Eight shares for the future

Although I've removed FW Thorpe from my list of shares for the future, I'm not heading for the exit. At 8%, FW Thorpe is the Share Sleuth portfolio's biggest holding, precisely because I have a lot of confidence in its future.

The shares have risen nearly 20% in the last month though, enough to reduce FW Thorpe's earnings yield to 6%. If the company continues to perform as I hope and expect it will for a long time, this will not matter.

But this list of shares to hold for the long-term is plucked from those 50 or so shares that the Share Sleuth spreadsheet tracks most closely, shares I would consider adding right now if the model portfolio had the cash because they are both good and cheap.

The earnings yield, a company's adjusted profit divided by its enterprise value (the market value of equity plus net debt) is a rough proxy for return on investment. Since profit is, in accounting terms at least, the money left over after all costs, the money that "belongs" to shareholders, a company could, in theory pay the entire earnings yield as a dividend, and stay in business. Most companies don't do this, they retain earnings to invest in growth, and if they do this well, our return will increase over time.

For companies likely to grow, I believe an 8% earnings yield is a good baseline, although I might use current earnings, the average of past earnings, or even an estimate of future earnings if I believe I can be certain enough. Although Thorpe probably will return more than the 6% indicated by its current earnings yield in future, because of its relatively high valuation now it leaves the "Add" section of the spreadsheet and joins the "Watch" section.

Since I aim to hold shares indefinitely, I prefer to focus on the culture of a company than its personnel. Culture is more likely to endure. News that John Rishton, chief executive of Rolls-Royce, has stepped down, and has been succeeded by Warren East has not changed my opinion of the company, which has technological prowess, trusted brands, scale, a culture of prudent innovation, and a strategy I believe will strengthen those advantages over the long-term.

To the extent that I can read personalities and tea-leaves, I approve of East as a replacement although his background is not in jet engines. ARM, the silicon chip designer, prospered under his management, and he is already a non-executive at Rolls-Royce so he's probably well-versed in the culture. ARM under East was brilliant at communicating with shareholders (it still is), a perceived shortcoming of Rolls-Royce.

The company that came closest to joining my elite cadre of good companies at cheap prices in April is Sprue Aegis. Sprue designs and distributes smoke alarms and carbon monoxide detectors. It’s a pucker growth company, at a pretty reasonable valuation, although I'm cautious about its curious and sometimes adversarial relationship with its supplier.

Dialight is also pressing for entry. Like Thorpe, Dialight manufactures LED lighting systems. Unlike FW Thorpe, it focuses on hazardous environments and manufactures the lamps as well as the infrastructure of circuit boards, reflectors, lenses, and power supplies around them. For the first time in recent memory the shares are on a higher earnings yield than Thorpe's. That fact alone does not make them a buy, but it does make them interesting.

Both of these companies trade on earnings yields of 7%, or about 15 times adjusted earnings.

With one relegation and no promotions, there are eight companies out of the fifty or so closely tracked in the Share Sleuth spreadsheet that I would consider adding to the portfolio now. As usual, the hyperlinked names lead to my analysis. The elite eight are:

Animalcare [EY: 8%] Manufactures generic and enhanced pet medicines. Also supplies pet identification and veterinary products.

BrainJuicer [EY: 8%] Conducts market research using techniques adapted from behavioural science research.

Castings [EY: 12%] Casts and machines cast iron parts for commercial vehicles.

Dewhurst [EY: 15%] Manufactures pushbuttons and other components for lifts, keypads and railway rolling-stock. Also bollards, signage, and other traffic management products.

Goodwin [EY: 11%] Manufactures castings and machined components, principally valves and pumps used in oil pipelines. Also processes minerals used to make casts, mainly for jewellery.

Rolls-Royce [EY: 8%] Designs, manufactures and services gas turbines for aeroplanes and piston engines for boats, trains, tanks, mining trucks, submarines and power generators.

Sagentia [EY: 10%] Does research and product development for customers in medical, industrial, consumer and energy industries. Advises on strategy.

Treatt [EY: 7%] Sources and processes ingredients, principally essential oils, for flavours, fragrances and cosmetics

All my recent analysis for Share Sleuth.