If I were to pick just one stock to buy for 2015, I’d want it to have the following characteristics:
- Be defensive. As Sergeant Phil Esterhaus memorably told the Hill Street Blues patrols, “Let’s be careful out there!” There’s good reason to bias your portfolio towards shares in defensive companies whose products are consumed in bad times as well as good;
- Have a high yield. It’s not that I want the income – generally I’ll reinvest it – but history suggests that high yield shares tend to outperform growth shares. Paying dividends is a great discipline on management. But make sure there are sufficient earnings and cash flow to sustain a growing payout;
- Have good visibility, i.e. be able to see where future earnings will come from. Companies that rely on a few, large contracts are inherently riskier;
- Have growth opportunities. Tobacco companies are classically defensive but they operate in a shrinking global market, which adds a dimension of future risk. I prefer companies where it’s possible to identify growth opportunities;
- Have a strong balance sheet and good cash flow. Even the best businesses can struggle if they don’t have strong finances, especially if they have too high borrowings and/or profits aren’t turned into cash;
- Be free from political interference. 2015 is an election year. The uncertainty of the outcome is itself a risk for shares, but some sectors have already been targeted by Labour leader Ed Miliband, including energy companies, banks, bookmakers and the rail sector.
There are just a handful of FTSE 100 companies that pass these six tests, but my top pick is National Grid (LSE: NG) (NYSE: NGG.US), the UK monopoly provider of high voltage electricity transmission and gas distribution. Just under a third of its profits come from similar regulated activities in North East US. Let’s see how it measures up:
- National Grid is certainly defensive – it supplies critical infrastructure;
- The current yield is 4.5% and the policy is to increase dividends at least in line with inflation;
- National Grid’s regulatory settlement in the UK runs through to 2012: that’s great visibility in an uncertain world;
- Growth will come from investment to renew the UK’s crumbling infrastructure, increasing the asset base which in turn increases regulated profits;
- That heavy capex takes a toll on National Grid’s cash flow and with net gearing at 180% (a level that could be fatal for most companies but safe for a utility), the cash cover of dividends could be the company’s Achilles’ Heel: but the certainty of utility-like returns makes the payout safe;
- The energy companies are in politicians’ sights but National Grid is too crucial to mess with, it has a regulatory settlement lasting throughout the next parliament, and because it doesn’t send bills to consumers there aren’t votes in attacking it.
Of course there is no perfect stock, but it’s a good discipline to have a checklist of ideal characteristics against which to measure a potential investment: otherwise it’s easy to get carried away by tips and stories.
