Watchlist review: Jan 2018

What goes on the watchlist is a key part of my investing process, as it is where I screen possible investment candidates for quality (which I define as the likely extent, certainty and consistency of future growth in profits). I only ever want to invest in the highest quality shares, as I believe this is the key driver of excess returns in the long run. You can read about how I try to identify quality here.

I’ve recently opened up my watchlist to US and EU listed shares and allowed it to grow from 60 to 100 members. The shares have been selected using my standard quantitative screens followed by a lot of thought about which have the best competitive advantages and growth prospects. This has been an iterative process over a few months, gradually replacing the incumbents with better candidates as I find and research them.

Unfortunately I can’t really share all this thinking – there are just too many (about 50) new watchlist members. So to keep this post from becoming absurdly long and me from going mad, I’ve kept my reviews below very brief. Hopefully this is sufficient for readers to do further research on any they think look interesting.  You can also have a look at how I currently rank these shares in my watch list spreadsheet.

Before getting to the list, first here are some overall descriptive facts about my watch list, after the recent additions. I think it’s worth trying to make sure my watchlist is adequately diversified to maximise the opportunities it presents, notwithstanding that I want everything on it to be high quality.

The new watchlist

I have 50 UK shares, 38 US shares and 12 EU shares. So far I’ve found it a lot easier to identify high quality US rather than EU businesses, but I will try to increase the proportion of EU in the future. I’m happy to have a higher proportion of UK as my trading costs are a bit lower and there is no exchange rate risk.

The market caps vary from £100m to over £500bn. Opening up my watchlist to US has shares has shifted my sense of scale as I’ve found many very large US listed businesses which are still growing at a rapid rate. I am conscious that research into factors suggests smaller caps outperform on average so I may look to rebalance the watchlist towards smaller caps in subsequent updates.

I’ve also had a look at the diversification of my watchlist across industry sectors. As you can see in the chart below, I’m heavily overweight in technology and overweight but to a lesser extent in healthcare and consumer cyclicals. I’m happy with this, though I may try to increase the proportion of financials and consumer defensives. I don’t have any energy or commodity shares on the watchlist as they are all too cyclical.

allocation

UK

I’ve only added one new UK share since the last review:

  • IG Group: provides an online trading platform and specialises in CFDs and spreadbetting. Its main draws are extremely high profitability, a strong competitive advantage and fairly ‘sticky’ customers. It has more steady rather than explosive growth potential and is likely a little cyclical. Its main downside has been the threat of regulatory intervention. This appears to have receded somewhat, based on an FCA announcement this week so I’ve decided to add it back to the watchlist.

US

A few US shares have already made it into my portfolio so I won’t cover them again here: Google, FacebookApple, MasterCard, Arista Networks, IPG Photonics. These are the remaining US shares on the watchlist (in no particular order):

