How last year’s tips fared
The fast rise in interest rates and weaker confidence in the prospects for the British economy hampered returns for London’s equity market this year. The FTSE 100 has risen by only 2.2 per cent, which translated to a total return of 2.7 per cent after factoring in dividends. The FTSE 250 closed up 2.8 per cent, equating to a total return of 3.5 per cent.
Against a meagre annual performance from the UK indices, Tempus’s tips for 2023 performed well. The average total return generated by the five companies tipped was 17 per cent. Those tips were: Diploma, Halma, Rentokil Initial, SSP and Whitbread.
The final name in that list was the best performing, generating a total return of 44.8 per cent. The owner of Premier Inn has benefited from a bounceback in demand after the pandemic and a dearth of supply, which has boosted room rates. Results for the six months to the end of September were ahead of expectations and guidance for the full year was similarly bullish.
Diploma entered the FTSE 100 in the August reshuffle of the index, producing a 32.2 per cent total return this year. The industrial distribution specialist defied expectations that it would falter against a contraction in manufacturing output, managing to maintain better organic sales growth into the fourth quarter.
Its industrial peer Halma also beat the FTSE 100, generating a return of 17.8 per cent. The provider of safety equipment to a range of industries entered the year valued at a discount to its five-year average after being pumped up during the pandemic. However, the group’s defensive credentials started to win back investors more comfortable with the group’s valuation.
A late rally could not push SSP, the owner of Upper Crust and Caffè Ritazza, ahead of the FTSE 250, of which it is a constituent. The group has been pursuing an expansion strategy in American airports, but macroeconomic uncertainty has weighed on sentiment. That is despite the group reinstating the dividend in December and sales and profit guidance for next year being raised. The hospitality group has ended with a total return of 2.8 per cent, after the dividend.
However, Rentokil Initial was the biggest drag on the average performance of last year’s tips, contracting by 12 per cent. In October, the group revealed an unexpected slowdown in organic sales growth during the third quarter in its key North American business. The pest control group cut margin guidance for the year.
Tips for 2024
Amazon
In December, the Federal Reserve gave its clearest indication yet that it would start cutting interest rates in the coming months. The US economy is expected to expand by 1.5 per cent next year, according to forecasts from the International Monetary Fund, outstripping the rest of the G7 economies bar Canada. This all bodes well for Amazon, seen as a bellwether for the American economy.
Slashing costs after an overambitious pandemic expansion has restored profitability and the group is back to generating free cash. Sales for the second and third quarters of this year were ahead of consensus forecasts as consumer spending proved more resilient.
A further clamber towards stocks with the ability to capitalise on artificial intelligence cannot be discounted next year. Amazon Web Services provides the space needed for AI developers to build and train large language models. In July, Amazon began allowing customers access to Nvidia’s coveted H100 chips via its cloud platform, which it could soon start to monetise more effectively. The shares have rallied strongly this year, but remain at close to the lowest multiple of forecast earnings since 2010.
Diageo
It was a bruising first six months in the top job for Debra Crew, the recently appointed Diageo boss. A shock warning in November that sales in Latin America and the Caribbean were likely to fall by about a fifth during the first half of next year wiped more than a tenth off the drinks group’s market value.
The shares are now close to their cheapest valuation in almost a decade, trading at just 18 times forward earnings. That could represent an opportunity for investors. The maker of Guinness and Johnnie Walker whisky has long attracted a premium rating, befitting of the strength and endurance of its brands.
Next year could mark a turning point for sentiment if Crew can demonstrate that problems in Latin America have not spread to other markets. There has been a “sequential” improvement in the key North American market and net sales should be higher in the first half of the financial year compared with the latter six months of last year. The broader shift towards premium alcohol remains and so do opportunities to push brands into new markets.
Empiric Student Property
Like most property companies, Empiric Student Property has endured a heavy sell-off in the face of the rapid rise in interest rates. If rates have peaked in the UK, as the market assumes, the student landlord could be due a re-rating.
Empiric’s shares are priced at a 26 per cent discount to the tangible book value forecast by analysts in 12 months’ time. Yet its latest half-year results showed a rise in the company’s net tangible asset value at the end of June, to 117p a share, from 115p at the end of December.
Empiric Student Property is not just a play on interest rates. A cheap valuation and the rental growth to be derived from an undersupply of student accommodation means the company could be a takeover candidate. In November management raised guidance for rental growth for the academic year that started in September to 10.5 per cent, double what it had initially expected. Rental growth guidance for the 2024-25 academic year has been set at “at least” 5 per cent. If occupancy remains as strong, upgrades could follow again.
Paragon Banking
Paragon Banking has defied the odds. The specialist lender is on course to end the year higher, despite a bias towards buy-to-let mortgages. A stabilisation in the housing market could mean the group’s resilience is more greatly appreciated next year. The company is still valued at a discount to its long-running average.
An annual return on equity of just over 20 per cent beat the lower end of the group internal target of 15 per cent for the second consecutive year. An analysis by RBC Capital has shown that Paragon has had the third most consistent earnings out of 45 European banks since 1999. Capital generation should remain strong and mean Paragon will hand back almost half of its £1.37 billion market cap in share buybacks and dividends between this year and 2025.
Peak interest rates and rising funding costs will be a challenge to net interest margins for banks next year. Paragon expects to hold its margin broadly steady at between 3 and 3.1 per cent, compared with 3.09 per cent. Even if the funding costs associated with its rapidly growing retail deposit base rises, growth in its higher-margin commercial lending business, which spans small housing developers, SMEs and the car market, should compensate, management has said.
Marks & Spencer
Marks & Spencer has long been a business of two halves. If the high street stalwart can demonstrate that it might finally crack a turnaround in its clothing and home business, the shares could push higher.
Better food sales and stronger margins across both sides of the business propelled adjusted pre-tax profits to £360 million, way ahead of a consensus forecast of £275 million in the six months to the end of September. Stuart Machin, the retailer’s chief executive, did not raise the outlook, even if consensus ticked up. Yet a good Christmas could prompt another boost to guidance.
Stripping back the number of product ranges in its clothing and home business is bearing fruit. Like-for-like sales growth in its clothing and home division is at its strongest in more than a decade.
The shares have more than doubled in value since the start of this year but remain inexpensive. A forward earnings ratio of 11 is roughly in line with the average since the 2008 financial crisis. But that does not factor in a much stronger balance sheet, progress in reworking the store estate in favour of food-only and modern stores with less surplus space, or better clothing sales.
