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HL Select Funds

Companies we avoid

HL SELECT UK GROWTH SHARES

Companies we avoid

Managers' thoughts

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Charlie Huggins

Charlie Huggins (CFA) - Fund Manager

14 November 2016

We try to avoid companies that have little or no control over their own destiny. These businesses tend to share certain hallmarks.

The biggest red flag for us is too much debt. More than anything else, it’s debt that determines which companies will survive and which will go bankrupt in a crisis. The more exposed to the economic cycle a business is, the less we like to see it using debt to fund itself.

Margins matter

Profit margins really matter to us too. We tend to view them as a verdict, by customers, on the value they see in a company’s products or services. A low margin can be a sign that little value is being added and there is little competitive strength in the business.

If a company has low margins, it can only generate limited amounts of cash for each pound of revenue it earns. The worst combination of all is a low margin, allied to a need for high levels of capital investment. Combine that with debt and the stock is best examined from behind a blast screen.

Cash flow matters even more…

We focus a lot on cash flow, and tend to avoid companies with weak cash generation. Businesses that struggle to generate cash are at the mercy of lenders, especially in a downturn; and have limited opportunity to reinvest, pay dividends or buy back shares. They are also more likely to employ aggressive accounting techniques, in our experience.

Deteriorating cash flow can be one of the first warning signs that a business is heading for trouble, so we look carefully at the trend, not just the current figures. Weakening cash generation accompanied by a large acquisition can be an especially large red flag.

Pricing power

We try to avoid companies that are price takers rather than price makers. Most metal bashers, airlines, and commodity-related industries would fall into that category. Combine this with an over-reliance on a few major customers and you are entering Russian roulette territory.

Don't ignore valuation

We don’t mind paying a fair price for quality. But when the valuation goes too far it can become a risk. We always try to seek a margin of safety in the valuation. If a share’s P/E is well above its historical average, and we can’t see a good reason why, we will tend to wait for a better time to buy.

More about HL Select UK Shares

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Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.