Three share ideas to make your money work harder
Investing in individual companies isn't right for everyone. Our three share ideas to make your money work harder are for people who understand the increased risks of investing in individual shares. If the company fails you risk losing your whole investment.
You should make sure you understand the companies you're investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.
Important notes
This isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investments will rise and fall, so you could get back less than you put in. Past performance isn’t a guide to the future.
Sophie Lund-Yates, Lead Equity Researcher
Inflation is at its highest rate in decades. In the UK and US, inflation is running at around 6-8%. That means life’s getting more expensive. And to keep inflation under control, governments are increasing interest rates. As a result, investors are demanding a better return from their investments. They need their money to grow faster than inflation rises. This is called making a ‘real’ return. It’s partly why we’ve seen the market turn away from more highly valued growth shares, and towards value names.
Generally, shares generate returns in one of two ways. Either the underlying business improves, or investors change their view of its outlook.
Growth style shares are ones where investors believe the business is likely to grow. They hope to profit from the share price rising in line with the business improving. This sometimes means paying a bit more for these perceived long-term strengths. With value style shares, investors are looking for companies that appear undervalued. Value investors hope to profit from others recognising the company's value and the share price rising to reflect it.
If investors are looking for a higher return, they may look to value instead of paying a premium on growth names. Finding shares that are more likely to do well when inflation is high is far from impossible. Historically, moderate inflation has actually been good for corporate earnings overall. This is the case for companies that have pricing power, meaning they can successfully pass higher input costs onto their customers. This type of business usually offers an essential service or product. The other thing to consider is if a business has an economic “moat”. This is when competitors are far removed from muscling in on market share because of barriers to entering the market.
With that in mind, here are three share ideas we think could thrive in the current inflationary environment and help make your money work harder.
Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.
Yields are variable and are not a reliable indicator of future income. Past performance is not a guide to the future and investments can rise and fall in value. You could get back less than you put in.
This is not personal advice. If you’re not sure of the suitability of an investment for your circumstances, please ask for advice.
Information is correct as of 11 May 2022 unless otherwise stated.
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Volvo Group
Not what you think
Long-gone is the car company you might be thinking of, that business was sold years ago. Confusingly, that’s now trading as Volvo Car, which is a completely different company. Volvo Group, however, is now a heavyweight in the world of trucking and transport. The group makes – and crucially services – these vehicles. Other Volvo Group vehicles are used to mine iron ore and haul stone and rock. The group has customers in 190 countries, with annual revenues of EUR37bn.
The recent truck driver shortage reminded us how crucial these huge vehicles are to global supply chains and production. Keeping these trucks serviced and running 24/7 is a priority. And it’s Volvo’s servicing infrastructure that makes it very difficult for competitors to spring up and steal market share.
VOLVO GROUP NET SALES BY REVENUE TYPE
Source: Volvo Group 2021 Annual Report
High barriers to entry mean there’s an element of reliability when it comes to demand. That can feed directly into profits and free cash flow. The group generated free cash flow of around EUR1.1bn last year, expected to rise to almost EUR2.3bn this year. The business model underpins a very healthy prospective dividend yield of 5.3%. No dividend is ever guaranteed.
Volvo is a leader in the electrification of bigger vehicles too. It’s been selling electric buses for ten years. The shift’s slower with bigger vehicles than cars. But we think Volvo is doing the right thing by going full steam ahead on this strategy.
Management’s taken a cautious approach to accepting new orders lately. That centres around the ongoing supply disruption in the automotive industry. While we think avoiding locking prices in now is a sensible move, it may keep a lid on growth while conditions are tough.
Volvo has a defensive market position and an attractive prospective yield. The Stockholm-listed company has all the ingredients to thrive in an inflationary environment, at a non-demanding valuation of 9 times expected earnings. Keep in mind, supply chain disruption increases the risks in the short-term.
Applied Materials
The power of a backlog
The world’s digital transformation is gathering pace. Semiconductors can be thought of as essential today. They’re needed in everything from car computers to washing machines. So now is a good time to be an important, and specialised, supplier to the semiconductor manufacturing process. Nasdaq-listed Applied Materials is just that.
The group’s seen its valuation come down dramatically from pandemic highs, with the price to earnings ratio now hovering at around 12. That’s largely to do with the wider US tech-sell off in recent months, and the effects of the global supply chain crisis surrounding semiconductors. This has of course been a challenge for Applied Materials, but we think the market’s correction may have been overdone.
The group is now sitting on its biggest ever order backlog of $11.8bn, 57% of which is related to semiconductor systems. That means demand is very visible and is expected to remain robust even as things start to get back to normal. The highly technical nature of Applied Materials’ work means its economic moat is considered wide. That should hold it in good stead in the future. Predicted free cash flow of well over $6bn is also nice to have.
Operating margins are facing slight stagnation – although at 31% these are far from crisis levels. The biggest risk is Applied’s exposure to a concentrated Asian market. The group doesn’t have a large number of clients and is instead reliant on a relatively small number of predominately Chinese, Taiwanese, and Korean manufacturers. With economic conditions very hard to predict at the moment, we can’t rule out ups and downs to the group’s performance in the short term.
APPLIED MATERIALS BUSINESS BY GEOGRAPHY
Source: Refinitiv Eikon, correct as of 11 May 2022. Percentages may not total 100% due to rounding.
Ultimately, we think Applied Materials is an alternative and compelling way to invest in tech. We think the current valuation doesn’t fully reflect the group’s robust demand and high barriers to entry. Investors should be prepared for some volatility, while the supply chain and economic challenges iron out.
DS Smith
Needs must
DS Smith makes corrugated cardboard, and other essential packaging. It’s a textbook example of pricing power. The world’s products need to be packaged come rain or shine, meaning DS Smith has been able to raise its prices, offsetting higher costs.
One of the main reasons we have faith in DS Smith over the long run is that it has large exposure to the e-commerce industry. Online shopping demand has permanently increased thanks to lockdowns and is expected to keep growing. DS Smith’s core customers include Fast Moving Consumer Goods (FMCG) which cover things like supermarkets and other consumer staples. In other words, the goods that the world needs no matter what. Box volumes are expected to rise at least 5% this year, despite the price hikes, showing just how sticky demand is.
Sustainable packaging is also an area of strategic focus. The group offers many eco-conscious solutions, including using mostly recycled materials and designing more efficient packaging. As consumers and investors continue to demand more environmentally friendly products, we see this as an area with strong growth potential.
DS Smith generates annual underlying operating profit of over £600m, with about 37% of that expected to drop through to free cash flow this year. That’s a function of the group’s large scale, and adds some breathing room if trading deteriorates. It also helps support a meaningful dividend yield of 5.3%, please remember no dividend is ever guaranteed.
The balance sheet's been carrying a little more debt than is ideal, following the acquisition of Europac - a French, Spanish and Portuguese packaging group. But management's expecting net debt to be 1.7 times underlying cash profits (EBITDA) at the full year, suggesting progress on this front.
NET DEBT TO CASH PROFITS RATIO
Source: DS Smith Annual Report 2021
There’s a lot to like about DS Smith. It’s a core supplier to reliable industries and we admire its potential. As an industrial business, it wouldn’t be totally immune to a severe downturn in Western economies.
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Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
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Important notes
This isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investments will rise and fall, so you could get back less than you put in. Past performance isn’t a guide to the future.
