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Why a checklist may be more important than ever in the uncertain months ahead

In a guest editorial, Stockopedia's Ben Hobson examines the importance of having an investment checklist in uncertain times
representing investment
So how can investors prepare?

It has become hard to tell the difference between silly season and the realities of what Brexit (especially a ‘no-deal’ Brexit) might actually be.

We’ve had eye-catching scare stories about stockpiling food and medicine and the prospect of motorways being turned into permanent lorry parks ...

With less than eight months to go before the official leave date, the more clarity that emerges about Brexit, the more mind-boggling the exercise seems.

Far from an orderly process, it feels more like a political barroom brawl. And considering that there could be far-reaching consequences for at least some UK shares, the uncertainty (and the hysteria) is likely to ratchet up considerably in the coming months. So how can you prepare?

The art of ignoring noise

The issue for stock market investors is that the outcome and consequences of Brexit are hard to predict.

One assumes that fund managers up and down the land are modelling various outcomes and considering how they might position themselves accordingly.

But for individual investors, this kind of forecasting is a difficult and very possibly futile exercise.

In the uncertain months ahead, what might make more sense is to tune out the market noise altogether.

In ‘The Little Book of Behavioral Finance’, the analyst James Montier insists that worrying about much of this stuff is a waste of time. He writes:

“It is far better to focus on what really matters, rather than succumbing to the siren call of Wall Street’s many noise peddlers. We would be far better off analyzing the five things we really need to know about an investment, rather than trying to know absolutely everything concerned with the investment.”

A good example of how this works in practice can be seen in the checklist-approach used by Keith Ashworth-Lord, whom I interviewed a couple of summers ago.

He runs the Sanford DeLand UK Buffettology Fund, which over the past five years has achieved an impressive cumulative return of 128.7%.

As the name suggests, Ashworth-Lord’s fund is inspired by the US investing legend Warren Buffett. But more precisely, his modus operandi is based on something called Business Process Investing.

Simply put, he has a strict checklist that each stock has to pass if it’s to make it into his fund:

●      Their business model is easy to understand; 

●      They produce transparent financial statements; 

●      They demonstrate consistent operational performance with earnings being relatively predictable; 

●      They generate high returns on capital employed; 

●      They convert a high proportion of accounting earnings into free cash; 

●      Their balance sheet is strong without unduly high financial leverage; 

●      Their management is focused on delivering shareholder value and is candid with the owners of the business;

●      Their growth strategy is more likely to rely on organic initiatives than frenetic acquisition activity.

Source: Sanford DeLand Asset Management

This is a useful list of criteria for anyone looking for high quality, Buffett-like businesses. But Ashworth-Lord also spends time digging through accounts and doing valuation work so he can buy the stocks he likes at prices below their economic worth.

As a result, he thrives when markets are volatile. Because, instead of being unsettled by market noise (like many others), his decisions are pre-made according to his checklist.

Ashworth-Lord is a buyer in uncertain conditions when valuations fall and he can snap up shares of firms he knows well. And once he’s bought them, he holds them until the investment case changes.

His checklist approach is a useful template for individual investors facing a particularly uncertain near future.

It would be remiss to not take a look at the kind of shares an Ashworth-Lord type strategy might consider at the moment.

In recent years, his fund has done well from positions in stocks like Games Workshop, Ab Dynamics and Bioventix among several other fast-growing small-caps.

At Stockopedia we model various strategies that echo this kind of high quality, Buffett-like approach. This screen looks for firms with strong profitability and cash flow, low leverage, price strength and reasonable valuations.

This snapshot of the results (sorted by ROCE) include a set of stocks that may well be familiar to investors who look for high quality, high momentum stocks - although some have seen their prices weaken in recent months.

Name

Mkt Cap £m

EPS Growth Streak

ROCE % 5y Avg

Free Cash Flow

Earnings Yield % Last Year

4,412

9

2,132

157.1

4.05

342.9

6

72.8

14.2

4.40

567.3

6

57.8

25.7

5.64

2,924

8

43.2

139.2

8.65

252.8

5

33.1

16.2

9.06

4,554

5

29.9

152.2

6.87

982.7

9

29.2

7.32

6.46

2,005

5

26.4

225.3

11.4

565.1

5

24.3

25.0

7.85

451.4

8

23.9

25.8

4.88

A checklist to combat uncertainty

One certainty amid the months of confusion that lie ahead is that stock markets could become unsettled as the UK edges towards the EU door.

The lack of clarity about what a deal (if there is a deal) will look like, sadly adds to the uncertainty. It’s in these conditions that it’s worth revisiting a personal investing checklist.

Regardless of what strategy you use, preparing for the prospect of a bumpy road ahead could be time well spent. Ignoring the noise and focusing on what really matters could help you keep your head when everyone else is losing theirs.

 

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