  • Moody’s: is a knowledge-based, capital-light and highly profitable business. It has a very strong competitive advantage, effectively providing the industry standard for measuring debt risks (in an oligopoly with S&P and Fitch), based on the huge amount of data and analysis it has accrued over time. Probably its main weakness is the long term capacity for further expansion, though it’s been pretty successful at this so far. It’s a relatively safe steady compounder, rather than exciting growth business.
  • Nvidia: is a current stock market ‘darling’ and the leading electronic chipmaker for a large number of applications. It seems to have a strong technological edge in big markets likely to experience huge secular growth. The main risks are from losing its technology lead and that the demand for its chips can be highly cyclical.
  • Activision Blizzard: is a world leading maker of computer games. This is a huge growth market with attractive economics. Activison seems to be ahead of the competition, owning a number of highly successful franchises, and is a first mover in developing eSports.
  • CBOE Global Markets: provides the world’s largest financial exchange for options and a wide range of financial derivatives. It’s a platform business, with excellent economics and a very strong competitive advantage in markets with a lot of growth potential.
  • Estee Lauder: a classic high quality consumer brands business. It’s highly profitable with a strong competitive advantage and should be very defensive too.
  • Stryker: makes a wide range of medical technology products. It’s a defensive market with very solid long term secular growth drivers. Stryker looks to have a strong competitive advantage and so should continue to do well for many years to come.
  • Trex: makes decking products out of wood-alternatives. It is at the smaller end of the US shares I’ve added to the watchlist, with a market cap of £2.5bn. It is very profitable with a good track record of growth in recent years. It looks to have a good competitive niche. I think it probably benefits from a secular growth driver as potential customers switch from wood to the cheaper and environmentally preferable alternatives it provides. On the downside I suspect it is likely to be fairly cyclical.
  • Accenture: is one of the largest global management and IT consulting businesses. It is a steady, boring compounder – very profitable and with a very long and reliable track record of growth (the long term share price chart is a joy to behold). Its reputation and the stickiness of its products and services likely give it a strong competitive advantage. These attributes have kept it right near the top of my watchlist since I added it, though the high valuation given the growth rate has kept me from buying till now.
  • Thor Industries: another stock that has persistently been near the top of the watchlist since being added, it has a clear competitive advantage from quality of products and scale and distribution efficiencies with almost 40% of the US recreational vehicle market. This allows it to make a lot of profit. The market has been booming of late: the bull case is that this is a secular expansion as younger generations are becoming more interested in RVs, while the bear case is that the boom is cyclical. I’m fairly positive but worried enough to be a little wary.
  • Intuitive Surgical: makes surgical robotic systems, which are controlled by a surgeon but have much greater precision. It has decent returns on capital and a good track record of growth. It is a first mover with a clear competitive advantage. Being a first mover is likely to be particularly advantageous in the healthcare sector. The growth prospects look excellent as the systems are more widely adopted across the world in a sector with defensive demand and secular growth. It looks expensive but also highly likely to be a long term winner.
  • Align Technology: another healthcare growth play, this is a similar proposition to Intuitive Surgical. It provides an innovative corrective orthodontic system that doesn’t involve unsightly braces. As a first mover, it has managed to dominate the market on the strength of its technology and the relationship it has built with dentists (through training etc.). It is currently growing into the larger adolescent market. Again, it’s expensive but probably justifiably so in the long term.
  • Allegion: is a provider of mechanical and electronic security products. It is a highly profitable and defensive business. It seems to have a good competitive niche. It currently benefits from a growth driver from demand for products with greater connectivity.
  • Mettler-Toledo: makes precision measurement and weighing devices for various industries. It is highly profitable and defensive, with an excellent track record of growth. It is one of the largest companies in its industry. Its competitive advantage comes from technology and product quality and, in its words, from a heavy focus on service to ensure customer retention and recurring revenues.
  • Priceline: has several platforms for travel and restaurant booking, notably Booking.com. The business has excellent economics and has been wildly successful, with an incredible track of growth over an extended period. It benefits from network effects and has a very strong competitive advantage as a result. The market benefits from secular growth as more consumers move to booking online.
  • AO Smith: makes water heaters and related products. It has excellent ROCE and margins and a long track record of growth. Its products have a technological advantage and it has almost 50% of the US market. It has good opportunities to expand overseas and is making good progress, particularly in China.
  • Visa: a payment provider very similar to MasterCard (reviewed here) though somewhat larger. So similar in fact that I don’t really have anything additional to say about Visa.
  • Adobe Systems: Adobe offers cloud based media and document processing software as a service (‘SaaS’). Its competitive advantage comes from market leading innovation and from very ‘sticky’ customers locked in to its subscription model. Both its consumer and business products are market leaders. While it is already a global business, it has a lot of opportunity for further growth through further improvement of its products and market penetration.
  • Monster Beverage: owns a number of energy drinks brands. It has been phenomenally successful with a long track record of growth and high profitability. Its competitive advantage comes from its brands. While it has already grown pretty large (it is more than 10 times the size of Fevertree for example), it still appears to have plenty of scope to continue to grow internationally.
  • IDEXX Laboratories: develops, manufactures and distributes technology products for the veterinary market. It is exceptionally profitable with high margins and huge returns on capital. Its competitive advantage comes from superior technology and its vertically integrated business model. As a result it has exceptionally high  customer retention rates and recurring revenues. The market is defensive and benefits from secular growth. in addition, IDEXX can take further market share and continue to expand globally. IDEXX is right near the top of my watchlist at the moment, having recently broken out to new highs, though it is a little pricey.
  • Cognex: makes machine vision products that incorporate camera technology into production lines. It has grown at a very fast rate for the past few years and has high returns on capital. It is a global technology leader with strong international and secular growth potential. It is likely quite cyclical. It publishes some extremely quirky annual reports (written by the founder).
  • Intuit: makes software to help US individuals and small businesses navigate their overcomplicated tax system. It is extremely profitable with a near dominant position and sticky customers on a subscription model. It has grown very quickly and continues to do so, though it appears limited from expanding internationally as its services are US-centric.
  • Cantel Medical: makes infection prevention products for the healthcare market. It is fairly specialised with a focus on automated endoscopy re-processing systems (to sterilise equipment for re-use), where it seems to be a market leader. I believe it has a competitive advantage from its technology and ‘sticky’ customers who are unlikely to switch. It has a really excellent track record of growth and has a lot of scope for further geographic expansion.
  • Stamps.com: provides internet-based mailing (stamps that you can print off from your computer + related tracking services etc.) in collaboration with the United States Postal Service. It is a very capital light and profitable business and has grown very rapidly in the last few years. The market is experiencing secular growth and Stamps.com looks to be having success in taking market share from other mailing companies. This suggests some competitive advantage to its USP. However, from a longer-term more strategic perspective, its competitive advantage seems less certain. I think there is a legitimate concern that it could get innovated around (or face entry from a larger player like Amazon).
  • Amphenol: is a large manufacturer of connector products (think electrical cables) and systems to the military, aerospace and various industrial applications. It has very healthy profit margins, decent returns on capital and an excellent track record of growth. While I’m not sure about the basis for its competitive advantage, it is the largest player in many of its markets and is gaining market share. It looks to benefit from secular growth trends.
  • Rollins: is a global pest control company. It is highly profitable, has excellent returns on capital and has an amazing track record of growth. Based on its scale and distribution network I’d say it looks likely to have a strong competitive advantage. Its main draw is that it is in a very defensive market with strong growth drivers and opportunities for international expansion.
  • Michael Kors: is a fashion brand, particularly specialising in women’s accessories. Its competitive advantage comes from its brand. It is a premium brand, which I like, but I don’t think it is the highest quality. Michael Kors is highly profitable with a track record of rapid growth, though it has faced some difficulty in the past couple years where this growth has slowed down.
  • Masimo: makes patient-monitoring technology (pulse and blood monitoring). It is exceptionally profitable and looks to dominate a narrow niche in a defensive market. It is a fairly small business and the growth prospects look promising.
  • Alibaba: the Chinese online consumer platform. It’s quite like Amazon basically, and appears to have massive growth potential. It is more profitable than Amazon at the moment.
  • Microsoft: dominates PC operating systems and is now moving more into providing cloud software services. This has rekindled its growth prospects after a long period of stagnation, despite its size. Its competitive advantage is undisputed.
  • PayPal: provides one of the fastest growing payment systems, originally linked to eBay but then spun off. The business economics are likely to be very good. It hasn’t been listed that long but has been growing very fast and appears to have great growth potential.

