Three stocks to buy for reliable returns

Each week, a professional investor tells us where he’d put his money. This week: Mark Whitehead of the Securities Trust of Scotland.

As an income-focused investor I need to have confidence in the sustainability of dividend payments. To gauge this I need to get a strong handle on cash-flow dynamics and how these relate to the structure and quality of the balance sheet. Rigorous credit analysis is integral to this, as any deterioration here tends to ripple through to payouts to shareholders. A detailed assessment of capital expenditure is also critical. Firms that cut back excessively here may be sacrificing future returns for short-term cash flow improvement, and thus jeopardising future growth to support dividend distributions.

As a starting point I look for those companies that can generate a strong and consistent return on invested capital (ROIC). Back tests show that companies with above-average ROIC typically outperform those with weaker return profiles. We also know that there is a strong statistical link between superior returns on invested capital and dividend growth. The following three companies illustrate the type of stable, yet growing, business profile we look for.

Airbus (Paris: AIR) is the manufacturer of the best next-generation fleet of civil aircraft, with attractive prospects in this expanding market. Global air traffic is forecast to grow at 4%-5% per year until 2034 and Airbus has secured more than 60% market share of next-generation narrow-body aircraft orders. It boasts a nine-year order backlog and strong financials, including a healthy dividend cover.

I believe that the market underestimates the potential of Airbus’s product portfolio to capture rapidly growing demand. The company’s improved ability to sustain that growth and its continuing improvements in operational efficiency is similarly undervalued in our view.

Swiss firm Givaudan (Zurich: GIVN) is a leader in the manufacturing of fragrances and flavours, capturing over one-quarter of this market globally. It has built a strong competitive “moat”, thanks to its market knowledge and unrivalled capabilities with regards to ingredient palettes and technology, and long-standing expertise when it comes to application and regulatory processes. This is reflected in a strong record of organic growth and attractive shareholder returns. Givaudan’s free cash flow is robust enough to maintain dividends even in a pessimistic scenario.

Logistics giant UPS (US: UPS) is another industry-leading business with sound fundamentals and bright prospects, building on a single integrated network and proven financial strength. It has been transforming its business model to seize on the growth in online retail, which is outpacing both US and global economic growth.

Business-to-consumer shipments continue to grow at a brisk clip, and now constitute nearly 50% of US domestic packages. We expect top-line growth to remain healthy and earnings and cash flow to grow over time.