Five shares for the watchlist

Each month Richard Beddard trawls through annual corporate results for his Watchlist and the Share Sleuth portfolio of companies that satisfy key valuation metrics such as earnings yield and return on capital - and profiles the most interesting candidates.

Add: Cohort

Defence technology company Cohort is growing more profitable despite the budget constraints of its main customer, the Ministry of Defence (MoD).

Almost half of revenue derived from the MoD is attributable to high-priority strategic programmesThe company is a collection of five businesses that focus on secure communication and information systems, cyber-security and electronic warfare. It manufactures and distributes products, and provides training, consultancy and expert staff.

In the year to April 2016, Cohort raised revenue 13% and profit 23%, helped by two acquisitions. Excluding the acquisitions, the company calculates that revenue increased by 5% and profit by 13%.

Perhaps its most significant recent acquisition, though, was a majority stake in Portuguese naval communications systems specialist EID, acquired after the year-end.

EID gives Cohort a base in the European Union and a new home country to export from, which may reduce its dependence on the MoD.

Cohort can respond to changes in defence priorities by adaptation and acquisitionsAlthough UK defence spending contracted for five straight years up to and including 2015, the government is committed to increasing spending over the next five years, and Cohort's expertise and products are in demand.

The company says almost half of the revenue it derives from the MoD is attributable to high-priority strategic programmes confirmed in the latest Strategic Defence Review.

Because of its technology focus, consultancy and research, Cohort is well-placed to respond to changes in defence priorities by adapting its existing businesses and acquiring new ones.

A share price of 320p values Cohort at £125 million, about 12 times adjusted profit. The earnings yield is 8%.

Add: Colefax

In the year to April 2016, luxury wallpaper and fabric designer Colefax experienced a reversal of fortunes. A good first half-year followed by a poor second half resulted in a very average year. Average is good enough, though.

Colefax achieved a return on capital of 10%. Typically, accounting profit was closely matched by cash flow, which suggests the returns are real and not dependent on accounting judgements that may or may not be justified.

Since 81% of revenue from fabric is earned abroad, sterling's slump is a boonWhen luxury homes are changing hands they need decorating, and customers spend more decorating a new house than refurbishing an old one, so Colefax's fortunes wax and wane with the mansion market.

In 2016, the company says, uncertainty about the US election, higher stamp duty in the UK and the weak European economy all suppressed demand. Over the whole financial year, profit - up 13% at the half-year - rose just 2% and revenues were flat.

Colefax also sells antiques, manufactures furniture and decorates luxury homes, but its fabric division, comprising five famous wallpaper and fabric brands, earned 87% of revenue in 2016 and most of the profit too.

Since 81% of revenue from fabric is earned abroad, principally in the US, the devaluation of sterling following the UK's vote to leave the EU should make sales in foreign countries more valuable when converted back into the home currency.

Colefax won't receive much of the benefit for a while, however, as it hedges its revenue in dollars, protecting itself against any losses due to the appreciation of sterling but forswearing the benefit of depreciation in its value.

Colefax is a stalwart, consistently profitable in cash and accounting termsColefax refreshes its designs every year, and distributes worldwide mostly through agents, outsourcing manufacturing to over 100 suppliers.

It's subtly shifting strategy by opening its own showrooms in Boston and Atlanta (it already has showrooms in London), and seeking more business in the Middle East, Australia, Russia and China.

With firmly established brands and conservative management, Colefax is a stalwart, consistently profitable in cash and accounting terms. A share price of 456p values the enterprise at about £70 million or 14 times adjusted profit. The earnings yield is 7%.

Add: Dart

Dart almost doubled profit in the year to March 2016. Revenue increased 12%.

The company earns most of its revenue and profit from leisure airline Jet2.com, which flies to holiday locations; its rapidly growing integrated package holiday business, Jet2holidays, helped Dart earn a 20% return on capital, a record by some margin for the past decade.

Rising revenues and growing profitability confirm Jet2holidays is flourishingReturn on capital has averaged a respectable 12%, backed by strong cash flows.

