Backing growth stocks has been like swimming against the tide so far this year, so it’s no wonder that smaller companies specialist BlackRock Throgmorton Trust has been sent into reverse.
The FTSE 250 constituent’s shares have fallen 15 per cent since the start of this year, while its net asset value has declined by just over 8 per cent since the end of November — worse than the 2.8 per cent fall in its benchmark, the Numis Smaller Companies Plus Aim Index. That unravelled the premium that had been attached to the shares versus its NAV, which has tipped into a marginal discount against the recently lowered asset value figure.
The trust has a bias towards investing in small and mid-cap companies that it believes can generate high earnings growth over the longer-term, rather than stocks with beaten up valuations. Those companies are defined as being valued below the FTSE 100, including London’s Aim market. Once a stock’s value grows to the extent that it is pushed up into the top index, as was the case with JD Sports, the trust has a year to sell out of the holding.
But it is not interested in speculative, “jam tomorrow” companies, which are heavily loss-making and whose valuations have been propelled by the rising tide of easy money in the financial markets. “Not all growth is equal,” argues Dan Whitestone, a portfolio manager.
Instead, Whitestone looks for companies with a longer track record of organic revenue and earnings growth, a high proportion of which is translated into cashflow. Likewise, it eschews companies that prioritise dividends at the expense of investing in their operations or maintaining a stable balance sheet. Which fit the bill? Electrocomponents, the electronics and industrial products distributor, Impax, the sustainable asset manager, and the fantasy figurine manufacturer, Games Workshop.
Those companies have been stock market winners over the past three years, delivering a total return at least three times higher than the trust’s benchmark index.
For BlackRock Throgmorton, that had helped it deliver an 86 per cent NAV return over the three years to November versus the 39.6 per cent generated by the Numis smaller cap index. Over ten years, that cumulative outperformance has equalled 252 per cent.
However, high forward earnings multiples attached to some of the trust’s top holdings, including Watches of Switzerland, the luxury retailer, and Games Workshop, carries two chief risks. It leaves little room for error and it means some holdings could be caught in a further sell-off if inflationary pressures persist, both of which could cause more pain to the trust’s NAV.
The trust doesn’t only bank on share price moving upwards, it also bets on some falling. Stocks shorted last year included a certain spread-betting specialist that issued an extensive profit warning as trading activity fell from its pandemic-era highs.
Most short positions were closed out in 2020, after slumps in share prices as the impact of global lockdowns hit some businesses.
Taking short positions in stocks is a much smaller part of the trust’s investing activity, given the firm cap on potential returns made on a share price falling — ie to zero — versus the multiples by which a share price could rise. But Whitestone has begun to increase the trust’s short exposure, eyeing stocks that have low margins, “undifferentiated” business models and could be squeezed by a fall in demand and rising cost inflation but still have hot air in their valuations.
Smaller companies have natural potential to deliver higher compound returns than larger counterparts.
ADVICE Hold
WHY The shares are worth holding for potential long-term compound gains
Barratt Developments
Housebuilders have faced a perfect storm this year: rising interest rates, supply chain disruption and concerns that further money needs to be set aside to tackle unsafe cladding. For Barratt Developments, it’s a storm that has left its shares trading at an almost as pessimistic valuation as during the depths of the first lockdown, or eight times forward earnings.
But the housebuilder has a sweetener for investors — the prospect of a beefier dividend. The housebuilder plans to reduce dividend cover from a weighty 2.5 times adjusted earnings per share last year to a multiple of 2.25 this year and 1.75 by 2024. Brokerage Peel Hunt expects that to translate into a dividend of 51.5p this year, equivalent to a rich yield of 8.1 per cent at the current share price. With net cash of £1.1 billion on the balance sheet at the end of December, there’s scope for a return to special returns, too.
How might earnings fare this year? Completions have come down from the lofty levels recorded last year, but the strength of demand means full-year completions are expected to be about 250 higher than the 18,000 initially guided towards, which would also be ahead of the 2019 level. Higher volumes should feed through to better margins, too. Build cost inflation is a challenge and expected to rise to 6 per cent this year. But the forward order book incorporates underlying sales price inflation of about 7 per cent for the second half, which means the impact on the margin of rising wages and raw material prices should be neutralised.
There are risks up ahead. The help-to-buy scheme is due to come to an end next year, which could precipitate an easing in demand, although the number of Barratt customers using the government support scheme had already declined to 22 per cent of reservations during the first half, versus 49 per cent the same time the prior year. Then there is the potential for further provisions being taken to cover the cost of unsafe cladding, which so far totals £220 million. It seems likely some heat will come out of sales prices, too, which depending on where inflation is at, could weigh on margins. But judging by the group’s depressed valuation, investors have already discounted enough for those.
ADVICE Buy
WHY Prospect of generous dividend despite risks ahead