Three stocks with earnings that are set to power ahead
Professional investor Jamie Ward looks for cheap companies with sustainable earnings. Here, he picks three of his favourites.
A professional investor tells us where he'd put his money. This week: Jamie Ward of the CRUX UK fund highlights three favourites.
Our cautious approach means worrying about the downside much more than being excited by the upside; concerning ourselves with what might go wrong, not what could go right. It is about avoiding mistakes and letting the upside take care of itself.
To that end, when assessing potential investments we take a long-term view of businesses to understand better the risk we are taking. Aspects of this approach are straightforward. For example, we do not buy hugely indebted businesses.
A key determinant of an equity investor's success is the price paid for an investment, but using valuation alone is only half the job. There are many valuation metrics, ranging from the very simple price/earnings ratio (p/e) to the complex discounted cash flow (DCF) analysis. However, we contend that if a stock has a low p/e, it probably looks cheap on a DCF basis.
Are earnings sustainable?
Mistakes rarely result from a flawed technique for determining cheapness; more often, they occur from not anticipating changes in a business. Typically, this type of mistake occurs when buying a stock at its peak earnings, rather than buying when the price relative to those earnings looks too high. We focus on mature businesses that behave fairly predictably. This does not preclude cyclical firms, but it forces us to think deeply about earnings sustainability.
The following three businesses show how this thinking partly informs our decision. PZ Cussons (LSE: PZC) is a consumer-goods business that owns brands such as Imperial Leather and St Tropez brands that allow the business to generate a profit. It also generates a great deal of revenue in Nigeria. Consequently, its fortunes follow that of the Nigerian economy to some extent. Here, the economic environment has been tricky and so PZ Cussons's earnings seem depressed. Its shares offer a moderate rating attached to earnings that have scope to recover.
Precise and profitable
Renishaw (LSE: RSW) makes world-leading products in precision engineering. Its innovative technology allows it to extract a high and well-deserved return on invested capital. The principal metrology business (products range from machine-tool probes to mapping sensors), however, is plugged into the global capital-goods cycle and during periods of retrenchment, such as now, profitability declines. Nevertheless, these lower earnings are temporary. In addition, emergent business units within the group related to additive manufacturing and robotic surgery offer potential for new, highly profitable earnings streams. The valuation looks high, but the earnings are depressed compared with their potential.
Bank on Barclays
Finally, in Barclays (LSE: BARC) we have a business where the global financial crisis and the response to it created an environment that has depressed earnings for ten years. Today, however, we see signs that the decade-long balance-sheet repair is over, so the bank is once again perfectly capable of generating sustainable profits. Barclays is on a very low multiple of depressed earnings. The dividend yield alone ought to breach 5% this year and could increase by another third in the next couple of years.