UK equities have had a healthy bounce in the past month with the FTSE 100 index advancing 7.6% and the FTSE 250 rallying 16% since 12 October.
The reasons for the sudden about-turn are two-fold – the normalisation of UK government bond yields after they spiked following the political upheaval of the summer and disastrous mini-Budget in September, and generally better-than-expected corporate earnings.
From a low of 2% in August 10-year UK government bond yields jumped to almost 4.5% in mid-October as investors panicked over unfunded tax cuts and the strain on UK finances.
Since then, yields have dropped back to 3.3%, triggering a rally in shares and in particular risky stocks.
At the same time, while there have been one or two calamities, on the whole company updates over the last month have generally been in line with or slightly better than expectations suggesting UK plc is doing alright.
Look how the FTSE 250 picked up as gilt yields retreated
Weaker than expected US inflation figures have also helped to drive share prices higher around the world.
Big FTSE 100 companies have benefited from overseas demand together with a tailwind from the strength of the dollar, while smaller FTSE 250 companies which mostly sell into their home market have shown they are coping reasonably well with a slowing UK economy.
UK stocks are relatively cheap compared with other markets, and many bombed-out stocks have rallied hard but could just as easily fall back again.
Now is the time to look for opportunities to buy good quality companies, with strong fundamentals, at a discount.
Stable or upgraded earnings revisions
A lot of companies have just reported their latest results or updated on trading which has given analysts the important information needed to revise their earnings estimates. Investors should look for stocks where earnings estimates are stable or, even better, been revised upwards.
Analysts will have already factored in a more difficult environment for companies and so those which are holding up well or doing better than expected will be the ones catching investors’ attention.
Remember that over the longer term, earnings drive share prices so you want to avoid those where earnings expectations are in decline.
Here are three stocks from the list of companies with upgrades to earnings forecasts over the past month, according to data from Stockopedia.
DR. MARTENS (DOCS) 273.8p BUY
Iconic British footwear brand Dr. Martens has seen its shares gain 25% over the past month while analysts have increased their earnings expectations by 5%.
Shares believes the strength of the brand and its inherent pricing power leaves the business well positioned to continue its growth path despite the tough economy, supporting further share price gains.
A comprehensive brand study conducted by the company earlier in the year showed ‘that our brand is stronger than ever, with significant growth in awareness, familiarity and recent purchase’.
In a July trading update the company said it had successfully pushed up prices to offset inflation, seen third-party factories return to higher capacity levels after Covid disruption and enjoyed improved shipping lead times.
Dr. Martens maintained full-year guidance to 31 March 2023 for revenues to increase by a mid-teen percentage. Analysts seem more bullish, with the consensus being a 19% increase to £1.08 billion.
In the medium-term Dr. Martens expects the proportion of e-commerce sales to reach 40% of total sales and to achieve a 30% group EBITDA (earnings before interest, tax, depreciation and amortisation) margin.
The company anticipates opening 25 to 35 new stores a year in the medium-term as it strives to exploit the brand’s global potential.
WH SMITH (SMWH) £13.66 BUY
The resumption of its dividend, guidance that the North American travel operations are about to become more profitable than its UK high street stores, and progress with various digital initiatives show WH Smith is no longer a stuffy old-fashioned retailer.
Many people view it as one of the last men standing on the tired UK high street, but what they miss is how these shops are cash cows. They provide a solid backbone to the business, allowing the company to be quite aggressive with its expansion plans in the travel arm which includes shops in airports and train stations.
The latest results were solid, and management was upbeat about the future. It is doing well in the UK, US and Australia and there is good reason to suggest its overseas fortunes could be even better as the travel market continues to reopen.
While the shares have been moving higher in recent weeks, they are still down 13% year-to-date. That presents investors with a great opportunity to buy a decent business at an undemanding rating. The shares trade on 16.5 times forecast earnings for the year to August 2023.
Disruption to its travel arm during the pandemic means the past few years’ profits and returns on investment look unattractive. It’s better to look back pre-Covid to see how WH Smith generated returns on capital employed above 50%. Put simply, the money invested in expanding its business has generated very strong returns.
HALFORDS (HFD) 207.33p BUY
Motor accessories and push bikes seller Halfords has perked up on the stock market since September thanks to a combination of factors.
A cheap valuation and attractive dividend yield caught the attention of value investors. No change to earnings guidance in a 7 September update was a relief to the market, and the acquisition on 5 October of a motoring services business went down well with investors.
Halfords has a strategy to derive more revenue from motoring services, saying they provide more resilient, needs-based revenue streams. While the boom in cycle sales during the pandemic was short-lived, investors can have a lot more confidence in the motoring accessories and services part of Halfords.
No matter the state of the economy, people will need their cars fixed. If anything, they’ve probably more willing to keep an existing motor running than buy a new one if we’re heading into a recession. Also, there isn’t the risk that people put off such spending as you can’t delay an MOT.
