Every December, Sanlam Private Wealth’s analysts choose the stocks they expect to offer the most value to investors in the coming year. Alwyn van der Merwe, Director of Investments, has made these stock picks.
Combining value and momentum
Over the years we’ve learnt that the one-year investment outcome of a limited list of shares can be very random. Sometimes the selected shares might have a good start, only to fade towards the end of the period. Sometimes a share that looks attractive on valuation grounds might be a non-starter as investors take longer to recognise the value.
Because of these uncertainties I follow a particular approach to ensure we can at least explain the methodology in picking these shares. Last year I followed an approach where I picked shares on valuation criteria in combination with so-called momentum criteria – price momentum and earnings revision. I’ve followed a similar approach to select shares for 2016.
Sappi
This share trades at the same price it did in 1989! It was a company that operated in a very competitive industry where it had little influence on the price of the products it sold and where the returns on the assets were particularly small. However, the valuation looks attractive as the share trades on a 9.5 times forward earnings multiple, which is a steep discount to the rest of the market.
The company has been on an efficiency drive, with a number of initiatives to improve in areas where the business was poorly run. These improved efficiencies are likely to provide impetus to improved earnings performance. The latter should lead to a higher rating from investors and therefore outperformance for those who believe management will deliver on its promises.
KAP
Since the lows recorded in 2009 the share price has displayed a clear bull pattern. The risk is always that one is too late into the action as the share trades on quite an elevated earnings multiple of 17 times.
However, this is a classic case of the management team transforming a company. Management has focused on the businesses it is good at and divested from the rest. The result has been a business with higher margins and a better return on capital. We assume that although the low-hanging fruit has been harvested, management can still squeeze out further efficiencies, which is likely to support the share price.
Barloworld
This company screens very well on value but not on momentum as it struggles with substantial headwinds in the industries in which it operates. As it is largely exposed to resources markets, the earnings stream is more cyclical and, of course, given the current slump in commodity prices, new orders are significantly down. In addition, Barloworld’s operations in Russia will do little to boost investment confidence.
Management, however, has divested from some non-performing businesses like its European logistics and Australian vehicle retailers. The increased focus and the limited downside of the operations in the resources area should turn the fortunes for the share price from very depressed levels.
Nedbank
Nedbank is another share selected largely on valuation criteria. The share trades at an attractive earnings multiple of 9.7 times and on a price to tangible book value of 1.6 times. The share has delivered steady earnings yet the share price has lagged the sector average. Investors question the bank’s provision policy and are clearly concerned about the ‘lazy’ capital following the latest Basel capital requirements for SA banks.
Nedbank might be boring but we’re comfortable with a bank that doesn’t produce negative surprises. It recently bought into Ecobank – operating in Africa – which should also be earnings accretive. With no negative surprises and a low rating, this one is likely to provide a good return relative to the risk one takes on board when investing in this bank.
(More stock picks to follow)
