Semi Year SNAPS - more top stocks for 2015

Most stock market watchers could be forgiven for thinking that 2015 has been a bit of a damp squib. Some promising early gains for the FTSE 100 have been all but given up, Greece worries have weighed hard and the dour Scot failed again to regain his Wimbledon crown. But beyond the headlines stock markets have been treating sensible small cap investors to quite a bounty.

The FTSE Small Cap Index is up over 7% year to date while the FTSE Fledgling Index has rallied 17%. Closer to home my own 20 stock “New Year NAPS” list has stormed to a 29.5% return in just over 6 months. In the light of this recent good fortune, I felt it time to dust off my quill and pen a few words to reflect on what’s gone right, what’s gone wrong and what on earth should be done now… if anything at all.

From NAPS to SNAPS…

Newcomers to the site might want a quick refresher of how the NAPS were selected. We’re a DIY research site and we don’t do ‘tips’, so rather than hand pick some stocks for the year like you might find in newsletters or magazines, we thought we’d just throw the task at our core algorithm - the Stockopedia StockRanks. With a few simple filters to avoid tiny and hard to trade stocks we named the 2 highest ranking stocks across each of our 10 ‘economic sectors’… from Energy to Telecoms…. and threw them in a portfolio. You can check out all the original rules here.

Genuinely, I didn’t have vast hopes for this set of stocks as many were selected across sectors (e.g. Utilities) not exactly renowned for market beating returns. But they’ve absolutely trounced the market, beating the FTSE 100 by 22% in six months. Only Idox has fallen into negative territory while every other stock has returned 10% or more. The best, International Greetings, has more than doubled.

All this good fortune has started to make me nervous. After all, this was essentially a systematic portfolio and one of the most important parts of any good system is sound risk management and rebalancing. The portfolio positions have now drifted substantially leaving greater exposures to some stocks and smaller exposures to others. Should we just let our winners run, or should we be a bit more mechanically ruthless ?

Our tracking of the StockRanks has found that more frequently rebalanced portfolios have outperformed annually rebalanced StockRanks though at the expense of higher potential costs. So we thought why not pitch the laissez-faire New Year NAPS portfolio against a six-monthly rebalanced SNAPS alternative ? Perhaps we’ll gain a few more insights by year end in the process.

But first…

…some half year lessons learned

While it’s far too early to draw conclusions from the performance to date… it’s much more fun to give it a go… ;-)

1. Diversification works: The top two performers year to date have been card distributor International Greetings ( up 106% ) and toy maker Character Group ( up 75% ). Both were ‘honourable mentions’ in the original list - qualifying amongst the top 20 NAPS (+29.6%), but not among the top 10 (+23.7%).

Now a lot of macho investors think that high conviction concentrated portfolios are the only way to build wealth in the stock market. But a 10 stock concentrated portfolio would have underperformed by missing out on these two huge performers.

Perhaps instead of thinking that owning more stocks leads to a smaller contribution from each winner - try thinking that owning more stocks gives you a higher chance of owning the really big winners. That’s what makes the difference.

2. Elephants don’t gallop (as much): The best performers were either micro-caps or small caps well under the radar of institutional investors. These are the kinds of stocks that only private investors can make the most of. The big caps, Berkeley Group, BT and Imperial Tobacco, all performed admirably up between 17% and 34% but can’t offer the kind of giant outperformance available in small caps. It’s worth remembering that investing in small caps can be a double edged sword (ask anyone who was investing in 2008) … so diversifying across different sized companies is plain common sense.

3. Watch your stocks not the indices: The most critical barometer of stock market health is sets of actual stocks not the market indices. The major indices are very poorly composed, often subject to the bully boy tactics of the big leveraged futures traders and not necessarily reflective of underlying market health. It’s notable that in spite of the macro nervousness the NAPS portfolio (and the top 10% of StockRanks stocks in general) barely fell more than 1 percent at any time year to date.

William O’Neil taught me that the time to escape equities is when they all individually start behaving negatively, not when the major indices are having a wobble. So keep yer head son !

4. Sector overweighting: The one thing I’m uncomfortable with in the original portfolio is the fact that we’ve put equal weightings into every sector. It could be argued that we should put less positions in sectors that have less weight across the market (like Telecoms and Utilities) and more into sectors with larger weights where there’s a higher probability of finding outperformers (e.g. Cyclicals & Industrials). But we started with a plan so we’ll continue.

On the merits of sloth

Before we do anything… let’s praise bone idleness. One of my best all time portfolio picks was Domino’s Pizza which I bought for an investment club back in about 2004. It duly proceeded to ten-bag within 10 years and I still parade this as an emblem of my own stock picking prowess to the others in the club.

What I don’t tell them is that I bought it in my own portfolio at the same time, with rather more measly results. The 25% I pocketed 6 months later felt good at the time, but was extortionately expensive with hindsight. The one thing I’ve learned since has been best phrased by the great Jesse Livermore in Reminiscences of a Stock Operator:

After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! …. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money.

The truth is that most of the stocks in the NAPS portfolio are still behaving well. Only Idox and Town Centre Securities have dropped below an 80 StockRank. Shouldn’t we just let these winners run? Why on earth do we need to rebalance the portfolio at all ?

Well the truth is we don’t and probably shouldn’t. Trading stocks is expensive and it adds a big drag on any portfolio. Small caps have wide bid-ask spreads costing several percent on the round trip buying and selling a stock. If you do that a few times per year the transaction costs will eat up your outperformance. So when in doubt it’s often best to do nothing at all.

