Recent volatile markets have given me the incentive to cast my net wider in the search of quality shares. My watchlist has taken on more of a growth dynamic, even though much of my focus is on income, and to a lesser degree value, and likely always will be. Nonetheless, with income and value out of favour, I think it’s prudent to tap into – in a measured way – the potential of smaller, growth shares. This is why I’ve fairly recently bought into Team 17, which is in the red-hot gaming sector. A similar logic can also be applied to my purchases of Moneysupermarket and Diageo – the latter in particular not being particularly cheap nor high yielding.
Part of this shift in strategy will involve tracking shares that have a high P/E and may on the face of it appear to be expensive. However, a P/E is only part of the equation and has its drawbacks. I’ve found shares that combine a high P/E with a low PEG, indicating they may be good value. Though at first glance they may not appear it. That’s why it’s always worth spending time researching shares.
Here are just four shares that have come onto my radar, are on my watchlist, and may be worth further investigation. The first is what I’d categorise as a growth at a reasonable price (GARP) share, the second is growth while three and four are FTSE 100 companies. As you can see then they’re all quite different. But all potentially would make good additions to a portfolio for different reasons.
Polar Capital (LSE:POLR)
This AIM-listed investment manager combines a good value, as shown by both the P/E and PEG, along with a high dividend yield making it quite the share in my book. However, the most recent update which came after I first analysed the fundamentals wasn’t as positive as I might have hoped. Perhaps this explaining why the shares are cheap. The update showed a drop in assets under management and profit for the year.
Polar Capital operates in an industry that usually has good margins. Polar’s margins of 33% feel like they compare well. Another smaller asset manager like Liontrust has an operating margin of around 20%.
The group has 24 funds (at the time of writing – July 2020) covering themes ranging from financials to artificial technology through to regions such as Asia. Many of the funds are quite small but the Global Technology Fund has £4.2bn of assets under management.
Overall, combining high margins, a cheap valuation, earnings growth and paying a dividend all put Polar Capital right at the top of my watchlist. With a market cap of just under £500m, it has room for growth. It’s a share I’m very likely to invest in, despite the less than glowing recent update.
AB Dynamics (LSE:ABDP)
Automotive testing company AB Dynamics has carved out a profitable niche for itself and earned a high P/E. The P/E is over 30, but based on historical earnings, the PEG is a much more reasonable 0.6. On that basis its shares would be investable – based on criteria set out by Jim Slater in The Zulu Principle. Along with ROCE of 18.7%, a non-exec chair who owns 26% of the shares, and a debt to equity ratio of 0.26 means it has many of the hallmarks of a quality company.
The part that worries me is what will happen to it as the car industry and how will this affect the company and its share price?
It seems to me like there are two competing stories when it comes to this share. On the plus side, there are vehicle safety regulations which are driving sales of its Advanced Driver Assistance Systems (ADAS) test platforms. On the other, Investors Chronicle points out automotive R&D budgets are expected to fall in both 2020 and 2021.
It’s a good company, judged by the historic fundamentals, but I’m less sure about the market it operates in. Given how important sentiment is to all share prices, but perhaps more so with smaller companies, I’m not completely convinced by the company – but it could be profitable longer term. It’s likely to stay on the watchlist for the foreseeable future.
Severn Trent (LSE:SVT)
Water company Severn Trent is never going to set pulses racing. At the current time though, where the future is more uncertain than it has been in previous years, a boring company could well make for a profitable investment. If part of a wider portfolio that has some cyclicals in it and other companies with better pricing power then I think Severn Trent has its place.
I’d never recommend only investing in a utility with regulated earnings. Most investors would want to see better growth than Severn Trent could ever offer. On the other hand, though a relatively secure dividend, high visibility over future earnings and a business providing a vital service – the delivery of clean water to millions of homes, means the utility will survive covid-19 and one would have to think most challenges that can be reasonably be expected to come up in the future.
There’s nothing wrong with having some defensive steady eddy, boring companies as part of your portfolio. I’d argue that they have a value to play for every investor, but especially those looking for income. Given growth is never likely to be high and investors have been turning to defensive companies as the stock market has oscillated, finding the right entry point for buying the shares might be the trickiest part.
Rio Tinto (LSE: RIO)
Rio Tinto is not without controversy, most recently upsetting Aborigine communities in Australia. This may come at a bad time for the miner as ESG investing seems to be gaining ascendency. Yet, it’s hard to overlook the dividend. In the short-to-medium term, it’s very likely emerging economies, especially China will care more above lifting millions of citizens out of poverty rather than cutting carbon emissions.
Another downside is Rio Tinto is highly cyclical and reliant on global prices for what it mines, giving it relatively little pricing power. Instead what it does well is mining at low cost which helps it achieve high margins.
Rio Tinto is attractive to income investors based on the yield. It’s currently around 6.9%. As with any cyclical stock, the dividend is always more at risk, but overall I’m happy there is enough dividend cover for investors. There’s also in my view enough potential for dividend growth, despite the controversies around the company.
This is a mixed list of watchlist shares. The first two have gone through screening and I think could be very good buys, especially in the case of Polar Capital which is much lower-rated. Along with AB Dynamics, the shortlisting of these shares marks my slight shift towards growth in this current environment which is tricky for income investing. The fundamentals make them the best of a long list of AIM shares I looked at.
The inclusion of Severn Trent is consistent with my approach in these uncertain times to include steady eddy shares to protect my downside – along with holding cash. Rio Tinto is on the watchlist because of its income potential and particularly because of the high dividend yield.
This article is not a recommendation to buy these shares and just reflects my personal opinion. As always any investor must do their own research.
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