Analyse your stocks in seconds
Expert insights you can understand
Improve the odds of your stock picks
Generate investing ideas fast
Track & improve your Portfolio
Time your trades better with charts
Explore all the featuresStockopedia contains every insight, tool and resource you need to sort the super stocks from the falling stars.
When I looked at the performance of Value at the end of 2022, it was a rather depressing picture:
While it was clear that expensive stocks were not the place to be, the top decile of the Value Rank underperformed the FTSE All Share. Indeed, all of the deciles underperformed. It may seem strange: how can a series of portfolios that contain the whole market not match the index performance, on average? The reason for this mismatch is the difference between the market cap weighting of the index and the equal weight of the Value Rank deciles. An equal-weight portfolio has greater relative exposure to the performance of small cap shares. In 2022, the performance of large caps held up the value of the indices while the median stock underperformed.
One of my Value Themes for 2023 was that small and mid-caps were due to play catchup. Fast forward a year, and we have some good news:
The cheapest Value Rank decile outperformed with a +5% return versus a broadly flat index. We still see most of the deciles underperforming, led by the woeful performance of the most expensive stocks. So the large cap bias has remained, although to a lesser extent. This is confirmed when I look at the performance of the Quality Rank. Here, all deciles remain below the performance of the FTSE All Share in 2023:
This suggests that the rotation away from large caps still has a way to go. Anecdotally, many small caps look simply too cheap, and I created a screen a few months ago that aimed to identify these small cap value opportunities.
My second Value Theme for 2023 was that it would be a stock-pickers market. To test this assertion, I decided to look at what the best-performing stocks have been so far in 2023. Using the Stockopedia Screening Tools, I picked the top 3% of UK stocks on absolute price change that were currently greater than a £10m market cap. These are the 40 best-performing stocks of the last year:
The first surprise is how little return is required to make the top 3%. Only 32 companies more than doubled in the UK market. Again, this reflects the weak market trends for UK stocks. The second surprise is that, although smaller companies are more likely to have outsized returns, some big companies are also in there. Sometimes elephants do gallop!
The real stand out, however, is how low the Value Rank is for many of these companies. Of course, this may be because these companies’ share prices have increased significantly, so the Value Rank has fallen. However, with a median Value Rank of just 26, this doesn’t seem to be the only explanation.
As I have already discussed in previous articles, there can be a negative correlation between Value and Quality. Companies that look cheap on assets rarely have a high Return on Equity (RoE). However, the low Value Rank doesn’t appear to have been reflected in higher Quality metrics. The median 5-year Average RoE of last year’s top performers was -12 %. Indeed, only two companies appear to have a 5-year average RoE above their cost of capital, hence generated any long-term shareholder value: Ashtead Technology Holdings (LON:AT.) and DP Eurasia NV (LON:DPEU) . So, one of the stories of 2023 has been a dash to trash. It appears it was not a stock-picker's market but a speculator’s one!
My third value theme was that uncertainty will be high, and it will be hard to stay rational. I predicted that because the outlook for many companies is highly uncertain, it would require something special to get investors to initiate a new position. In such a scary environment, investors want to feel safe and secure, relying heavily on external voices to provide that reassurance. And this is what we have seen, particularly in recent months. Newspaper tips can move the price of stocks significantly, sometimes by more than an actual trading statement. Of course, the rationality of investing on the recommendation of a 25-year-old journalist who is not allowed to own any individual stocks is doubtful. However, it is a feature of the current market, and investors need to be aware of it.
Similarly, since many of the best-performing stocks in 2023 were expensive and poor quality in 2023, investors need to be wary of deciding to throw away Quality-Value principles. The reality is that the dispersion of returns amongst such speculative stocks is large. The most expensive and worst quality StockRank deciles massively underperformed in 2023. This means that the average stock’s performance in these buckets was so poor that it didn’t make up for the strong performance of a few big winners.
So, what of 2024?
