How you can find truly exciting manufacturing stocks

The London 2012 Olympic Games are nearly upon us. And after years of training, the athletes will be looking for every possible advantage in their preparation. They will wear the tightest lycra shorts, shave their body hair. They will eat and drink various combinations of legal substances priming the body for success. But for most athletes there is one thing you really need to get right – their footwear.

Today, athletes can have their running shoes designed to fit every contour of their feet and every idiosyncrasy of their running style. I’ve been researching this process and it is fascinating.

First, the athlete’s foot is scanned to capture and display its unique shape and structure. This scanned model is then sent to the laboratory where a 3D digital model is used to create a shoe that exactly fits the foot. This could be the difference between winning gold or silver for an Olympic athlete.

In fact, this technology is not just being used on athletes. According to Clive Martel, chief executive of Delcam, it won’t be long before we are all wearing custom-made shoes. And all because of a new technology that could utterly change manufacturing over the next few years.

The CAD technology revolutionised manufacturing

Clive is chief executive of one of the UK’s very best companies. This is not just my opinion. Decorating the lobby of Delcam’s offices in Birmingham are six framed Queen’s Awards – three for innovation and three for exports.

I thought this was impressive until I discovered that Renishaw (RSW) has no fewer than 14 Queen’s Awards. But there is a connection here. Renishaw holds 19.4% of Delcam’s shares and, as we toured the building, no shortage of Renishaw equipment was in evident use. As Clive described Delcam’s business the reason became apparent.

Delcam is a specialist in CAD/CAM technology. Short for ‘Computer Aided Design’ and ‘Computer Aided Manufacturing’, these have revolutionised the entire manufacturing chain over the last thirty years. Replacing draftsman and drawing boards, just about any object from a child’s toy to the tiniest aircraft widget is today likely to be designed on a computer.

The dimensions can be set to the exact standards, the image can be rotated and viewed from all sides, and the product can be fitted to other components on screen.

But this is only one step in the manufacturing chain. Take a step back and you can see the reason for Renishaw’s interest. In order to design a custom fitted shoe, you must first measure the foot. Highly accurate measurement is what has won Renishaw all of those Queen’s Awards – and made its shares such a favourite with private investors. So Delcam can take an object, measure its exact dimensions, and transfer these into a three dimensional on-screen image.

But again it does not end there. That image has got to be copied on the finished product, and that requires knowledge of materials and the manufacturing process.

Unlike it competitors, Delcam has a large workshop in which it can produce the very objects that it designs. This enables them to learn valuable lessons about the process and the materials, helping them to create close relationships with its customers.

The next big game changer in manufacturing

As Martell guided me through the premises, I saw Delcam’s engineers working on all sorts of things from highly complex parts for aircraft engines to dental implants.

The thing that really got me excited though was a 3D printer. I have read plenty about 3D printing, but never seen it in action. Manufacturing is typically done by the subtractive process. In other words you start with a block of wood, say, and chisel away at it until you have got a salad bowl.

That is fine except when you need to make something that has a void inside – a tennis ball for instance. For such things the typical method is to make two halves of the object and stick them together. By building an item from the bottom, depositing one layer upon another a complete item can be printed with as many void spaces as you like.

The particular application at Delcam was for jewellery. Intricate designs for rings and baubles had been submitted from computer images to 3D printers and the latter produced prototypes. Although 3D printing is in its infancy, and Martell thinks that it will be a while before we are printing our own jewellery in the garden shed, this is certainly part of the future of manufacturing.

The biggest lesson of my visit, was the integration between the imaging, design and the manufacturing process. Delcam’s CAD/CAM software is at the heart of this. With 35,000 customers worldwide Delcam is the world’s third largest player behind IBM, Dassault and Siemens and with just 6% of its revenues coming from the UK it is a truly global business.

The importance of “the invisible dividend”

Delcam has an enviable record of profitable growth, it is highly cash generative and crucially, it spends a quarter of its revenues on research and development. And that’s absolutely vital in this business.

In fact, my colleague Dr Mike Tubbs, bases his entire investment strategy on research and development (R&D). He calls it “the invisible dividend”. Because after decades of advising blue chip companies, he realised that it is this spending on R&D which often signals the greatest investments in everything from manufacturing to biotech to software. That’s how you find the real innovators. And that’s how you make big returns over time.

It’s an approach that has delivered serious returns for his Research Investments readers so far. He even stacks up against the world’s most successful investor, Warren Buffett. As he pointed out in a recent issue…

• In 2009, the Research Investments (RI) portfolio was up in value by 39.1% compared to Berkshire Hathaway’s share price up 2.7%. Berkshire’s book value, which is Buffett’s preferred performance method, was up 19.8%.

• In 2010, the RI portfolio was up 36.6% compared to Berkshire’s share price up 21.4%. Berkshire’s book value was up 13.0%.

• In 2011, the RI portfolio increased by 4.9% but Berkshire’s shares were down by -4.7%. Berkshire’s book value was up 4.6%.

Now, I’m sure that not all of Dr Tubbs’ tips have done well. A lot of his stocks are quite high risk. And past performance isn’t always a great guide of future success. It’s certainly been a tough year for picking stocks so far.

But you have to say it – that’s a pretty impressive performance.

Find out Dr Mike TubbsResearch Investments hottest stock picks.

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Dr Mike Tubbs’ Research Investments is issued by Fleet Street Publications Limited which is authorised and regulated by the Financial Services Authority. www.fsa.gov.uk/register/home.do (FSA No 115234). Managing Editor: Frank Hemsley. Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Past performance is not a reliable indicator of future results. Please seek independent financial advice if necessary. Fleet Street Publications Ltd 020 7633 3600.