Raymond Greaves, Head of Research at finnCap
As an engineer by background, I love data and using it to model complex systems.
I firmly believe this can be applied to stock selection too. Many investors will say they do the same but too often it is focused on subjective analytical techniques and shrouded in non-financial considerations like quality of management or even gut instinct. Very few people in my experience have systematic ways of assessing businesses – Harry Nimmo, Head of Smaller Companies at Standard Life Investments, being a notable exception with his quantitative tool called the Matrix.
Data is non-subjective and is also increasingly available. Through improved investor tools like Factset, Capital IQ and Datastream, there is now a far greater democratisation of data.
In the UK small/mid cap space, there are around 1,500 companies – far too many for a generalist fund manager to get to grips with. No one broker covers them all, so the universe is very fragmented.
Therefore, I have developed a methodology which has a clear set of fundamental rules and tests and have been doing this for eight years. I call it The Slide Rule. It is effectively equity research on a massive scale with computing doing all the leg work.
Firstly, the system only considers companies with revenues and profits. Therefore it instantly rules out early stage businesses. We also avoid banks and insurance companies as they have their own complexities. This leaves us with approximately 500 companies.
The Slide Rule then looks at 11 key metrics which fall under four categories: Quality (eg return on capital), Growth (eg EBIT growth), Value (eg P/E ratio) and Momentum (eg earnings revisions): QVGM. The factors can then be combined and/or ranked in any way. At its most basic, we can find the cheapest stocks in the universe, the highest quality, fastest growing or highest momentum.
We can then apply 12 ‘red flag’ tests which are designed to sift out companies which might have issues such as poor quality cashflow, limited dividend affordability, elevated levels of financial stress or any unusual movements on the balance sheet.
Our preferred approach to stock picking combines the Q, V, G and M metrics in a proprietary way but the weighting is towards Quality and Growth. We also apply the 12 ‘red flag’ tests. We select the top 30 companies and re-run the process on a quarterly basis. We call this portfolio of stocks QVGM+.
So, how successful is QVGM+? The answer is: very. The methodology has delivered an annual compound 31% return (over 8 years, including dividends). This compares to UK small/mid-cap which has grown by a measly 6% compound over the last eight years (also including dividends).
The Slide Rule has provided us with many fruitful ideas. One is the Ambition Nation Listed 50, a simplified version of The Slide Rule that attempts to identify the ‘best’ 50 quoted companies in the UK. The Slide Rule is recalibrated to find the companies with the best blend of quality and growth (valuation and momentum are not considered). The other criteria are: they must be UK-based companies and range between £100m to £1 billion market cap and, of course, pass all the 12 red flag tests.
The outcome is an annual report and set of awards that acknowledge the best of the best in small and medium sized companies, celebrating the achievements and innovation of these businesses which are potentially the FTSE 250 companies of the future (indeed many have gone on to be so). They are not only the businesses of today, but the businesses of tomorrow. It is a celebration of the lifeblood of corporate Britain. They are the top 50 small and medium listed companies across the UK that are driving the growth of the economy. They actually show what is good about the UK listed environment, reminding people of the benefits of being a listed company.
We recently announced the winners of the 2020/2021 Ambition Nation Listed 50. As a group, these 50 companies delivered an average return of +74.5% over the year to September 2021, outperforming the underlying market by 33% – a very satisfying outcome! The overall highest ranked business was City of London Investments and the best performing company overall was technology group Cerillion (+183%). If we look at the composition of winners and also those included in the new cohort (2021/2022 Ambition Nation Listed 50), a common underlying theme is that these companies are generally capital light businesses, lean and agile organisations, which have adapted well to the pandemic. The data would suggest these could be the businesses of the future.
