Share Sleuth: beware allowing one factor to obscure the wider picture

Richard Beddard cautions against allowing one glaring issue to put the rest of the investment outlook in the shade.

This article was written in November for the December 2018 print edition of Money Observer. Market data and share prices are likely to have since changed.

FW Thorpe and Quartix, both profiled in December’s Share Watch column, expose a tension in my investing process, which I described in last month’s Share Sleuth column.

On one hand I believe there are significant risks in owning shares in these companies, and I should be cautious about recommending them.

In FW Thorpe’s case, demand for lighting systems may fall. The business has received a boost in recent years as manufacturers, logistics companies, shops, hospitals and local councils have rushed to install LED lighting, which provides better lighting at lower cost (over the lifetime of the lighting fixture) than outdated fluorescent systems. But the company believes the boost has peaked, and since lighting systems last a decade and more, some of the customers who might otherwise have replaced their lighting in coming years will already have done so.

At Quartix the risk is that something of long-term significance is putting the skids on growth. Two years of pedestrian performance by the company’s standards – the current year and the year to December 2017 – are not just growing pains as it builds scale in the USA.

On the other hand, my process stops me from letting one single factor outweigh the others. As I explained last month, I score each of five factors about a company independently. I seek businesses that are profitable, adaptable, resilient, equitable and cheap.

A graph entitled 'Trusting in proven performers' for the Share Sleuth portfolio

 

Impressive record

Neither company is obviously cheap, so they will have to perform well to be worth the asking price. But I really admire the managers of Quartix and FW Thorpe and believe they have the interests of shareholders, staff and customers at heart (they are equitable). Their historical records in terms of profitability and growth are very impressive (they are profitable). They have developed products that stand out from the crowd, and their strategies demonstrate that they are innovating to keep it that way (they are adaptable).

Of the four factors that relate to the quality of the businesses (as opposed to their market value), FW Thorpe and Quartix only fail to achieve a maximum score for resilience. Although I think their strategies address the risks they face, and I certainly couldn’t tell them what to do better, I am not as confident as I would like to be that they will prevail.

You may well ask why I am so even-handed. Surely sometimes one factor can outweigh the others if I feel strongly enough about it?

To explain why I compartmentalise things this way, let me ask you what you think of Alan and Ben after reading these two descriptions: Alan: intelligent, industrious, impulsive, critical, stubborn, envious; Ben: envious, stubborn, critical, impulsive, industrious, intelligent.

This is from a famous psychological experiment (the Asch Experiment). The two lists are identical, they are just presented in the opposite order. But if you are like me, you will have formed a more favourable impression of Alan than Ben, because you have been influenced by the biggest, most obvious trait, the first in this case. Psychologists call this the “Halo effect”.

My fears for the futures of these two companies, the threats to their resilience, loom largest, but even though sometimes my prejudices may be proved right, generally I think it is best not to let those fears cast a pall on the investment. I have a second reason for being wary about predicting the future: I don’t think I am any good at it. My modus operandi is to find good companies I trust, and let them worry about finding a way to prosper.

Three of the companies profiled in December’s Share Watch column are in the Share Sleuth portfolio. They are Alumasc, Renishaw and FW Thorpe. The fourth, Quartix, may be joining it soon. That would require me to expel a share, because Share Sleuth only has £816 in cash. The most likely candidate for expulsion is MS International, which has the lowest score in the portfolio.

 

A table of the Share Sleuth portfolio

 

Subscribe to Money Observer Magazine

Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.

Subscribe now

Add new comment