SIF October review: Small wins and big losses leave me lagging the market (BON, MOTR, KLR, NXR, EZJ & BNC)

The recent market sell-off has hit by rules-based Stock in Focus (SIF) fantasy fund hard. Although SIF is still ahead of the market on a one and two-year view, over the last six months it’s fallen behind index-following rivals.

Unsurprisingly, this month’s correction has accounted for the majority of the portfolio’s losses.

What’s gone wrong? I think it’s fair to say that this sharp drop has highlighted the risk of investing in stocks whose valuations have been lifted by strong momentum. When momentum goes into reverse, the same businesses are suddenly given lower valuations.

Did I overpay for some stocks? Perhaps a few.

Are they bad companies? I don’t think so. In most cases I’d be happy to hold the stocks for a medium-term recovery if my trading rules allowed me to do so (they don’t - see here for an explanation).

I’ve bought more easyJet: A portion of my own real-money portfolio mirrors the SIF. By and large, I follow the same rules. But I do allow myself the occasional exception, and in October I bought more easyJet shares.

easyJet shares have fallen by about 25% over the last three months:

This decline appears to have been driven by three factors:

• Fears of Brexit armageddon;

• the possibility of a Ryanair-style profit warning;

• the risk that sector profits will be hit by overcapacity and rising fuel prices.

Personally, I see easyJet as a leading operator that’s avoiding Ryanair’s largely self-inflicted problems. So I’ve bought more. Please note I haven’t averaged down the SIF fund’s holding. I’ve only increased my personal shareholding.

Averaging down: I’m aware that for momentum investors, averaging down is seen as the ultimate folly. You’re buying more shares when you’ve already been proved wrong.

On the other hand, for value investing I think it’s perfectly logical. You’re buying more when something good just got cheaper. That’s what I think is happening with easyJet, although obviously I could be wrong.

5 stocks under review

I’ve touched on the portfolio’s disappointing half-year performance already. In the remainder of this piece I’m going to look at some of the individual stocks behind this slump. No fewer than five stocks are up for review this month, after having been in SIF for nine months or more:

• Ladieswear retailer Bonmarche Holdings (LSE: BON)

• Used car supermarket Motorpoint (LSE: MOTR)

• Spanish banking group Banco Santander (LSE: BNC)

• Geotechnical engineering specialist Keller Group (LSE: KLR)

• Bathroom products group Norcros (LSE: NXR)

Here’s how each stock has performed so far during its time in the portfolio:

Bonmarche Holdings (LSE: BON)

Original coverage 13/12/2017

Last month I decided to keep Bonmarche in the folio for another month, as it still passed my screening criteria. Unfortunately the firm issued a sales warning two days later, sending the shares down by 18% in one day.

Graham Neary covered the problems in his small-cap report that day, which you can read here. I share Graham’s view that management are in danger of appearing complacent, and may need a more proactive strategy to cut store costs and numbers.

The stock no longer pases my screening rules on several counts, so will be sold this week. A chunky 7.7% dividend yield has saved SIF from a bigger loss, but the outcome remains disappointing.

Verdict: Sell
Total return: -9.2pc

Motorpoint (LSE: MOTR)

Original coverage 06/12/2017

For the second consecutive month, the UK’s largest retailer of used cars continues to qualify for the SIF screen. So it will remain in the portfolio for at least one more month.

Verdict: Hold
Total return to date: +8.2pc

Banco Santander (LSE: BNC)

Original coverage 03/01/2018

The UK banking sector has suffered a big sell off this year. Despite a diverse international footprint, Spain’s Banco Santander has been hit hard. The shares are down by 25% so far in 2018.

Stockopedia’s algorithms have also turned hostile on the stock, awarding it a StockRank of 38 and a StockRank Style of Value Trap. This has left the Spanish bank as one of the worst-ranked stocks in its sector.

The bank’s latest results suggest to me that its performance hasn’t been all bad. An underlying return on tangible equity of 12.2% compares well to most of the big London-listed banks. A cost-to-income ratio of 47.5% is also better than most.

However, a Common Equity Tier 1 ratio (CET1) of 10.8% is lower than that of most rivals. This measure of surplus capital is also fairly close to the regulatory minimum, which I understand to be 9.5%.

Another concern is that bad debts are relatively high, at 3.92% of outstanding loans. Although this figure is falling, Lloyds only reported an impairment rate of 1.8% at the end of June 2018.

Santander’s falling share price has given the stock a negative relative strength value, so it no longer qualifies for my screen.

Verdict: Sell
Total return: -17.3pc

Keller (LSE: KLR)

Original coverage 10/01/2018

I covered Keller’s profit warning in my piece two weeks ago (you can read it here). So I won’t spend much time on this today, except to admit that this is a big disappointment.

I think the lessons learned here are that even though this specialist groundworks contractor is a market leader, it’s still prone to the classic construction sector problems of slim margins and lumpy revenues.

A second point is that this month’s profit warning isn’t the first time Keller’s Asian business has fallen short of expectations. So I should probably have been more sceptical about management guidance for a return to profit in this region.

A trading update is due later in November. This may contain better news. But rising debt, falling profits and a share price slump mean that the stock no longer passes my screening tests and must leave the folio.

Verdict: Sell
Total return: -36.6pc

Norcros (LSE: NXR)

Original coverage 23/01/2018

This maker of bathroom and kitchen fittings always seems cheap and always appears to be on the cusp of stronger growth. The firm’s recent H1 trading update was a good example. Reported revenue was +12.1%, but constant currency like-for-like revenue was -0.3%.

It seems that much of the firm’s growth in recent years has come from acquisitions. Improvements in margins and return on capital employed seen in 2016 haven’t been sustained:

This still looks a good cheap business to me, if a little lacking in quality and competitive advantages. Stockopedia is cautiously optimistic, with a StockRank of 84 and a Neutral style.

However, rising debt, dilution from a recent share placing and falling margins are all concerns. They are also among the reasons why the stock’s Piotroski F-Score has fallen below my minimum of 6/9.

As a result, Norcros no longer qualifies for my screen and must be sold.

Verdict: Sell
Total return: +6.2pc

What next?

After this article has been published, I’ll sell both the fund’s virtual holdings and my personal holdings in the stocks I’ve marked as a sell.

I freely admit that the SIF folio is now in uncharted territory, as the market momentum we’ve enjoyed in recent years appears to be fading. Despite this, I won’t be making any changes to my trading rules or screening criteria just yet.

Next week, I hope to return to the acquisition trail with an affordable growth stock that isn’t about to issue a profit warning!

As always, I really appreciate your feedback and comments, which help to shape my thinking and coverage of the SIF fund.

Disclosure: Roland owns shares of Bonmarche Holdings, Banco Santander, Keller, Motorpoint, easyJet and Norcros.