While inflation may remain persistent, and interest rates are unlikely to fall significantly, the shock of rapidly rising inflation is unlikely to be repeated. This will mean that companies struggling with rapidly changing prices will now have built them into their business model and may bounce back. However, the focus will shift from inflation to current economic conditions. Consumer confidence is likely to be weak for some time yet. Investors will want to own the best operators. For example, in omnichannel retail, this means owning Next (LON:NXT) , rather than the also-rans, such as Quiz (LON:QUIZ) or Sosandar (LON:SOS) . Investors may want to avoid sectors with UK consumer exposure altogether. The same goes for UK housing, where rate rises will continue to impact affordability long after rates peak, as very low fixed-rate deals taken out a few years ago roll off. Conversely, if we see rates moderate and consumer sentiment return, many companies will see a significant bounce back in trading. This will be a year where it pays to follow consumer trends.
While we are not seeing retail fund outflows of the magnitude that we saw in mid-2022, we are not seeing any real trend of positive flows into equity funds either:
[Source: The Investment Association]
In the medium term, these figures are favourable for the expected returns to equities since flows tend to be cyclical. However, in the short term, this remains a headwind. Since some funds may see sufficient outflows to make them forced sellers of illiquid stocks, investors should be on the lookout for bargains this year.
While patience and inaction are often the mantra of the Value investor, it can pay to be nimble in current market conditions. When a stock can go up 20% on a newspaper tip, and another can fall 30% on a minor miss of broker expectations or due to a forced seller, taking the opportunity to switch may prove lucrative. The reality is that in the current markets, newspaper tip spikes and forced seller drops are often transitory. The opportunity to switch back with a profit will likely present itself all too soon.
UK Small Caps below £100m still trade at a discount to larger companies. Here, I’ve calculated the median EV/EBITDA for different sized companies with positive TTM EBITDA:
Smaller companies often have much better growth prospects, so this lower rating, on average, seems unwarranted.
The past two years have proven a torrid time for investors who use the Quality Rank to select stocks, with pretty much monotonic underperformance:
Perhaps the only bright spot is that the Quality Rank will have helped investors avoid the real stinkers. However, over the last decade, the results have been anything but disappointing:
Some more popular Quality companies remain on high ratings, and the days of investors doing well by investing in QAAP (Quality At Any Price) seem long gone. However, now may be the time to consider investing in modestly-priced quality stocks that have experienced short-term but fixable challenges due to inflation or weak consumer sentiment.
While retail fund flows into equities remain weak, valuations remain compelling for those who do have cash that they wish to deploy into UK firms. Primarily, these have been overseas companies and Private Equity. While predicting which company will be taken out next is impossible, some trends should be considered. Private Equity funds have been raising Biotech and Software fund commitments over the last few years since these have been popular sectors. However, Private Equity firms tend to bid relatively low premiums for listed takeovers since they want to profit on a subsequent sale of a business. Trade buyers tend to be able to bid more and justify higher premiums as they often can access synergies from combining operations. Investors will want to find companies with unique properties that will make them attractive to others in their industry. The ideal candidate also has a blocking stake owned by management or founders, so the bidder has to prise the shares out of the hands of a committed long-term holder. However, the management stake shouldn’t be too significant, or the most likely outcome will become delisting rather than a takeover. In these cases, the minority holders rarely get a full price.
Whatever 2024 has in store, investors who can react to events rationally and objectively while others are losing their heads will see long-term outperformance. As always, Stockopedia remains the ideal companion to help investors do this.
About Mark Simpson
Value Investor
Author of Excellent Investing: How to Build a Winning Portfolio. A practical guide for investors who are looking to elevate their investment performance to the next level. Learn how to play to your strengths, overcome your weaknesses and build an optimal portfolio.
Disclaimer - This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
Mark
Thank you for your efforts - but it is very difficult to place too much weight on your findings when you are forced to paste in 10 year charts that ignore dividends and special divis entirely. Not your fault.
