Shares in focus: How our tips have fared this year

A disappointing 2014 for UK stocks has meant few big winners, says Phil Oakley.

After two years of gains, 2014 has not been a stellar year for the UK stockmarket. Between 1 January and 19 December, the broad market – represented by the FTSE All Share Index – fell by 2.3%.

Once again, the FTSE 250 index of medium-sized companies has done better than the FTSE 100, but it still ended up in the red. The mid-cap index lost 0.3%, compared to a loss of 3% for the index of the biggest companies.

This may be because investors are starting to shift their focus. For the last few years, stocks have been mostly driven by speculation over the direction of interest rates. The prospect of continued low rates of interest on savings accounts and bonds has kept the stockmarket going up.

However, in recent weeks people have instead started to worry about the outlook for company profits. A falling oil price has spooked investors that the global economy might be about to hit the rocks. If profits start falling, low interest rates are unlikely to support stock valuations that are far from cheap.

In fact, one likely reason why UK stocks have struggled to make much headway in 2014 is that professional analysts have been too optimistic. Share prices are very much driven by what investors expect company profits to be.

And according to a recent article in the Financial Times, accountants Ernst & Young have found that 2014 was the worst year for profit warnings since 2008. Nearly a quarter of the constituents of the FTSE 350 index has warned on profits in 2014.

In contrast, the better economic performance of the US has ensured that American investors have had a much better time of things. The S&P 500 is up 12% in US dollar terms, after gaining nearly 30% in 2013. Since the dark days at the end of 2008, American shares have gone up by 129% compared to a 59% gain for the FTSE All Share.

Hopefully 2015 will bring better returns. But with the year drawing to the close, it’s time to face up to how the stock tips made on these pages have fared. The short answer is not too well.

I’ve taken the view that most MoneyWeek readers are looking for places to invest their money. This means that I’ve been looking for shares to buy, rather than simply warning you what to avoid. That has not been easy in a market where bargains are scarce.

With hindsight the more cautious stance I’ve adopted in the last few weeks probably should have been applied throughout the year.

How our tips have fared

Cash and carry business Booker (LSE: BOK) has been my best tip this year, having rallied by nearly a third since I recommended it just over three months ago. I like the fact that Booker generates high returns on capital employed (ROCE), produces lots of surplus cash flow and has a relatively clean balance sheet with no debt.

It is also exposed to growing parts of the UK grocery market such as convenience stores, which should see profits continue to rise over the next few years. The shares were already richly valued back in September but now trade on a forward price/earnings (p/e) multiple of over 25. That looks a little too rich to me, despite how good a business Booker is. Take profits.

British American Tobacco (LSE: BATS) has continued to be a reliable performer. Despite the problems of black-market cigarettes, tougher government regulations and the strength of the pound for most of the year, BAT remains one of the most profitable large companies on the stockmarket.

Dividends look like they can keep on increasing for a while yet. If 2015 does turn out to be a rocky year for shares, then this one – with a yield of 4.4% – should be worth hanging on to. Hold.

Supermarket chain Morrisons (LSE: MRW) has had a terrible year. It has been struggling to tell customers what it stands for, and seems trapped in no-man’s-land between the cheap discount stores of Aldi and Lidl and more upmarket chains such as Waitrose.

I tipped Morrisons as a property play. My thinking was that rivals might want to exploit its weaknesses, break the company up and share its stores between them. This has not happened – yet – and Morrison’s profits have continued to fall sharply.

Based on profits alone, I think the shares have little support at the current share price. The dividend looks unsustainable too and is thinly covered by profits. It is being paid with the cash from selling some stores and warehouses. Once these sales end, a big dividend cut looks to be on the cards if profits haven’t recovered. Avoid.

Rolls-Royce (LSE: RR) looks more interesting. The shares did not look cheap when I tipped them back in January. With hindsight they were clearly too expensive and they have since fallen sharply on the back of a series of profit warnings. But I think there is more scope to profit from the share price now.

Rolls-Royce’s strength is its civil aerospace business. Air travel across the world is expected to keep growing, which means that aircraft makers such as Boeing and Airbus should keep buying Rolls-Royce engines in the years ahead.

This means that the installed base of engines should keep on growing, which in turn means more maintenance work and spare parts sales for Rolls-Royce. This should lead to a big increase in the amount of free cash flow Rolls-Royce can produce.

