Beating the index sounds straightforward in theory. In practice it can be a very different story. In fact, too many investors fail to outperform the FTSE 100 simply because they buy when others are greedy and sell when their investing peers are fearful. In other words, they buy and sell at the wrong points in the cycle. While satisfying short term ‘gut feeling’, that often leads to poor financial performance.
Things can only get better?
Take the oil sector at the present time. Many investors are currently selling out or are at least avoiding the purchase of oil companies such as BP (LSE: BP). This could make a great deal of sense in the short term because things could get worse. But crucially in 2016 and beyond, things could get a lot better for BP and its industry peers.
That’s at least partly because further problems already appear to be priced into BP’s valuation. For example, it trades on a price-to-book value (P/B) ratio of only 0.9 and while impairments are a real threat over the medium term, there appears to be significant scope for an upward rerating to BP’s share price. Further evidence of this can be seen in the fact that BP has a yield of 7.7%. While a dividend cut is on the cards, even a major fall in dividends would be likely to leave the company’s shares looking cheap compared to the wider index.
In terms of a positive catalyst, BP continues to enjoy a relatively strong financial position even after the huge cost of the Deepwater Horizon oil spill. Its modestly leveraged balance sheet and resilient cash flow mean it could emerge in a relatively strong position versus its peers and increase its market share. That would help it improve profitability and beat the index over the medium to long term.
Also offering upside potential is Greencore (LSE: GNC). It’s a convenience food specialist that has delivered a rise in its bottom line in each of the last four years. This year it’s expected to post a 2% decline in earnings before returning to double-digit growth next year. As a result, there could be an opportunity to buy after the company’s shares have posted zero growth in the last six months.
Greencore also appears to offer appealing value for money with its shares currently trading on a price-to-earnings growth (PEG) ratio of only 1.5. And with dividends being covered 2.8 times by profit, there’s scope for a rapid rise in shareholder payouts, which could act as a positive catalyst in 2016.
Also having the potential to beat the market next year is funeral company Dignity (LSE: DTY). Its track record of earnings growth is superb, with net profit on a per share basis rising in each of the last five years at an annualised rate of 16.4%. And looking ahead to the next two years, Dignity is forecast to continue its excellent track record of growth with rises in its bottom line of 23% and 6% being pencilled in by the market.
Certainly, Dignity trades on a rather high valuation, with the company having a price to earnings (P/E) ratio of 22.8. But with the outlook for the global economy being relatively uncertain, stocks such as Dignity could see increased demand in 2016 from relatively nervous investors, thereby providing index-beating performance over the medium term.
Peter Stephens owns shares of BP. The Motley Fool UK has recommended Greencore. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.