A new top stock

The Decision Engine has a new algorithm and a new top stock.

Before I discuss the companies tracked by the Decision Engine that have revealed more about themselves over the last month, a brief word of warning. I'm in the process of changing the algorithm used to rank the shares. Dramatic re-rankings are unlikely, the changes are only modest, but the ranking may be more volatile than usual over the next month or two.

Since the Decision Engine identifies drivers of long-term performance, normally the rankings change very gradually. The shares in the top 20, therefore, remain investments to buy and hold, perhaps indefinitely.

I explained why I've changed the algorithm and how I've changed it earlier this month, but because I'm going to show you exactly how each company scores, here's a recap of the criteria and their definitions. Businesses should be:

1. Straightforward. It's apparent how the company makes money. The business model should be comprehensible, and the accounting should be clear.

2. Generating excess returns. Over a long period, preferably at least a decade, the business should have earned a return on capital not less than 8%, and more in most years. It should also be generating enough cash to fund present and future activities.

3. Resilient. The business should profit from activities that are likely to be relevant in future. Preferably it should do these activities in a distinctive way that is costly for others to copy, making its product or service especially valuable.

4. Managed for the long-term. Judge management by their actions and their incentives. They should invest steadily to grow and adapt the business. They should profit by making the company better, preferably through their ownership of shares.

5. Valued attractively. I use a much adjusted cousin of the price earnings ratio, an average earnings yield, to compare company valuations. An earnings yield of 10% or more scores two. Less than 4% scores zero. For earnings yields between 4% and 10%, the score rises with the yield from zero to two.

Castings

At its AGM, Castings, which manufactures vehicle parts for European truck manufacturers, warned that demand from major customers had 'softened' since it reported full-year results in June. Then, it already expected a temporary slow-down due the end of a major contract.

The company does not say whether uncertainty due to the UK's vote to leave the European Union is causing European customers to be more cautious about ordering from their UK supplier, saying it will take time to gauge the impact of the Brexit vote.

Since it's a well-managed business, a policy of riding out past challenges, the financial crisis in 2008 for example, has proved very profitable over the long-term.

However, the vote, which may make trading with European customers more difficult, and the possibility, however distant, of a wholesale switch to electric vehicles requiring different parts made from lighter materials*, could be substantial threats.

The AGM would have been a good opportunity to discuss these threats, but I was on holiday and unable to attend (for the second year running).

Despite these reservations about Castings resilience, whether its products will be in demand in the long-term future, it scores wells on most other factors:

XP Power

XP Power's half-year report, published at the end of July, is encouraging. The company, which manufactures power adapters for industrial, medical and electronic equipment, says its strategy is to move up the value chain. This is jargon for a process that should be as natural for businesses as it is for a plant to grow towards light.

The value chain is the activities that add value to a product or service; what the customer pays for, and what the firm profits from. Moving up the value chain simply means engaging in more valuable, profitable, activities.

When a company can articulate clearly how it's moving up the value chain, it's a good sign. XPP, which was originally a distributor, now designs and manufactures most of the adapters its sells, allowing it to develop products that are easy to design into its customers' equipment.

XPP says revenue lagged because it takes years for customers to design its products into their ownThe adapters save space, energy and installation time and are highly reliable, thereby adding value. A factory in Vietnam opened in 2014 and now producing complete adapters at lower cost than in China, improves the profit potential. Since it's more profitable as a manufacturer than it was as a distributor, the story, and the numbers match.

XPP says it has introduced a significant number of new products in the last three years, but because it takes years for customers to design them into their products, they have yet to earn much revenue. The implication is that they may do soon.

Citing record order intake, a strong backlog, and new contracts, it predicts growth.

Partly because valuation has less of an impact on the Decision Engine's rankings than it used to, and partly because the company meets all the other criteria for long-term investment, XPP has risen up the list into first place. A share price of £16.35 values the enterprise at £330 million, or about 16 times adjusted profit. The earnings yield is 6%.

Games Workshop confounds me, and, therefore, the Decision Engine. If you read my review of its annual report earlier this month, you'll probably understand why it ranks just outside the top 20. Here's its updated score based on the new algorithm:

Three other companies in and around the top 20 have published annual reports recently. They are: Cohort, Colefax, and Goodwin. I'm still in the process of assimilating the information into the Decision Engine and you can expect the results shortly. The scores may change again if I visit their AGMs, and of course the valuation scores shift automatically as the share prices do.

Here is the top 20 as it currently stands:

*For more on the potential threat of electric vehicles see this article. Since I wrote it, a correspondent has sent me a clipping about a Mercedes-Benz eTruck that can haul up to 26 tonnes for up to 200km on a single charge. The head of Daimler Trucks believes falling battery costs, and increased performance, means it will not be long before electric trucks for short-haul activities like bin lorries and grocery delivery, are economical.

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.