20 shares for the future

Every year, every company tracked by the Decision Engine is re-evaluated, and its rankings adjusted to reveal good long-term investments.

Scrutinising preliminary results is the first of a two or usually three stage annual evaluation of the firms tracked by the Decision Engine. I feed in new data, profit and cash flow earned in the recently concluded financial year, borrowings at the year end and other figures into the spreadsheet and they affect the firm's valuation and, perhaps, its ranking.

In most cases, prelims omit some of the financial data required to complete the Decision Engine's calculations, though, so it uses estimates until the data is confirmed by the more comprehensive annual report.

This month four of the 60 companies tracked by the Decision Engine published preliminary results. One of them, Castings, features in the Top 20, and one of them, MS International, used to.

At Castings, revenue rose by 1% and profit by 10%. Cash flow improved dramatically. The company's cash pile is so tall it's returning some to shareholders as a special dividend. I don't think the market recognises how successful this company is, probably because it casts and machines parts for vans, hardly a glamorous business, and growth comes in fits and starts, aided or hindered by economic conditions and European regulation. It's earned an average return on capital of 17% over the last ten years, though, which is the kind of figure more fashionable companies should envy.

The company is circumspect about the outlook for the new financial year because CNC Speedwell, Castings' machining business, finished a major contract at the end of the year and it has yet to replace the work. Long-term investors have learned to ignore the occasional step backwards or sideways at Castings, though, to profit from the many steps forwards.

Disappointing for three years

For the third year running, MS International announced disappointing figures. Revenue was 13% higher and profit 7% higher than in the previous financial year, but in 2015 and 2014 MSI's performance had deteriorated sharply due to contractions in defence spending (it makes naval gun systems). Now MSI reports recession in the quarrying, agricultural and construction markets it supplies with fork-arms (for forklift trucks and other heavy equipment) and although there's been an increase in orders for petrol station canopies and other forecourt infrastructure since the year-end in April, these were largely deferred from before the year-end.

Just as in 2015, MS International only achieved a 7% return on capital in the year to April 2016, below the 8% minimum I use as a rule of thumb to identify stable businesses. The number is imprecise, but it leaves me questioning whether the Decision Engine ought to be tracking MS International at all.

Trifast, which manufactures screws, rivets and other industrial fasteners, and Vp, which hires out plant and machinery, also announced preliminary results. Both companies are performing well, as they have been for many years, a factor that may explain their less attractive valuations and rankings just outside the Top 20.

Traders forget that the word 'preliminary' indicates something that comes before something else. Preliminary results quickly inform traders and investors how a company has performed over its recently concluded financial year, but there is more information to come.

When the annual report is published, sometimes months later, the headlines, how much revenue or profit has changed for example, are old news, so it's easily ignored by the media and the majority of investors. This, I think, is a big mistake as annual reports often contain much more information about how a company makes money, what it's doing to make more, and if the company is unusually forthcoming, what might stop it.

Air Partner's annual report, which I wrote about last week, is a good example. It explains that air charter brokers do more than negotiate deals between plane operators and people who want to fly, and claims specialist skills that give it a competitive advantage. But there's a discordant note in Air Partner's strategic symphony. The company is diversifying, perhaps partly in response to the development of businesses that use technology on websites to bring operators and clients together without the need for a broker. The broking business may face a new competitive threat.

Next improving

I have also been busy feeding in conclusions reached after scrutinising Next's annual report. The dramatic growth of Next's catalogue business, Next Directory, seems to be slowing as customers shift to Internet shopping. The revelation in the annual report that Next has been slow to develop websites for mobile devices raises questions about the future of one of the most profitable and stable retailers. However, the performance of its new mobile sites is improving, and the company is spending more on online marketing.

I assess the risks and feed this 'soft', non numerical information, into a checklist designed to verify that a company is highly profitable and likely to remain so. The company receives a score depending on the number of checklist criteria it meets, which is added to a score derived from its market valuation. The shares are then ranked by this combined score.

Next just about makes it into the Top 20. Air Partner, despite a very attractive looking valuation, just misses out.

That may change when I attend the Air Partner Annual General Meeting later this month. AGMs are a good opportunity to quiz management about the challenges they face, the third stage in the annual evaluation.

I am very close to adding two new companies to the Decision Engine. Both are in the food distribution business. Hilton Foods processes and packs meat for supermarkets (primarily Tesco and Ahold), and Booker wholesales food to convenience stores and caterers. So far, both tick all the boxes in my checklist except perhaps valuation. They look like profitable, self funding, resilient businesses and you're likely to hear more about them in future Decision Engine updates.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard

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.