But there are great merits in rebalancing too… if some stocks have got ahead of themselves, rebalancing can, like Robin Hood, steal from the rich and give to the poor and help to improve risk adjusted returns. We’ve often written that the optimal frequency of rebalancing is very dependent on one’s personal situation - taxability of the account, portfolio size, choice of strategy etc - so there’s certainly not one shoe that fits all. So what we’re doing here today is to be taken as an illustration only. DYOR and check out some of our archive articles on the subject.

The Semi Year SNAPS…

To make the SNAPS rebalancing easy we’re going to stick to our original criteria - bringing the portfolio back in line with an equal weighting across all the currently qualifying candidates. It’s brutal, but this kind of approach has been shown to work. Winners that still qualify (like International Greetings) will be sold down back to a 5% weighting while those that no longer qualify will be sold completely, being replaced by new candidates.

In screening for the new candidates using the StockRanks portal we found that half the stocks that originally qualified in January still do today. This is great as it minimises the churn (and potential transaction costs) in the SNAPS portfolio.

Thanks here to Ben Hobson who has written a brief summary of the stocks that are new in the SNAPS portfolio…. for a brief write up of the stocks that REMAIN please see the original NAPS article.

Consumer Defensives

Imperial Tobacco REMAINS. £31.63bn, StockRank 98.

Cranswick is OUT replaced by… Carr's Milling. Carr’s is a diversified group specialising in agricultural feeds and supplies and flour production. It also has an engineering division that manufactures equipment used in the nuclear and oil and gas, among other activities. Mkt Cap £151.6m, StockRank 96

Consumer Cyclical

Character Group is OUT replaced by … Epwin. Defying the trend for new IPOs to end in disappointment, shares in building supplies firm Epwin have risen by more than 30% since it floated on AIM in July 2014. This is a cyclical business that’s benefitting from improving economic conditions. It has some strong quality indicators in addition to the surging momentum. Mkt Cap £176.2m, StockRank 99.

Berkeley Group REMAINS. Mktcap £4.5bn, StockRank 98

Industrial

Dart Group is OUT replaced by… Empresaria Unlike some other recruitment firms, shares in Empresaria have been fairly muted over the past year. However, signs of improving efficiency and management ambition have invigorated the shares in 2015 and Damian Cannon gave it a big write up in May. Mkt Cap £30m, StockRank 99

Costain is OUT replaced by … Air Partner. Shares in Air Partner took off in April after the aviation services company bounced back from a poor first-half to report better than expected full year results. No debt and more than £18m of cash meant the dividend was hiked, leading to a forecast yield of 6.2%. Mkt Cap £43m, StockRank 99.

Financials

Catlin delisted (OUT) in the first half and was replaced by H&T Group. H&T, best known as a high street pawnbroker, is in the midst of a restructuring programme to reinvent itself. It has managed to survive in a tough period where other peers like Albemarle & Bond went bust. It is cash generative and has been paying down debt. £73m MktCap, StockRank 99.

Town Centre Securities is OUT replaced by… 3i. 3i is a stalwart of the British private equity and venture capital industry, and a member of the FTSE 100. The key factor here is momentum, with the price of 3i shares on a positive trend since early 2013 and brokers consistently increasing earnings forecasts over the past year. Mkt Cap £5.38bn, StockRank 98.

Basic Material

James Latham is OUT replaced by Sylvania Platinum. AIM listed mining shares have a terrible reputation for being highly speculative investments that often turn sour. Shares in Sylvania Platinum, a producer of platinum group metals are well down from their highs four years ago, but momentum has been building. The company recorded a loss last year but a rebound to profitability looks to be on the cards in 2015. Mkt Cap £34.8m, StockRank 95.

International Greetings REMAINS. £91m, StockRank 99.

Technology

Idox is OUT replaced by Computacenter. It describes itself as a computer infrastructure company and has a name that’s stuck in the ‘90s. Yet Computacenter is starting to reap the rewards from two years spent refocusing its business. It throws off cash and has some strong quality credentials. Mkt Cap £946.9m, StockRank 98.

Cohort is OUT replaced by 888. Online gaming company 888 is currently in a battle to buy rival firm Bwin.party. Its share price momentum has been strong in 2015 and it boasts some impressive quality characteristics, including a high return on capital and wide margins. It might be a sin stock, but it’s highly profitable. Mkt Cap £978m, StockRank 96.

Energy

Lamprell REMAINS. MktCap £514m, StockRank 96.

NWF REMAINS. Mkt Cap 72.3m, StockRank 97.

Telecoms

Adept Telecom REMAINS. MktCap £47m, StockRank 93.

BT REMAINS. MktCap £39n, StockRank 89.

Healthcare

Animalcare REMAINS. MktCap £45m, StockRank 96.

Alliance Pharma is OUT replaced by… Indivior. Shares in pharma company Indivior have risen by 68% in the seven months since it was spun out and floated by Reckitt Benckiser. Concerns exist about the future profitability of its drug portfolio butr on the current financials it continues to rank exceptionally well on a blended basis. Mkt Cap £1.79bn, StockRank 99.

Utility

Jersey Electricity REMAINS. MktCap £58m, StockRank 96.

Dee Valley REMAINS. MktCap £56m, StockRank 87.

Trumping those behavioural biases

I can’t tell you how much that new list of stocks makes me squirm. The idea of rebalancing out of such names as Cohort, Costain, Character Group and James Latham into some of the above stocks fills me with terror. My own bias says Indivior has done enough already ( I own it ) while Empresaria, Air Partner and Sylvania Platinum are sending the overall list deeper into microcap territory which is not an area of the market I personally enjoy investing in. So my bets are on the original NAPS portfolio winning the horse race at the end of the year… but of course… I most likely am seriously biased and over-attached to the names already held. Would be fascinated to hear your opinions.

Disclosure of interest - Of all the stocks mentioned Ed currently has stakes in 3i, Berkeley Group, Character Group, Computacenter, Costain, Dart and Indivior.