Eighteen shares for the future

One feature that may not be apparent from what I allow myself to believe is a polished exterior is that the Decision Engine is a work in progress.

The giant spreadsheet is getting bigger all the time, as I add new companies to it. Each company is ranked using an ad-hoc formula that calculates the market's valuation and incorporates my level of confidence in the business.

It should also be improving, as I add data about each company and as I learn more about what makes them special*.

The special qualities I'm looking for will rarely pay off spectacularly or predictably over the next few months or years, they're advantages that should enable a business to profit more than adequately for many years.

Buying and holding shares near the top of the ranking should be profitable over the long-term, especially if they are bought at the kind of market valuations deserved by more humdrum businesses.

These are the highest ranked shares of the 54 currently tracked in the Decision Engine:

Three companies appear for the first time: InterContinental Hotels, Wynnstay and XP Power.

None of them are obviously cheap. Wynnstay's earnings yield is 7%, which is another way of saying that investors might expect an average return of 7% if the company earns similar levels of profit in future. InterContinental and XP Power have earnings yields of 6%. If these companies grow profitably though, they will be more profitable investments.

Wynnstay's principal advantage is scale. Once a farmers' cooperative, the company has grown out of its Welsh heartland and processes, distributes and retails animal feed, seeds, grain and fertiliser in adjoining parts of England too. Scale should enable Wynnstay to negotiate low prices from raw material suppliers, for example, and enables it to operate across all agricultural sectors, arable, dairy, and meat (as well as a chain of pet shops). Diversification protects it from the many uncertainties of farming, including blight and the weather.

InterContinental owns famous brands, which include InterContinental, Crowne Plaza, and Holiday Inn. The company, which originated in Bass, the brewery, has long since shed its pubs and restaurants. The most recent stage of its evolution has been to shed the hotels. It may seem an odd move from a hotel company, but it now sells services: the brands, training, and management to franchisees and hotel owners. The new business model has transformed profitability, perhaps by hiving off the most profitable part of the business and focusing on its development.

XP Power is slightly more difficult to pin an advantage on. It manufactures power adaptors. The adapters are built into the design of machinery used in industry, requiring XP to develop close relationships with machine manufacturers. This decade, XP is much more profitable than it was in the previous one, probably because of a decision more than a decade ago to develop and manufacture adapters, rather than distribute them. Perhaps, now it has more control of design, XP is supplying a better product.

This month I attended the Annual General Meetings of Victrex, ITE, and Dewhurst. Victrex and Dewhurst are highly ranked by the Decision Engine, but ITE is borderline and the meeting confirmed that its main form of funding, advanced bookings for Russian and Central Asian trade shows is contracting, due to recession in those countries and the declining value of their currencies.

Rolls-Royce is also borderline. It has slipped out of the list of companies currently favoured by the Decision Engine due to a bounce in share price after the publication of its full-year results. The company, which has tremendous engineering expertise and operates a virtual duopoly with GE supplying wide-body jet engines, is going through a difficult period as it phases out old engines in favour of new ones. While profits from its Marine business might have helped Rolls-Royce through, they've collapsed because Marine supplies the offshore oil and gas industry. Although new chief executive Warren East appears to be stabilising the business, its accounting is so complicated backing Rolls-Royce at this stage is a triumph of faith in the reputation of the firm over uncertainty about the numbers. Caught between a rock and hard place, the Decision Engine is prevaricating.

On Thursday, Science, formerly Sagentia, the Cambridge based research and development consultancy published full-year results. I have yet to write them up, but have incorporated the results into the Decision Engine. Although Science has written off some of the goodwill attributed to OTM, an oil and gas technology consultancy it acquired a few years ago, and Leatherhead Food Research, which it acquired last year, lost money (as anticipated), I don't think these hiccoughs undermine what is still a very profitable business. It's earnings yield is 8% and the shares are probably good value.

Microprocessor designer ARM, newly included in the Decision Engine and also based in Cambridge, is at the other end of the scale. The business is even more attractive, but the earnings yield of 2% probably isn't.

As an investor with his sights set on the long-term, a few weeks ago I set out to find out what it might be like. Three years ago Kerry Balenthiran published a book mapping out the market for a little more than the next three decades. I caught up with him to find out whether his first predictions came true, and he still thinks the future will play out according to his theory.

*And because users point out errors, for which I remain forever grateful. If you'd like online access to the Decision Engine, so you can make your own copy or simply see it in all its glory email me: richard.beddard@iii.co.uk.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.