The trouble is that the company looks like it is trying to do too much elsewhere, which is hurting the value of its shares. But investor pressure to sell the less significant parts of the business could increase in 2015, and that would be good news for the share price. Buy.

The gamble that paid off

My “gamble of the week” column looks for shares that have the potential to make big gains, but come with a reasonable amount of risk attached to them. Consequently, they can make
big losses as well.

I look for companies that may have fallen on hard times that could recover, momentum plays where profits can keep on pushing the share price higher, possible takeover candidates or just shares that look very cheap. In 2013, investing in these kinds of shares paid off. But 2014 hasn’t been as kind as it became increasingly difficult to find opportunities.

My best suggestion was a small US company looking to build water pipelines in California called Cadiz Inc (Nasdaq: CDZI). I was intrigued by UK hedge fund manager Crispin Odey buying a big chunk of its shares and decided they were worth a punt.

So far this gamble has paid off. Cadiz shares could still go up a long way if its plans come to fruition, but as I said back in June there is a big risk of dilution from issues of new shares in the future. Take profits.

However, Mothercare (LSE: MTC) shares still look interesting after a fundraising of its own. The company has rebuffed a takeover approach this year and has a decent strategy for getting its troubled UK business back into the black.

It has tapped shareholders for fresh capital and this should ensure that it’s debt free, which lowers the risks of the business going forward.

The overseas business is very valuable and this is probably not reflected in the current share price. If the UK business can get back on an even keel then I think Mothercare shares are comfortably worth over 200p. Buy.

A bad year for oil stocks

Unfortunately, some of the gambles have gone spectacularly wrong. Smaller oil and gas companies whose values mainly hinge on them making big new discoveries have always been highly speculative investments. The recent plunge in the oil price has made matters worse for many of them.

However, if these types of company can avoid going bust then they could be a good – albeit a risky – punt on a rebounding oil price. Afren (LSE: AFR) has received a takeover approach whilst Tullow Oil (LSE: TLW) shares could also bounce. Both remain a risky buy.

The most disastrous pick of 2014 was IGas (LSE: IGAS), which aims to produce onshore gas in the UK through hydraulic fracturing (fracking). Fracking remains controversial and largely unproven in Britain, and this makes the shares very risky.

Matters have not been helped by a complicated transaction by the company’s chief executive, which made it look as if he was selling shares by the back door.

That said, IGas remains profitable as it continues to produce oil and gas from its existing fields. Around half its production is hedged until September 2015 at a price of $87 per barrel.

Recent drilling has gone well with 1,400 feet of shale gas found at Ellesmere Port. The coming year could bring better fortunes. Still a risky buy.

The best buys
Company Date Price then Price 19 Dec Change What we think now
Pepsico 28/02/2014 $78.22 $95.44 22.0% Hold
Friends Life 04/04/2014 300p 372.5p 24.2% Hold
Booker 12/09/2014 119.75p 157.25p 31.4% Take profits
BATS 17/01/2014 3,066p 3,500p 14.2% Hold
Home Retail 08/08/2014 166p 191.75p 15.5% Hold

 

The howlers
Company Date Price then Price 19 Dec Change What we think now
Morrisons 10/01/2014 263p 176.25p -33.0% Avoid
Rolls-Royce 24/01/2014 1,246p 864p -30.7% Buy
BHP Billiton 07/02/2014 1,768p 1,348p -23.8% Avoid
N.Brown 09/05/2014 460p 349.75p -24.0% Avoid
Standard Chartered 28/03/2014 1,206p 927p -23.1% Avoid

 

The gambles that paid off
Company Date Price then Price 19 Dec Change What we think now
Mothercare 23/5/2014 139p 172p 23.7% Buy
Cadiz 20/06/2014 $8.28 $11.49 38.8% Take profits
Dart Group 25/07/2014 208p 285p 36.9% Take profits
Ted Baker 01/08/2014 1,708p 2,220p 30.0% Take profits
Money
supermarket
13/06/2014 180p 216.6p 20.3% Take profits

 

The gambles that backfired
Company Date Price then Price 19 Dec Change What we think now
IGas 31/01/2014 134p 37.5p -72.0% Risky buy
Tullow Oil 07/02/2014 795p 424.25p -46.6% Risky buy
Netplay TV 08/08/2014 12.25p 7p -42.6% Risky buy
Afren 15/08/2014 96.25p 47.5p -50.6% Risky buy
De La Rue 04/04/2014 814p 518p -36.4% Avoid