Halfords is by no means a perfect company – there is scope to greatly improve efficiency and have more joined-up systems. Yet investors are being given the chance to invest at a depressed valuation, with the stock trading on 7.5 times forecast earnings for the financial year ending April 2024. The risk/reward is in investors’ favour at this price.
Stocks that offer good dividend growth or a UK base rate-beating dividend yield
Even though UK rates are expected to hit or exceed 4% next year, investors can still find plenty of options among stocks and shares that offer higher yields.
The trick is to look for companies which can afford to pay good dividends well covered by earnings and where they’ve reported resilient trading, so the market won’t start to worry about the sustainability of the dividend.
We’ve looked for more robust dividend stocks where there has been some recent good news, signs of healthy trading and where the valuation is attractive.
SMITHS NEWS (SNWS) 43.1p
Business has picked up sharply for the distributor of newspapers and magazines as the economy has reopened, with sales at rail stations and airports seeing a particularly strong recovery.
Revenues, profits and cash generation are ahead of forecasts while the firm has paid down its debt significantly, freeing up cash for a big final dividend which puts the shares on a yield of 10%.
Contracts for over a third of revenues have been renewed to 2029, providing a good degree of visibility, and discussions will start in the next year or so on the firm’s remaining contracts, so the good news should continue.
DS SMITH (SMDS) 314.3p
Packaging firm DS Smith has demonstrated the quality and resilience of its business in spades of late.
It’s no surprise in this context that investors have recently snapped up the shares. Even after a 17% return in the past month the stock still trades on just 8.7 times 2024 consensus forecast earnings per share. It offers a 5% dividend yield.
During the pandemic DS Smith and its peers were in big demand as an acceleration in the e-commerce trend drove demand for cardboard boxes. They were also popular with fashionable funds focused on ESG (environmental, social, governance) factors thanks to their commitment to recycling.
Sentiment then weakened as attention turned to the sector’s exposure to a deteriorating economic picture and exposure to inflationary pressures.
However, while a 10 October trading update did reveal a slight drop in volumes DS Smith pointed to full-year performance ahead of expectations as it demonstrated pricing power and a good handle on costs.
It would be wrong to suggest there are no risks to the outlook – including news of potential strike action around pay by members of the GMB union working at the business. However, these look more than reflected in the current valuation and investors happy with the risks should take advantage and buy the shares.
UP GLOBAL SOURCING (UPGS) 143.5p
The kitchenware and homeware maker is going from strength to strength with its expanding portfolio of familiar household brands and new products.
Sales are split between UK supermarkets, international markets and online, all of which are growing between 20% and 30%, and the firm has its finger on the pulse as shown by the runaway success of energy-saving products such as slow cookers and air fryers.
By investing in automation to improve productivity and product quality the firm is adding value to its offering and building yet another moat around its business, separating it from competitors. An approximate 5% dividend yield is attractive.
Stocks that have gone up without positive earnings revisions
It’s easy to get excited about UK stocks going up and assume it’s all based on good news. However, there are quite a few stocks that have moved higher over the past month despite having their earnings forecasts downgraded in the same period.
In such situations, shares might struggle to stay higher unless they were supported by positive fundamentals. The risk is that such stocks would soon fall back in the absence of good news. Here are two relevant stocks to avoid.
RESTAURANT GROUP (RTN) 36.48p
Frankie and Benny’s and Wagamama owner Restaurant Group has seen its shares jump 14% over the last month although year-to-date they have lost around two-thirds of their value.
Restaurant Group has done a good job of mitigating increased costs, having hedged its utility costs out to fiscal 2024. In addition, the firm has reduced interest rate exposure by arranging a cap on £125 million of gross debt from November 2022.
Despite the business showing resilience with like-for-like sales growth ahead of the market, the pressure on households’ budgets and consumer spending is likely to intensify. That raises the risk that families will switch from a trip to Restaurant Group’s outlets to a cheaper experience like McDonald’s (MCD:NYSE).
Shares believes it would be wise to avoid the shares given heightened risks of a consumer slowdown and persistent downward earnings revisions.
Over the last year analysts have reduced their earnings forecasts for 2022 and 2023 by 20% and 50% respectively.
INTERNATIONAL DISTRIBUTIONS SERVICES (IDS) 246.07p
Given at their 2022 nadir shares in Royal Mail owner International Distributions Services had fallen by more than two thirds it’s only natural they have recently attracted bargain hunters, with the stock jumping nearly 19% over the past month.
However, there’s little in its operational performance and earnings profile to suggest this is anything other than a value trap.
The company’s strained relationship with its workforce is creating huge problems and while strikes in mid-November were called off, there is still a planned walk-out over the busy Black Friday and Cyber Monday events.
The only potential catalyst for the shares is a demerger of its more robust GLS international parcels division but investors can have no certainty over when or if that will come.
‹ Previous2022-11-17Next ›
magazine
