Monitoring Performance In February

Tuesday, 1st March 2016 09:24 - by David Harbage

As promised, this regular article seeks to follow the fortunes of the company stocks mentioned in our blog of 30 October 2015, ‘Identify, and run with your winners’.

The attached schedule shows how each share performed in February, which was another roller coaster month for the UK equity market.  The FTSE100 index retreated by 9% to reach 5,537 on 11 February – a level not seen since May 2012 - before bouncing back smartly to the 6,000 level over the following week. It seemed that the low point coincided with a number of market commentators appearing to ‘throw the towel in’ on any prospect for growth in the global economy in the foreseeable future.The big domestic news of February has surrounded the prime minister’s negotiations with his European peers and subsequent calling of a referendum on 23 June when the citizens of the UK will decide if we remain in, or leave, the EU.

While sterling has weakened dramatically on this prospect, domestic equities have barely been affected. In part this no doubt reflects their multinational, rather than domestic character – and increasingly flexible domicile (for tax or regulation purposes, as well as operational location). Perhaps the market is also reasonably efficient in anticipating such political outcomes, as evident in current betting of 1/3 on remaining and 2/1 on Britain leaving (termed Brexit) or portrayed in CFD terms by IG’s binary call of 68% on retaining the status quo.  

Before turning to comment on some of the individual companies, there are a few general observations worthy of note. First, the dispersion of performance amongst the constituents of this list is quite significant; more than half of the stocks have produced double digit returns – be they positive or negative – since we began this exercise four months ago. In a month characterised by a plethora of trading announcements and plenty of surprises on analysts’ forecasts, fund managers have not ‘sat on the fence’ - but rather have taken decisive action, one way or another, within their portfolios.

Secondly, following the publication of calendar year end interim or final results, the research departments of all the major brokers have been busy in assessing future prospects, and issuing stock notes with updated profit and dividend predictions to their clients. This is reflected in the new EPS (earning per share) forecasts – usually for the year after the current one (most commonly calendar 2017, but occasionally encroaching into 2018) – and also the prospective yield, calculated by reference to dividend pay-out forecasts at the current share price.

Third, it should be noted that the PEG ratio (which compares the PE, or share price to earnings per share, rating to the pace of growth in those earnings) might often appear extreme – compared to the intuitive norm of 1.0, which would imply that the average UK company stock with a PE rating of say 11 times might deliver 11% earnings or profit growth. For what it may be worth, in times of low or sub-trend economic growth as currently applies, the writer would adopt a more conservative prediction: of a PEG ratio closer to 1.5 than 1.0.

The above schedule represents a snapshot of ratios at a particular point in time (close of business figures on 29 February 2016) which can be misleading because, in reality, the numbers are changing on an hour by hour basis – as share prices move and analysts’ forecasts are revised to duly influence the consensual estimates. In addition, it should be noted that the EPS, PEG & PE multiples and Yield figures all relates to FY2 (the second forward-looking year) and therefore, without exception, those numbers are not quoted for FY1 - the current year – which could represent a similar pace of growth as FY2, or a very different one. 

The latter would distort the PEG ratio; for instance, Berkeley Group’s EPS growth is predicted to be 52% and 6% in their trading years to 30 April 2017 and 30 April 2018 respectively. The 6% appears pedestrian compared to the PE ratio, and so produces an unimpressive PEG, but does come after an exceptionally strong previous year. If one was looking at the intermediate year, of FY1, to 30 April 2017, Berkeley Group’s PEG becomes very appealing at just 0.2. By contrast, the same dozen or so research houses expect fellow house builder Bovis to deliver earnings growth of 16% in the current calendar year and 14% in 2017 – that steady picture results in an attractive sub one PEG ratio for FY2, as well as for 2016 incidentally.

Finally, on the subject of the published PEG numbers, the reader should note that where no earnings growth is anticipated it is not possible to cite a PEG. In such circumstances, which might simply reflect a small downturn in earnings following an exceptional previous year (when perhaps earnings were flattered by a one-off profit on the disposal of a business or property), n/a or ‘not appropriate’ appears in the schedule. The absence of a PEG ratio is a warning – flagging, as it does, a fall in earnings compared to the previous year – but may not necessarily suggest that a business has gone ex-growth.    

In looking at broker coverage of the selected stocks today, as compared to the 31 December 2015, there are a number of interesting developments. None more so than Paysafe Group, previously known as Optimal Payments and renamed following its successful takeover of Skrill Group, a European company of similar size in August 2015 moved from a listing on the Alternative Investment Market (AIM) to the main market on the 23 December 2015. As a consequence of this and the group doubling its market capitalisation in the second half of last year, Paysafe has come to the attention of more investors – and therefore analysts too, in part no doubt attracted by the prospect of further (fee earning) corporate action.

In the last two months, the number of research houses monitoring the stock of this company - which is a global leader in providing online payment solutions - has jumped from two to seven. With a view to broadening the business activities represented by this article, to include technology, Paysafe has been incorporated into the above schedule – at the expense of Bovis, who will be removed next month although its industry segment will still be represented by its London-biased peer Berkeley Group.  

Beyond new coverage of the Paysafe Group, it is notable that a number of investment houses have been active in revising their recommendations to reflect the more appealing valuation that emerged when several prices retreated in the first week or two of February. One such stock that merits particular attention is Aviva; the life assurer represents a geared play on stock exchange assets and a number of institutions have upwardly revised their view on UK equity as an asset class, highlighting life assurance and the fund management sector as two sectors which appear to have been oversold and therefore capable of leading a recovery. In the next article, we will discuss some of the news and other factors that have driven stock specific performance in February.David Harbage 1 March 2016

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.