SIF Portfolio: Pan African Resources update + Alternative Networks

The temptation to break your own rules when investing is immense. But there’s a lot of evidence which suggests that sticking to a set of buying and selling rules over a long period is one of the best ways of generating decent returns.

The proof of the pudding can be found in the exceptional long-term returns of disciplined, methodical investors such as Warren Buffett, David Dreman and Jim Slater.

Indeed, if you’re interested in seeing how a Buffett-inspired value and quality approach can be applied successfully to the UK stock market, I’d strongly recommend reading Strategies Editor Ben Hobson’s new interview with fund manager Keith Ashworth-Lord. Keith runs the Sanford DeLand UK Buffettology Fund which made 27% in 2015, pushing it to the top of the IA All Companies sector.

Should I tweak my screen?

In my case, the temptation to tweak the rules of my Stock in Focus screen in order to broaden the potential pool of buy candidates is stronger than ever this week.

I’ve mentioned before how steep valuations and limited earnings visibility have caused a big drop in the number of stocks qualifying for my SIF screen. A high valuation means that my requirement for an earnings yield (EBIT/EV) of 8% or more isn’t satisfied. Poor earnings visibility means that earnings growth metrics are too weak.

Because companies must qualify for my screen before they can join the SIF portfolio, finding new buys is difficult at the moment. The number of stocks qualifying for the screen has hit a new low of three this week.

Of these three, Somero Enterprises and BAE Systems are already in the portfolio. The third stock is a Russian energy firm which I feel is probably outside my circle of competence.

Of course, when building a portfolio, there is rarely any rush. There’s certainly no need to buy a new stock every week. However, I’m keen to understand how market conditions are affecting the number and type of stocks qualifying for the screen.

To satisfy my curiosity, I’ve been experimenting with the screening rules. I wanted to know if there was a single requirement that was blocking otherwise attractive companies. I’ve discovered that many companies which would otherwise qualify are being excluded because they’ve underperformed the market this year.

This underperformance is reflected in a negative 1-year relative strength figure (RS 1y). My screen specifies that this should be positive. Removing this screening requirement increased the number of stocks which met all the other requirements for my screen from 3 to 17.

Should I ignore relative strength in order to find attractive stocks?

What about Alternative Networks?

One of the stocks which qualified for my screen when the requirement for RS 1y >0 was lifted was telecoms reseller Alternative Networks. Telecoms is classified as a defensive sector and Alternative Networks would have been a useful, diversifying addition to the Stock in Focus Portfolio.

The stock scores highly for value and quality and has a StockRank of 81.

However, a profit warning earlier this year knocked the share price, which has continued to drift lower. This means Alternative’s 1-year measure of relative strength is negative, preventing it qualifying for my screen:

I was originally tempted to ignore this requirement and add the stock anyway. But I soon realised this would be a bad idea. Each of the criteria in my screen serves a particular purpose (I hope!). The purpose of relative strength is that it indicates share price momentum.

My screen was designed to find good, improving stocks at reasonable valuations. Alternative Networks doesn’t seem to fit this category, at least not at the moment.

After the profit warning in February (see Paul Scott’s write-up here) the firm’s interim results in June warned of a second-half weighting to profit. Market scepticism is reflected in a 7.4% forecast yield for this year. The market confidence needed for share price gains is currently missing.

As a result, I’ll be sticking to my rules and will not be making any additions to the portfolio this week.

Do you stick to the rules?

Stockopedia is very much focused on using rules and statistical factors as the basis for investment choices. Long-term use of Stockopedia has certainly made me focus more seriously on developing a repeatable process for my own personal investments.

I’d be interested to know what you think about this. Do you have a fixed, rules-based process for picking stocks, or do you rely more heavily on an individual analysis of each business?

Pan African trading update

Getting back to the SIF portfolio, gold miner and portfolio member Pan African Resources issued a surprise trading update on Tuesday. Pan African was one of the earliest members of the portfolio and is the top performer so far, up by 46% since May.

Tuesday’s update was made to satisfy the requirements of the Johannesburg Stock Exchange, where Pan African is also listed. Whenever results for the current period to reported upon are going to differ by more than 20% from those of the comparative period, a trading update is required.

Pan African’s fast-rising earnings mean that’s the case here. Picking out the key figures from Tuesday’s update, normalised earnings per share for the year ending 30 June 2016 are expected to be between 2p and 2.13p. Headline earnings are expected to be between 1.37p and 1.5p per share.

For JSE-listed companies, I tend to view headline earnings per share (HEPS) as a useful measure. HEPS is a measure of adjusted earnings defined by the JSE. It’s designed to reflect trading performance, excluding non-cash items such as asset impairments. However, it’s more restrictive than companies’ own adjusted earnings.

Pan African shares didn’t move after yesterday’s update. I suspect this is because the firm’s earnings guidance appears to straddle current broker consensus forecasts of 1.71p per share. So full-year results in September seem likely to be broadly in line with expectations.

One thing that Pan African’s trading update did highlight was the massive dependency on currency factors for South African commodity firms:

The lack of currency hedging and the interplay between the South African Rand, US dollar (in which gold is priced) and Pan African’s GBP reporting currency means that reported profits won’t always change in line with the price of gold.

However, Pan African’s performance last year appears to have remained in line with expectations. The stock will remain in the portfolio until its six-month review in October.

Disclosure: Roland owns shares of BAE Systems.