Trending value: 5 stocks for the next boom market?

Earlier this week Ed published a piece exploring the idea of Trending Value – in other words, buying cheap, improving stocks with positive momentum. These might be stocks overcoming temporary difficulties or perhaps going through a period of transition.

The key is to ensure they have momentum as well as value – this is a quite different strategy to the Deep value approach Ed discussed previously.

In the StockRank system, trending value shares are typically those with high ValueRank and MomentumRank scores. Even more simply, we can look for stocks with a high VM Rank – you can find a handy listing of the Top VM Rank stocks here.

A new boom market?

I’d suggest exploring the VM Rank listings as a starting point. I can certainly see some shares that are on my radar on this list right now. However, I think there’s scope to refine this view further by narrowing down the selection using some additional metrics – or perhaps – by narrowing down the choice of sectors.

One interesting trend I’ve noticed in my own research over the last 6-12 months is the number of times my screening has flagged up industrial stocks as potential buys. One great example was Bodycote (LON:BOY), which I covered in a Stock Pitch in November last year.

What I’ve been finding is that these industrial businesses have often looked in quite good shape, reasonably priced and with a fairly positive outlook.

At the same time, I’ve faced a mental stumbling block due to the prevailing narrative that we could be facing a broader economic slowdown. If this happens, surely the outlook for industrials will deteriorate?

Well, perhaps it will. I certainly wouldn’t rule out this happening, at least in the short term. But I’ve become aware that there’s another medium-term narrative here that could drive a wave of momentum for industrial stocks and other related sectors, such as defence and infrastructure.

Are we heading for a capex boom?

Ed pointed me towards an article that tells this story very well.

In short, noted financial historian Russell Napier believes the wave of government-guaranteed loans we’ve seen since 2020 are becoming a policy tool for Western governments to direct banks’ lending – and thus, to direct capital investment.

As with quantitative easing after the 2008 financial crisis, government credit guarantees started out as an emergency measure. But they are rapidly becoming an established policy tool. As economist Milton Friedman once said:

“nothing is so permanent as a temporary government program”

Legislation such as the US Inflation Reduction Act and similar policies emerging in the EU and UK give us an idea of how this policy tool might develop.

Loan guarantees could be used to help solve important and pressing problems. Obvious examples include renewable energy, climate change, nearshoring manufacturing, and enhancing western defence capabilities.

Using government guarantees to direct and induce lending may also offer two other benefits. The first is that credit guarantees enable governments to increase credit issuance without having to issue more debt themselves.

The second is that by influencing the creation of credit, governments can keep inflation slightly above interest rates. This approach – known as financial repression – could be an effective tool for eroding the increasingly burdensome levels of debt in western economies.

I hope this doesn’t sound too political; that’s not my intention. I don’t know how accurate Russell Napier’s predictions will be and I’m certainly not advocating a particular ideological viewpoint here.

Napier’s ideas do have a certain logic though, in my view, and what he suggests would not be unprecedented. Governments of all stripes implemented policies of this kind in the UK and other western economies after WWII.

Napier’s theory is that these policies would initially be both popular and successful. Broadly speaking, I agree. Many people could benefit from wage growth and employment opportunities, while countries might see security and environmental benefits.

Of course, as with all unbalanced systems, things would probably go awry eventually. But that day isn’t here yet. In the meantime, I think the capex boom predicted by Napier could lead to some interesting opportunities for equity investors.

Where to invest?

If we combine this economic thesis with our theme of trending value, where might we find good opportunities today?

I do think there’s value in focusing on industrials, technology and adjacent sectors. These shares are classified by Stockopedia as Sensistives rather than Cyclicals.

What this means is that the business does not just provide a commoditised product. In contrast to a miner, for example, the activities of a sensitive business will typically create significant value in some way. Such companies may also benefit from intangible advantages such as intellectual property, brands, and network effects.

What this means is that a well-run industrial business may be able to weather boom and bust cycles without the extreme swings in profit we’re used to seeing from oil and mining stocks, for example.

