and equating to a PEG of 0.6x. The company is set to pay a maiden dividend of 0.5p next year, based on the forecasts of the 15 brokers that research the stock. Of those 15 analysts, 13 say Buy and 2 Sell; again, consensus EPS expectations have increased over the past week, month, quarter and year.

3. Micro Focus International – 4.42% invested in this £4,258m market cap provider of management software solutions. In the year to 30 April 2018, 12 brokers forecast EPS of 121.5p, putting the shares (priced at 1862p) on a forward looking PE of 14.3x, a PEG of 2.0x. The company is expected to pay a dividend of 53.5p next year which, on the current stock price, equates to an income yield of 3%. Of those analysts, 8 say Buy, 2 Hold and 2 Sell, their price targets range up to 2150p and consensus EPS expectations increased over the past week, month, quarter and year.

4. Ascential - 3.74% invested in this £990m market cap media group, specialising in exhibitions and business services, which has only been listed since February 2016 at £2. In the year to 31 December 2017, 6 brokers estimate EPS of 17p, putting the shares (priced at 247p) on a forward looking PE of 14.6x, and a PEG of 1.0x. The company is expected to pay a dividend of 5.7p next year which, on the current stock price, equates to an income yield of 2.2%. Looking at analytical opinion, 5 say Buy and 1 says Hold, and their price targets range between 250p and 290p.

5. RPC Group – 3.45% invested in this £2,647m market cap plastic packaging group. In the year to 31 March 2018, 5 brokers estimate EPS of 60.8p, putting the shares (priced at 841p) on a forward looking PE of 13.8x, a PEG of 1.1x. The company is expected to pay a dividend of 22.3p next year which, on the current stock price, equates to an income yield of 2.8%. All 5 of the analysts recommend a purchase, their price targets range between 820p and 1004p and, again, consensus EPS expectations have increased over the past week, month, quarter and year.

6. SSP Group – 3.28% invested in this £1,458m market cap operator of food outlets in airports and railway stations. In the year to 30 September 2017, 13 brokers estimate consensus EPS of 15.7p, putting the shares (priced at 307p) on a forward looking PE of 19.5x, and a PEG of 1.6x. The company is expected to pay a dividend of 5.8p next year which, on the current stock price, equates to an income yield of 2%. Of analytical opinion, 6 say Buy, 6 Hold and 1 Sell, price targets average around 350p and consensus EPS expectations increased over the past week, month, quarter and year.

7. Ashtead Group – also 3.28% invested in this £5,870m market cap equipment rental firm. In the year to 30 April 2018, 16 brokers estimate consensus EPS to be 103.3p, putting the shares (priced at 1170p) on a forward looking PE of 11.3x, a PEG of 1.2x. The company is expected to pay a dividend of 27.2p in that year which, on the current stock price, equates to an income yield of 2.4%. Of those analysts, 10 say Buy, 4 Hold and 2 Sell, their price targets range between 660p and £12 and again consensus EPS expectations increased over the past week, month, quarter and year.

8. Boo.hoo.com - 3.14% invested in this £685m market cap online women’s fashion retailer, which came to the market in March 2014 at 70p. In the year to 28 February 2018, brokers estimate consensus EPS of 1.8p, putting the shares (priced at 61p) on a forward looking PE of 34.3x and, anticipating 24% profit growth, a PEG of 1.4x. The company is unlikely to pay a dividend, based on the forecasts of the 10 brokers that research the stock, but consensus earnings forecasts have increased over the past 3, 6 and 12 months. Of those analysts, 8 say Buy and 2 Hold.

9. Barratt Developments – 3.12% invested in this £4,125m market cap house builder. In the year to 30 June 2017, 15 brokers estimate consensus EPS to be 52.7p, putting the shares (priced at 411p) on a forward looking PE of 7.9x. In that year profits are forecasts to fall by 2.8% (after a 19% increase in the year just finished) so a PEG ratio cannot be calculated. However, the company is expected to pay a dividend of 31.75p (a 9% hike) in the year to June 2017 which, on the current stock price, equates to an income yield of 7.8%. Of those analysts, 6 say Buy, 8 Hold and 1 Sell, their price targets range between 660p and £12 and consensus EPS expectations had been rising until the past month – since when likely EPS has been lowered 12%.

10. Pets At Home Group – 3.04% invested in this £1,197m market cap household pet group. In the year to 31 March 2018, 7 brokers estimate consensus EPS to be 16p, putting the shares (priced at 239p) on a forward looking PE of 14.9x and, expecting profit growth of 4%, with a PEG of 3.7x. The company is predicted to pay a dividend of 7.7p in that year which, on the current stock price, equates to an income yield of 3.2%. Of those analysts, 4 say Buy, 1 Hold and 2 Sell, their price targets range between 200p and 340p and consensus EPS expectations had been slipping back.

