3 share ideas for a volatile stock market

Right now, good economic news feels like a very distant memory. That’s had a knock-on effect on the stock market. London’s basket of the 100 largest shares, the FTSE 100, fell below the 7,000 barrier at the end of September for the first time in six months.

But to put this in context, we’re only 13% below the all-time high of 7903.50 seen in May 2018. We’re also still well above the low points that correspond with the most notable crises of this century.

At the start of the Iraq War in March 2003, the index touched 3277.50. The ‘Great Recession’ of 2007-2009 saw the FTSE hit a floor of 3460.71 in March of 2009. Most recently was the paralysis of global mobility that was the pandemic, when the FTSE 100 bottomed out at 4,898.79 in March 2020.

With the US and the UK not officially in recession, there could be some large swings in the months ahead. Remember though, past performance isn’t a guide to the future.

FTSE 100 performance

Past performance isn’t a guide to the future. Source: Refinitiv Eikon, to 13/10/2022.

We recently looked at how to spot an opportunity in a volatile market and shared what characteristics stand out. Below, we highlight three shares we think score well on that basis.

This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments and the income they produce fall as well as rise in value, so you could get back less than you invest. Remember, yields are variable, and not a reliable indicator of future income.

Investing in individual companies isn't right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

DS Smith

DS Smith is a stock that at first glance doesn’t sound too exciting. It makes cardboard boxes. But its extensive range of sustainable corrugated cardboard solutions has an enviable customer list that includes Amazon and Tesco. Its environmental credentials (its products are now 100% recyclable) have also earnt it a rubber stamp from the Ellen MacArthur Foundation, an opinion leader on the transition to the circular economy.

We like that DS Smith is exposed to structural growth drivers that are linked to more than just broader economic growth. As well as a shift towards sustainability and plastic replacement, e-commerce still has the potential to outgrow regular retail, with some markets like Italy, Spain and France still underpenetrated.

DS Smith’s exposure to Fast Moving Consumer Goods (FMCG), or small ticket items typically deemed as necessities, gives it some shelter in the face of a challenging economy. This has enabled it to enjoy a recent earnings upgrade, based on strong pricing and cost-management, despite a small fall in volumes from previous record levels.

The group’s gradually improving margins and is expecting a material uplift in the current financial year. However, we caution that inflation still poses a risk to profits should it persist for the long term.

We’re impressed with DS Smith’s approach to capital management. Its ratio of net debt to cash profit fell from 2.2x cash profits to 1.6x in the year ending April 2022. In the same period, it increased dividends by 24% to 15p, slightly more than twice covered by underlying earnings, the bottom end of its targeted range of 2.0 to 2.5x.

The reduction in debt and increase in dividend pay outs are supported by strong cash generation. The valuation could however be pricing in some downside risk as it’s at a ten-year low when compared to earnings per share. The forward dividend yield of 6.4% is attractive, but can’t be guaranteed in the face of high inflation and a weakening global economy.

VIEW THE LATEST DS SMITH SHARE PRICE AND HOW TO DEAL

SIGN UP FOR UPDATES ON DS SMITH

PepsiCo

PepsiCo’s flagship cola is truly a giant among iconic brands which include a huge range of food and beverage household names like Walkers Crisps, Quaker Oats and Tropicana. Growth in excess of that of the economy seems hard to come by, but the group’s expecting 12% underlying revenue growth this year following a recent upgrade. Its diversity in terms of brands is also matched by its wide geographical reach. It’s a true global player.

Pepsi’s valuation is demanding, and on an earnings basis has crept above the long-term average. But it has an incredible long-term track record of delivering shareholder value, albeit with some bumps along the way. Past performance isn’t a reliable indicator of the future though.

Surprisingly in both snacks and beverages, it has under 10% market share globally and is committed to long-term organic growth targets of 4-6% per year. PepsiCo consistently invests mid-single digit proportions of its net revenue into the business and is targeting $1bn of productivity savings through digitising the supply chain by 2026.

We see Pepsi very much as a long-term investment with the potential to generate relatively stable returns, rather than spectacular growth. And with that, comes some shelter against volatility.

We’d like to see debt come down further (about 2.5x forecast cash profit). The dividend yield of 2.8% is modest, but we view it as sustainable given the consistency of financial performance. However, as with all dividends this is never a given.

VIEW THE LATEST PEPSI SHARE PRICE AND HOW TO DEAL

REGISTER FOR UPDATES ON PEPSICO

GlaxoSmithKline

Following the spin-off of its consumer health arm Haleon, GlaxoSmithKline now offers a purer exposure to speciality medicines, which command premium prices. This is expected to help push operating margins up to close to 30% in 2023.

It’s performing well, in fact significantly better than its targeted annual growth of 5% per year for revenues, and 10% for underlying operating profit out to 2026. If that’s the case, the current valuation, which is just below the long-term average, looks relatively undemanding. However, patent disputes and supply chain pressures mean it’s no sure thing.

Despite its acquisition activity and hefty research and development budget, GSK has seen its prospective dividend yield creep up to over 4% in recent months. Analyst consensus forecasts suggest that dividends for 2022 are approximately twice covered by net profits and even more so by cash profits. Remember, no dividend is ever guaranteed though.

At the last check, GSK’s debt was £21.5m, about 2.4x this year’s forecasted cash profits. But with free cash flow forecasted at £5.1bn GSK does have the financial strength to lower its debt levels.

GSK continues to push hard in clinical trials, with some 68 vaccines and medicines in clinical development across infectious diseases, oncology and autoimmune disorders.

It’s not all about new breakthrough therapies either. GSK recently got approval on a new formulation of the Menveo vaccine for meningitis – allowing a more convenient single vial to improve convenience to practitioners. This also includes selective acquisitions, such as this year’s Sierra Oncology purchase, which is hoping to see Momelotinib approved in the US next year. This is a ground-breaking treatment for Myelofibrosis, a rare blood cancer, and could add over $600m a year in revenue at its peak.

In August, GSK completed the acquisition of Affinivax which included an upfront payment of $2.1bn adding an exciting pneumococcal vaccine platform to the pipeline. This is an area still very much in focus following the pandemic. But it’s a disease area that goes well beyond just respiratory diseases.

We see healthcare as relatively defensive in the current environment, and not massively dependent on consumer spending power. A wide pipeline provides diversification and potential for the next blockbuster. But drug discovery is a high-risk pursuit, and no approvals are ever guaranteed.

VIEW THE LATEST GLAXOSMITHKLINE SHARE PRICE AND HOW TO DEAL

SIGN UP FOR GSK RESEARCH UPDATES

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.

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 disclosure for more information.

Share insight: our weekly email

Sign up to receive weekly shares content from HL.