Stocko consistently ignore my pleading (despite their verbal promises to sort it our 5 years ago). Until they bite the bullet and do total return properly it will undermine how much faith we can place in the Rank scores.
Ed will of course come up with his "average dividend yields" for various categories to paper over the absence, but it just makes things worse I'm afraid.
Anyone who has used a proper Total Return calculator knows it can utterly transform how you view the historic performance of certain stocks, in both absolute and relative terms.
Hopefully you can assist with making the case to the powers that be that this should be a priority for future development plans?
Dear Mark,
Earlier this year you were enthusing about Luceco - price unchanged to down and questioning the value of Zotefoams which has gone up. Could you update us on the bull and bear case here or have you changed your mind? no offence intended not every call works and some work after some delay and sometimes the facts change and one’s opinion changes
Interestingly, I summarised some thoughts on both companies recently here: https://smallcapslife.substack...
Not all my own work, it is an amalgamation of several contributors, but since I write these weekly summaries, I tend to broadly agree with them!
Basically, it comes down to the quality of the business. Do they consistently generate a return on capital above their cost of capital? With Luceco (LON:LUCE) they do, with Zotefoams (LON:ZTF) they don't. Yet on valuation, you are paying 12x forward earnings for a business with a history of good economics and 19x forward earnings for a business with a history of bad economics.
I get that history isn't always a guide to the future and that there is blue-sky potential with Zotefoams. However, if they had a history of generating innovative products that were actually profitable, then I'd be more willing to give them the benefit of the doubt over future products. Perhaps the recent retirement of the CEO will lead to better management with a greater focus on generating acceptable returns on capital. Paying a high multiple for unproven blue sky, or betting that a new management can fundamentally change a business that has been poor for many years, just isn't my style of investing. If you have a history of doing blue-sky investing better than me, then that's great, I wish you luck.
In terms of changing my mind, I will certainly do so, if the underlying performance of the businesses and the valuation changes. If Luceco (LON:LUCE) ends up on a P/E of 20 with a few years of ROCE in single digits it will almost certainly be a sell. If Zotefoams (LON:ZTF) ends up on a forward P/E of 10 and manages to double its ROCE, then it will almost certainly be a buy. Price action alone will not change my mind since the short-term link between the two is shaky, at best. Speculation can take the value of shares far above fair value, and despondency far below fair value. My aim is to do the opposite: buy the widely hated and sell what the crowd is most excited about. That's simply my preferred style, and it certainly isn't for everyone.
I respect Paul's analysis, and he does a great job on the SCVR. However, in terms of investing style, he is much more willing to bet on high-risk blue-sky or highly-valued stocks than I am. Sometimes it works out for him, sometimes it doesn't. I couldn't personally live with the level of volatility in performance he has over the last few years. But that's why we all have to come to our own investment decisions and find a style that matches our own risk tolerance and strengths and weaknesses.
It goes without saying, but I will labour the point just in case: purchasing any stock simply because myself, Paul, or any other market commentator likes it is bound to end in tears. As the market saying goes, "You can borrow someone else's idea, you can't borrow their conviction".
*Past performance is no indicator of future performance. Performance returns are based on hypothetical scenarios and do not represent an actual investment.
This site cannot substitute for professional investment advice or independent factual verification. To use Stockopedia, you must accept our Terms of Use, Privacy and Disclaimer & FSG. All services are provided by Stockopedia Ltd, United Kingdom (company number 06367267). For Australian users: Stockopedia Ltd, ABN 39 757 874 670 is a Corporate Authorised Representative of Daylight Financial Group Pty Ltd ABN 77 633 984 773, AFSL 521404.
Thanks for the article Mark
Although your posts don't gather the feedback like the scvr, I'd like to add that as I find them all informative and really helpful in improving my investing knowledge then I'm sure other subscribers at a similar stage must share my view
Please keep these up
Callum