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Investment Times

My approach to picking stocks

| 24 December 2014 | A A A
My approach to picking stocks

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Back in early December, 2014 was shaping up to be a year when much happened, but little changed, given that the market was within a whisker of its January 1st level.

Then the tumbling oil price wreaked havoc upon the shares of energy producers and their suppliers and almost 6% was wiped off the FTSE 100. So, despite a year when the UK moved to the top of the developed nation growth tables, when multiple FTSE 100 companies received takeover offers and when interest rates remained at rock bottom levels, investors look set to see their capital eroded by a few percent, only partially compensated for by dividends received.

In unpredictable markets, careful stock selection is key. I like to look for businesses that are in control of their own destiny, and have the potential to prosper whatever direction the general economy is headed. That means focusing on quality, looking for stocks with strong balance sheets and products or services where demand has drivers that are in some way independent of the economic cycle.

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

As the last year has shown, the capacity to pay dividends can be crucial to returns and it is important to consider not just the initial percentage yield, but also the rate at which the company might be able to grow the dividend in future. A great example, and one of my favourite UK stocks, is Halma plc, a £2.5bn business focused on health and safety markets, where regulation drives demand and creates a focus on product performance.

As business managers, they work hard to keep a performance edge on their product range that allows them to maintain healthy profit margins, which leads to great cash flow. This has allowed them to grow profits consistently and to increase the dividend by at least 5% in each of the last thirty five years, without fail, though naturally there are no guarantees this record can be sustained.

Investors who bought Halma in 1994 would have paid about 120p per share and earned a dividend of about 1.3p, giving an initial yield of just over 1%. Not exciting at first glance, but those shares would today be worth around 670p, a gain of 462%. Steady growth in the business has allowed the dividend to rise to just over 11p per share, per year, giving a yield of almost 10% per annum on the original investment, on top of that capital gain.

Halma - annual dividend in pence per share

Source: Halma PLC. Please note dividends are variable and not guaranteed and past performance is not a guide to future returns.

Finding great businesses, like Halma, is a real thrill and the rewards are clear. Not every idea can be as successful as Halma, but here are some areas that I think look interesting for the year ahead.

View Halma share prices, charts and research

Two stock ideas for the year ahead...

The tumbling cost of energy puts money back into the pockets of consumers as prices at the petrol pump go down at long last. Retailers and hospitality firms will find their customers have more money to spend. On the high street, I like Next plc. It has a great track record of growth, is a big player online and is taking the Next Directory overseas via the web with great early success. Like Halma, investors who bought into Next and held on tight have seen fabulous growth in both their capital and dividends, despite numerous wobbles along the way.

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View Next plc share prices, charts and research

I'm intrigued by the prospects for TalkTalk Telecom Group plc. Spun out of Carphone Warehouse, it has a big base of customers for landlines, broadband and mobile and has grown its Plus TV customer base strongly. The rest of the industry is consolidating, as operators try to offer the same sort of 'quad-play' service that TalkTalk can offer. BT is considering buying O₂ or EE, and Vodafone is reported to be eying up Liberty Global, owners of Virgin Media. TalkTalk's positioning looks strong and analysts forecast strong growth in profits and dividends. Investors should benefit from this growth longer term, and there's a chance that TalkTalk could attract interest as part of the industry's consolidation.

View TalkTalk Telecom Group plc share prices, charts and research

…and one stock which could have a tougher time

Discount retailing has been a buoyant sector, and Primark owner, Associated British Foods plc (ABF) has been rewarded by a share price that has almost quadrupled over five years. Primark has swept the board across Europe and is now poised to try and break into the US.

ABF trades on 30x analyst consensus earnings, roughly double its longer-term average. Almost half of ABF's profit comes from the food businesses, which if separate, would be valued far lower than 30x in my view. Even Inditex, Europe's premier value fashion retailer is trading on a lower multiple than ABF. And over in the States, The Gap Inc, the stalwart of cheap chinos and festive fair-isles trades on just 14x consensus earnings.

Reversion to the longer-term average is the enemy of investors in highly rated stocks and ABF looks optimistically valued. In my view there are many other good value retail businesses.

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View Associated British Foods plc share prices, charts and research

The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments. This website is not personal advice based on your circumstances. So you can make informed decisions for yourself we aim to provide you with the best information, best service and best prices. If you are unsure about the suitability of an investment please contact us for advice.


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