EU

EU shares on my watchlist come from France, Germany, Italy, France, Belgium and Spain as these are the exchanges my broker allows me to trade online at lower cost (and the Netherlands but I haven’t found anything worthy of going on the watchlist there yet). There are quite a few interesting prospects I’ve seen in Scandinavia and Switzerland but I feel I’ve got enough on my plate without looking at these markets.

So far I’ve bought one EU share – Washtec, only to sell it again fairly soon afterwards to recycle the proceeds into what looked like a better prospect at the time.  I have the following additional EU shares on my watchlist:

  • Kinepolis: is a Begian listed cinema chain that operates in Begium, France, Spain and Poland. It does need to invest in physical assets but maintains a high level of profitability and has a good track record of growth. The business is quite defensive and the prospects for continued growth look very promising.
  • DiaSorin: is an Italian healthcare company that makes reagent kits and technology platforms for in vitro diagnostics. It is very profitable and has a fairly decent track record of growth. DiaSorin has a competitive advantage from its investments in technology which then need to get regulatory approval and sticky less price sensitive customers (laboratories who need high quality and reliability and to install specific equipment to carry out the testing).
  • Amadeus IT: is a Spanish company that offers Global Distribution System (GDS), a software platform used as a single point of access for booking airline seats, hotel rooms and other travel-related services. It is the largest of three providers of GDS. The platform gives it an impenetrable competitive advantage and provides a platform to sell additional value added services. The business model is capital light and extremely profitable. Growth prospects appear decent. This is one of my favourites.
  • Moncler: is an Italian high-end fashion brand focusing particularly on ski-wear. It is a relatively nascent brand that appears very strong (niche and luxury). It is highly profitable with a successful track record of growth.
  • Rational AG: is a German manufacturer of cookers for commercial kitchens. It is exceptionally profitable with a long track record of growth. It has a very strong competitive advantage: it is the dominant company in its sector and has a very strong brand and reputation for quality. The one question mark at the moment is whether the growth prospects are sufficient to justify its premium valuation.
  • Melexis: is a chip-maker for automotive electronics systems. It has very high margins and returns on capital and has grown steadily for a few years. It appears to have a strong position in a competitive niche. The growth prospects look good though the market may be a bit cyclical.
  • Atoss Software: is a German company that makes ‘workplace management’ software for use by HR departments. It is extremely profitable and has grown rapidly though is still a small company. I think it has a very strong competitive position, benefiting from recurring revenues and sticky customers. The growth prospects look promising.
  • Euronext: runs various market exchanges in Europe. It is a platform business with excellent economics and high profitability. Its growth is a bit patchy and is closely tied to the fortunes of the European markets.
  • Nemetschek:  is a German company that makes computer aided design software for the construction industry. The business model is capital light and highly profitable. It looks likely to have a strong competitive advantage and sticky customers. It is growing strongly.
  • Pharmagest Interactive: is a French company mainly focused on providing management software for pharmacies. It is highly profitable with very consistent growth. It has a very strong competitive position and has lion’s share of market share in the French market and various growth opportunities with related products and other European markets.

 

 

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