As can be seen from looking at the numbers below, the largest 10 stocks have a clear bias to growth and momentum over deep-seated value or income yield – based on earnings multiple and dividend pay-out of both the fund’s normal ‘fishing pool’ of medium sized companies or indeed the overall UK equity market. Of course, all the numbers shown above represent a snapshot in time, and an assessment of future profits or asset worth will change with every new piece of relevant company specific or wider economic or industry development. Wise investors will not limit their view to just a year or two out, but will take a longer term perspective on the prospects for individual companies – looking through short term factors or the cyclical nature of particular industries. Assessing longer term value will be largely determined by the level of confidence investors can have in the quality of its revenue, profits & assets (reliability or sustainability, based on economic conditions and a company’s ability to maintain or grow its business).      

Looking at the above mentioned leading holdings within Richard Watt’s portfolio, Barratt Developments stands out as the prime exception of being a Value (based on the stock’s low PE, high dividend pay-out, and absence of a PEG in respect of next year’s expectations) rather than a Growth investment. A low earnings multiple could represent a value ‘trap’ – so described because the PE ratio appears attractive, but could be indicating a fall in profits which would move the PE up towards a more normal, market-average rating – or perhaps an opportunity for investors. The ‘Brexit’ decision clearly represented a critical event for almost all domestic companies, and investors will have been having a hard think about (a) the consequences and (b) the extent to which equity of the most affected businesses have already been fairly re-valued by the market. Ahead of the UK’s referendum on EU membership, Barratt Developments was Old Mutual Mid Cap’s third largest exposure (4.1% of the fund as at 30 May 2016) and, for your interest, fellow house builder Taylor Wimpey was the fund’s 6^th largest holding (3.3%).

When fund managers make calls on whether or not to own a stock, this will normally be for a number of years, rather than months. To date, it does not appear as if the Old Mutual manager has lost confidence in these two house builders; their slippage down the fund’s top ten is simply driven by recent under performance. Finally, growth-focused funds will often be prepared to retain businesses which continue to enjoy positive news flow – even when the traditional valuation metrics become stretched – and, believing that the premium paid for superior performance is merited, will take an ever longer view in assessing a fair valuation. Certainly the performance of relatively new internet-facilitated/driven businesses, like Boohoo.com and Just Eat, have been buoyed by a series of positive surprises and broker upgrades over the past two years since their respective stock market floats (in March 2014 and April 2014, respectively). Looking forward a couple of years, it will be interesting to see how their valuations settle down as each business become more mature as inevitably more competition crowds in.    

Forward-looking assessments of Value

1. Market capitalisation is the total worth (based on the latest mid-price) of all the company’s equity or shares in issue.

2. Year end shows the company’s accounting year as far out into the future upon which brokers will typically provide a forecast of profit, dividends etc.(normally 1 or 2 years).

3. EPS represents earnings per share for that future year (‘looking out to the horizon’), based on an average of the published profit forecasts made by brokers. This figure can change rapidly as company news or wider circumstances develop.

4. PE multiple (or ratio) compares the EPS of that future year to the current share price.

5. PEG ratio compares the pace of the profit growth in the current or a future year with the PE for that year. A ratio of 1 implies average growth, of say a company share on a PE multiple (or rating) of 10 and delivering 10% growth in EPS in that year. Accordingly, a sub 1 PEG indicates higher earnings growth than the PE multiple might suggest, while a PEG in excess of 1 indicates slower growth than the implicit PE. Where no PEG ratio is displayed, this implies a fall – or static growth – in profits.

6. Broker view details the number and various mixes of recommendations made by brokers (on the ‘sell side’ of the industry, as compared to ‘buy side’ fund managers’ opinions which are reflected in their equity ownership). Large companies attract more broker interest (perhaps anticipating corporate fee-earning activity), while smaller companies are less well-researched, providing greater scope for surprise (both positive and adverse). Broker recommendations are biased towards the positive, in anticipation of maintaining a good relationship with listed companies (i.e. research concluding in a Sell, is rarer than what one might intuitively or logically expect)

7. Dividend Cover represents the number of times that a forecast dividend is ‘covered’ by earnings in the future year (mentioned in item 2 above, as the Year end). An EPS of 30 pence and a dividend of 10 pence for a given year would represent cover of 3x.

8. Yield is the forecast dividend for the future year expressed as % income based on the current share price. 

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.