Somero: trading this overlooked bargain

Mechanical-screed maker Somero dominates its niche and is attractively valued. Matthew Partridge picks the best way to trade it.

939_MW_P34_trading

Somero's products flatten the competition

Mechanical-screed maker Somero dominates its niche and is attractively valued.

Construction is hardly the most glamorous of industries. Not only is demand vulnerable to shifts in the economic cycle and levels of government spending on infrastructure, but intense competition keeps both margins and returns on capital low. Building is also perceived as a relatively low-technology industry, with basic techniques unchanged over decades. However, within the broader industry, many firms have been able to carve out profitable and fast-growing niches. One of these is Aim-listed Somero Enterprises (Aim: SOM).

Somero specialises in producing mechanical screeds. These are used during the pouring of concrete to ensure it is smooth and consistent.

A very basic version of a screed would be a simple board. However, the type of screeds that Somero produces are industrial-sized machines that use lasers to ensure the concrete is even to a very high degree of accuracy. After all, if you're building a large structure, such as a warehouse, shopping centre or car park, even small differences in the thickness of floors can create problems. As a result, a wide range of large retailing and manufacturing companies, such as Walmart, IKEA, Amazon, Mercedes-Benz and Tesla use Somero machines.

The quality of its products has ensured that Somero is regarded as a market leader in its sub-field, enabling it to enjoy a high rate of growth over the years. Its sales have doubled over the past five years and nearly quintupled over the last seven. What's more, its dominant market position in the United States has allowed it to combine this growth with returns on capital of around 35%-40%. This means that it has still been able to pay around 40% of its profits in dividends, which have grown tenfold over the past five years. Of course, the big question is whether this growth can continue. Somero's management, which recently unveiled growth of more than 9% last year, is confident it will, and is predicting this coming year will be its best ever.

What makes Somero so enticing is that despite the shares rising by 10% over the past few weeks, it still remains under-appreciated by the wider market, trading at only 12.4 times this year's earnings (and 11.9 times 2020 earnings), with an attractive dividend yield of 3.7%. This is the sort of valuation level that you would associate with a company that is struggling or at best muddling along rather than growing strongly. With Somero's stock price currently above both the 50- and 100-day moving averages, I'm therefore advising you to go long immediately at the current level of 390p; bet £9.50 per 1p (compared with the IG Index minimum of £1 per 1p). I'd also suggest you put a stop-loss at 290p. If you follow this advice, it will give you a total downside of £950.

Trading techniques: following insiders

Because they may have legitimate reasons for buying and selling shares (such as the need to raise cash to pay bills, or a desire to diversify their investments), they are allowed to sell their shares at certain times. However, even then they are still required to report these trades to the authorities (who display them on their websites).

Some traders believe that you should pay attention to their trades. After all, if an executive or director is willing to put their money into their company, they are, in effect, giving it a vote of confidence and backing it up with hard cash. Similarly, if the executive is selling their shares, it could mean they are not confident that it is a good investment. For example, right before Enron's demise its executives were dumping their shareholdings at exactly the same time they were encouraging the workforce to put their pension money and life savings into the stock.

Some studies suggest that insider transactions do indeed provide clues about where a company's stock is going. For example, a 2011 US study by Weimin Wang, Yong-Chul Shin and Bill B Francis, looking at insider transactions between 1992 and 2002, found that the combined stock purchases of chief executives and chief financial officers beat the market by an average of 4.2% over the following year.

How my tips have fared

Greene King has risen from 662p to 673p, Cineworld has gone from 284p to 297p, John Laing Group has climbed from 385p to 391p, JD Sports now costs 495p (from 481p), while Bellway is 3,104p (from 3,065p).

The only two that fell were Hays, which declined 1p to 155p, and Safestore (down from 610p to 593p). I'm currently making a net profit of £2,787 on my long positions.

My short positions have had a more mixed performance, with three rising, three falling and one staying the same. Bitcoin appreciated to $3,970 (from $3,722), Twitter rose to $31.08 (from $30.50) while Snap also increased to $10.94 (from $9.92).

However, Just Eat slipped from 769p to 735p, Weis fell from $46.59 to $40.93 and Tesla went from $285 to $269.49. Rightmove is currently at 500p, exactly the same price as a fortnight ago.

Overall, the net profits on my short positions have actually risen to £1,785, mainly thanks to the strong performance of Weis.

Altogether, my 14 tips are making a combined profit of £4,572. Clearly, this has to be offset against the losses on the closed positions of £3,255, but it does show that, after a disappointing 2018, I seem to be doing much better.

Since 15 positions is too many, I'm now going to suggest that you close the short position in Snap, which we tipped six months ago, taking a loss of £109. I also recommend that you increase the stop-loss on Greene King (which we tipped nearly a year ago) to 600p.

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