For me, this equates to a level of downside protection if Napier’s capex boom thesis turns out to be wide of the market (or simply premature).

My personal ISA portfolio is currently overweight industrial and technology stocks, compared to the FTSE 100 average. So to some extent, I’m talking my book. But I do believe there are opportunities in these sectors right now:

In the remainder of this piece, I’ll take a look at some examples of companies in these sectors that I think might be attractive from a value-momentum perspective.

Trending value stock ideas

Ed describes two approaches to finding trending value stocks – the lazy investor’s approach and an active trading approach. The latter of these is far too involved and active for me, so I’ve used the lazy approach as a starting point for my choices. I’ve also added a few other stocks that I feel could fit well into a trending value setup.

Before I get to the shares, a word of warning. These shares come from just a handful of sectors, so are not very diversified.

Ed’s suggestion is to have no more than three shares from any single sector in a portfolio of 20 stocks.

I’d add that it’s important to look at the business, not just the sector in which it operates. Companies in different sectors can sometimes overlap heavily or be exposed to similar external forces. That’s certainly the case with many of these shares.

I don’t have the space for a detailed review of all of these, so I’ve selected a few to comment on below.

Gulf Marine Services (LON:GMS) - this offshore platform operator was a deep value play but may now be maturing into a trending value situation. Strong conditions in the oil and gas market, growing demand for offshore renewables, and deleveraging could create a big winner here, in my view.

However, investors should keep in mind that this is still a small cap with lots of debt. Significant risks remain.

Kier (LON:KIE) - this infrastructure and construction group underwent a near-death experience due to excess debt in 2020. The business has now been refinanced. Recent half-year results show significant growth in profits and back orders, in addition to a far healthier balance sheet.

The P/E of 4 is a reminder of the risks faced by investors in this sector, which is an accident-prone part of the market. But if current momentum continues, I think Kier shares could deliver good returns for a while. The StockRanks suggest a strong value-momentum profile:

Renold (LON:RNO) - this 160-year-old business is a small cap, but it’s a market leader in producing industrial chains. These have applications in a wide range of sectors, including mining, defence, energy, transportation and even escalators and bicycles.

Earnings forecasts were upgraded earlier this year. The most recent trading update reported a 19% revenue growth at constant currencies for the year ended 31 March, with a strong order book.

The valuation still looks very reasonable to me …

… and the StockRanks show a strong Value-Momentum bias:

Sigmaroc (LON:SRC) - this construction materials group is primarily a quarry operator. Quarries can be nice businesses, as high transport costs means customers generally buy locally.

Any kind of major infrastructure splurge will need large quantities of aggregates – buy-and-build operator Sigmaroc could benefit.

Sigmaroc’s trading is said to have remained “solid” in Q1, with underlying EBITDA slightly ahead of management expectations. While residential demand is subdued, the company says it’s seeing “resilience” across the infrastructure, chemical, environmental, agriculture and metals & mining segments.

Broker forecasts have remained positive, with growth expected to extend into 2024.

Rolls-Royce Holdings (LON:RR.) - shares in this FTSE 100 stock have already doubled from October’s lows. But I can only see two probabilities. Either the early signs of recovery will prove to be (another) false dawn. Or else Rolls’ turnaround is still gathering pace and has much further to run.

My feeling is that the turnaround has further to go. Civil aerospace, defence and offshore energy are all enjoying tailwinds and the business is being managed by a new chief executive with much to prove (and a reputation as a very effective operator).

Technical momentum appears to be exceptionally strong at the moment, with a MomentumRank of 99:

Broker forecasts suggest a 50% rise in earnings next year. Forecasts elsewhere suggest double-digit progress in 2025 as well.

As with all of these stocks, further research is required. But I think Rolls-Royce could prove to be an interesting trending value situation over the next couple of years.

Please let me know what you think in the comments. Am I wide of the mark, or do you see opportunities in these sectors over the next few years, regardless of the wider macroeconomic outlook?