Himsworth: How to invest in modern warfare technologies

Companies that are unable to fulfill their forecast earnings guidance may suffer a hard landing in share price terms in 2014. One doesn’t have to dig too deep for evidence of this risk.

As 2013 drew to a close, Mothercare shed more than 30 per cent of its value in two trading days. RSA also dropped more than 17 per cent in November and in the same month oil services company Petrofac fell by the same amount when company management announced downgrades to earnings forecasts.

Performance of stocks over 3 months

Source: FE Analytics

Shudders of this magnitude may well continue this year. As I write, Mulberry Group shares are tumbling as the company announced that its like-for-like sales were down 3 per cent.

Last year saw a swathe of upward re-ratings of share prices for UK plc. These increases were almost indiscriminate of sector and while this was partly in anticipation of earnings upgrades, the effect of persistent liquidity injections from central banks has driven cash into stock markets, resulting in elevated share prices.

The price to earnings (P/E) ratio for the FTSE All Share index is currently circa 14 times. Compare this with the 2007 PE ratio of 12.5 times and the problem becomes clear.

Such expansion of ratings has removed a floor on prices and means that, should a company miss its earnings estimates, there is an increased risk of a harsh reaction from markets and a painful experience for investors.

What’s more, with few attractive alternatives for investors’ capital, there is no guarantee this trend will abate.

In this environment it’s sensible to revisit company earnings estimates and analyse the viability of these targets, avoiding companies where one does not have confidence that earnings estimates will be achieved.

Fortunately, there are a number of companies that are under-rated by the market. Technology in general has been a strong-performing sector over the past 12 months, with ratings at a P/E ratio of 26.1 times.

There are opportunities within the online gaming segment. As the high street betting companies are hit with the threat of new regulation in the UK, online companies, and particularly those with exposure to the latent US market, find themselves in the opposite position, with prospects building for the US market opening up.

Playtech is a multi-channel software provider with a range of services for social gaming and sports betting companies.

Performance of stock vs index over 1yr

Source: FE Analytics

With a diverse customer base and a platform adapted for TV and mobile as well as traditional online markets, it is one company in particular that is benefiting from the sector’s growth.

The sky’s the limit for companies developing modern warfare technologies

Concern over military budgets shrinking and sequestration in the US has affected the outlook for many aerospace and defence companies as well.

As western militaries reduce spending on equipment for terrestrial warfare, there are still opportunities for companies that have expertise in developing equipment used in more modern forms of warfare.

Advances in missile technology are accelerating; the US Department of Defense and China’s Ministry of National Defense are competing to build missiles that could travel at up to 15,000mph.

Cyber technology is continuing to build a prominent position in the intelligence units of defence agencies around the globe and in fact is the only area of budget expansion for the Department of Defense.

A leading example of this is Ultra Electronics – a company with technology including cryptographic systems that protect against hacking.

Performance of stock vs index over 1yr

Source: FE Analytics

Monetary stimulus has cultivated a fertile landscape for investors in recent years, but survey it with a degree of caution, as some of the low hanging fruit that at first seemed so ripe is beginning to leave investors with an acrid taste in their mouths.

Correlations between European stocks (which were as high as 56 per cent from 2007 to 2012) have now normalised, hence individual company news-flow dictates pricing to a greater extent than exogenous “macro” factors.

The markets have been kind to investors who have ridden the wave of liquidity; however as correlations, both intra-market and between asset classes, diminish, it is the prudent stockpicker who is best placed to reap the harvest.

Leigh Himsworth is the manager of the City Financial UK Select Opportunities fund. The views expressed here are his own.


Article source: http://www.trustnet.com/News/487685/himsworth-how-to-invest-in-modern-warfare-technologies/

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