Ten long-term holds for an ISA portfolio: Part 1
Part 1: The first five...
It's the ISA season. As the tax year draws to a close on 5 April, people with money and uninvested ISA allowances are thinking about what they might invest in before their annual £15,240 allowance expires*. Those who are more organised may be positioning themselves for another year of tax-free investing starting on April 6.
My speciality is selecting shares in established businesses that should prosper for the long-term by picking those that are best set for the future. I do that by answering five questions: Has the company been highly profitable? Is the business resilient and adaptable? Are its managers committed for the long-term? Is the share price low enough to promise a decent return? And do I understand the business well enough to be confident in the preceding four answers?
I funnel my answers into an algorithm I've dubbed the Decision Engine, and it tells me, on balance, which are the best candidates. The following ten-stock portfolio is picked from among the shares ranked most highly by this process.
Buying a share in a fit of enthusiasm because it's doing well, or it's been recommended by a pundit or a mate is one thing. It's quite another thing to hold on to the share through thick and thin.
You really need to know a company well if you are to avoid getting the jitters and selling out prematurely because its performance falters temporarily. You also need to know a company well to judge when things have gone so badly wrong it's no longer likely to be a good long-term investment. I hope to tell you enough about these companies that you think it may well be worth getting to know them better. Most importantly, I'll acquaint you with the risks, because the risks are what we must live with.
All of these companies have profitable pasts, all of them are in good financial shape, and all of them are managed by executives who have made them successful, or continued their success.
Dewhurst (DWHT) (660p)
The push button and lift component manufacturer has been in my lists of dependables for almost as long as I have been making them. It pioneered the design of robust vandal resistant pushbuttons, and to this day its superior pushbuttons reduce maintenance costs.
It's important not to be complacent though. Pushbuttons are being replaced in some lifts and ATMs by LCD displays, a development that has required Dewhurst to diversify. Now it produces a much wider range of components, including hall lanterns and whole lift control panel assemblies, often using bought in components including displays.
The shift from its historical niche has come at a cost. Dewhurst is less profitable than it was, although it's still highly profitable and, barring the odd setback, still growing.
XP Power (XPP) (£18.93)
I wish all investments were as straightforward as XP Power. The company used to be a distributor of power adapters for medical and industrial equipment installed in operating theatres and on production lines, but it decided it would be more profitable to manufacture as well.
Ten years on and the decision has been vindicated. The company's global network of sales offices mean XPP understands what its customers want, reliability and efficiency mainly, and its low-cost manufacturing capability allows it to meet those expectations.
Though profitability has improved significantly, because the adapters are installed in expensive machinery, profits are susceptible to fluctuations in demand as manufacturers adjust their capital spending.
Castings (CGS) (448p)
Castings is quite a contrarian pick. It's the biggest foundry in the UK, casting and machining ductile iron castings, primarily components bound for European truck manufacturers. Though it lost some business to low cost producers in China early in the last decade, it's a bigger more profitable company now due to the high levels of service it provides.
Revenue and profit are susceptible though, not just to economic growth and contraction, but also new European emission regulations which cause a run up in demand before they come into force, and a softening subsequently.
Castings, which earns 64% of revenue abroad, mostly in Europe, ought to benefit from the weak pound, while the UK is still in the EU, but after that it's dependent on new and yet to be negotiated terms of trade. The more distant probability that electric vehicles requiring fewer lighter components will one day replace diesels may also prove challenging. Castings adapted to globalisation and thrived, though, so perhaps it will meet these new challenges.
Colefax (CFX) (485p)
Colefax designs costly wallpaper and fabric, outsourcing manufacturing to over fifty suppliers. The brands, particularly Colefax & Fowler, are famous among the firm's wealthy clientele and encompass both the traditional English country house style and more modern designs, which gives it some protection against changes in fashion.
People are more likely to decorate when they buy another mansion, so Colefax is susceptible to movements in the high-end property market, which is cooling in London. Its biggest market is the USA though, so once again diversification helps.
The company may not actually print the wallpaper, it outsources production to a large number of contract manufacturers, but under the conservative management of David Green, it's become a money printing machine. Rather than risking the brand's cachet by spinning off derivative products into mass markets or building an empire by acquiring other brands, Colefax has chosen to return great globs of cash to shareholders by buying back shares.
While this is an example of good capital allocation, the board is also adept at directing capital to executives in the form of bumper salaries, which exceed those of the other companies in this selection, even though Colefax is a relatively small company. While I'm as averse as the next shareholder to largesse, at least Colefax is transparent. The money is not hidden in complicated incentive plans, it's in plain sight.
FW Thorpe (TFW) (313p)
FW Thorpe has been making hay as the lighting market switches from incandescent lighting to LED. Its biggest brand by far, Thorlux, lights industrial, commercial, and public buildings like schools and hospitals. Other brands target exterior lighting for roads and tunnels, and signage.
Though riding a boom may not seem especially meritorious, it's not been without challenges, principally retooling for the new technology and the expense of maintaining two product ranges while its customers migrate. While the costs have dented profitability slightly, the company is still highly profitable, and there remains the prospect of improvement as Thorpe retires incandescent products.
Thorpe manufactures the optics, controls and physical fixtures, but not the LED bulbs, so the increased lifespan of LED lamps, one of the advantages of LED lighting systems, is not necessarily a problem for Thorpe. While demand for the lamps will drop off when most properties are equipped with them, Thorpe expects LED fixtures to last ten years, much like incandescent ones.
Perhaps the biggest risk facing investors in Thorpe is its share price. Of the five companies listed here, the shares are the most expensive compared to the company's recent annual profit.
Next week: The final five.
*The allowance is £20,000 next year.
Contact Richard Beddard by email: [email protected] 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.