Dart says it's more profitable selling complete packages, often including rooms, transfers, meals, drinks and even lollipops for the kids. The more package holiday customers it flies, the better. In 2016, the mix shifted decisively.

The company is currently accumulating significant debt, borrowing to refresh and grow its fleetJet2holidays took 22% more people on package holidays than it did the previous year, representing 40% of the total number of customers flying with Jet2.com, compared to 33% previously.

Rising revenues and growing profitability confirm that Jet2holidays, a start-up 10 years ago, is flourishing.

The package holiday business may seem like a throwback to the previous century, but Dart says that in straitened times customers like to know in advance exactly how much a holiday will cost.

Investors should be cautious about this year's bumper profits. Jet fuel prices are low (Dart saved over £23 million in 2016, compared to 2015); moreover, Dart raised prices, earned more selling passengers stuff, and flew fuller planes.

The company is currently accumulating significant debt, borrowing to refresh and grow its fleetJust about every key metric moved in the right direction, which won't always be the case. Fowler-Welch, Dart's grocery distribution business, also performed well.

The company is currently accumulating significant debt, borrowing to refresh and grow its fleet. Nevertheless, the company could be good value.

A share price of 470p values the enterprise at £812 million or nine times adjusted profit. The earnings yield is 12%. A more cautious valuation using its average return on capital implies a 7% earnings yield.

Watch: Games Workshop

On the face of it, Games Workshop's results for the year to May 2016 don't look too bad, but uncertainty lurks behind the headline figures.

Revenue fell 1%, but adjusted profit grew 11%. The company still has no debt and return on capital was 15%, which is above average for Games Workshop. Examine the profit figure more closely, though, and it's a bit shaky.

Games Workshop sells fantasy miniatures, models of the creatures and objects that inhabit the Warhammer Universe it has popularised in war games and books.

Profit from that part of the business fell 27%, only to be rescued by income for royalty payments: Games Workshops licences its characters and mythology to computer games designers.

The company hasn't convincingly raised revenue since a dramatic expansion in the 1990sThe problem with royalty income is that it's volatile, and the inability of Games Workshop to increase revenue from its core business, selling models, may suggest the hobby is declining in popularity.

The company hasn't convincingly raised revenue since a sustained and dramatic period of expansion in the 1990s.

Management's strategy, increasing prices and cutting costs, has succeeded in maintaining profitability at attractive levels - but as revenue has not increased but prices have, Games Workshop is probably losing customers, bringing into question its growth credentials.

A share price of 535p values the enterprise at about £220 million, 14 times adjusted profit. The earnings yield is 7%.

Though that's not a particularly demanding valuation, it includes the bumper profit from royalties, so perhaps shareholders should be cautious.

Watch: Goodwin

Goodwin is busy diversifying, as revenues from the manufacture of valves used to control the flow of oil in pipelines, tankers and refineries dry up.

The company's performance was not impressive in comparison to previous years, when oil prices were high and driving investment in infrastructure by oil companies, but Goodwin remained profitable in the year ending April 2016.

We now know what Goodwin looks like when orders for its patented valves are fewer and won on tighter margins. Revenue has fallen 3% to its lowest since 2012, and profit is down 36%.

Goodwin doesn't predict an upturn in the oil industry; instead it plans to speed up diversificationThe company's borrowings are rising too, as it invests and extends more credit to customers. Return on capital was 10%, half the average since 2007.

Revenue from oil companies and related industries has shrunk from about 45% two years ago to 38.5% in 2016.

Out of necessity, Goodwin International, the casting and machining business that makes valves, is seeking new business in the power, defence and construction industries, while the company is expanding its refractory engineering division, which supplies powders and moulds for casting jewellery and tyres, and minerals for heat-resisting applications including fire extinguishers, insulation and paint.

In its annual report Goodwin does not predict an upturn in the oil industry; instead, it is planning to speed up its diversification.

A share price of £21.50 values the enterprise at £187 million or 18 times adjusted profit. The earnings yield is 6%. If profitability returns to former levels, the valuation is more compelling.

Assuming an average return on capital of 20%, the earnings yield is 11%.

This article was originally published by our sister magazine Money Observer here

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.