If you see a particular sector as overvalued and want to offset the risk, one strategy is to look for so-called picks-and-shovels stocks. It’s an idea named after the California Gold Rush, when the sellers of prospecting tools made profits no matter who found the gold.
So instead of companies at the sharp end of an industry, you invest in those providing intermediate goods and services.
But what if you think the whole market is overvalued, where do you turn then? I can’t help seeing the London Stock Exchange Group (LSE: LSE) itself as perhaps the best picks-and-shovels stock there is. Whether investors are piling into the next big thing, or rushing to sell due to the latest panic, the LSE gets its cut every time.
And it’s more than that, also being big in European capital markets, international benchmarking services and clearing, and financial information services. That’s been partly achieved by acquisition, as shown by Friday’s news that the company has bought up more of LCH Group Holdings, a clearing house that serves major international exchanges and covers a wide range of financial assets.
LSE looks pretty Brexit-proof to me too, with its network of subsidiaries throughout Europe.
The company’s Q3 update looks pretty good, showing an 8% rise in total income to £522m in the quarter, with total income for the nine months up 10%.
I think we’re looking at something pretty rare in the FTSE 100 — a company with sustainable growth characteristics. We can see that through years of strong, often double-digit, EPS growth, and through forecasts of further growth of around 15% per year for this year and next.
The share price has followed suit, growing 175% over the past five years. A result of that is a higher P/E valuation of above 20 — but quality costs more, and I don’t see many safer long-term stocks than the LSE.
The picks-and-shovels approach is one that I think applies well to technological sectors too, like the pharmaceuticals business. Our big two, AstraZeneca and GlaxoSmithKline, have been through a tough patch due to the expiry of key patents and increasing competition from makers of generic drugs, while there were few replacements coming through the drug development pipeline.
So why not go for the actual generic manufacturers instead, like Hikma Pharmaceuticals (LSE: HIK)? It makes generic products, as well branded ones and injectable pharmaceuticals — to stretch the analogy a little, perhaps it’s akin to makers of gold jewellery?
Its own troubles
Hikma has faced its own crisis which led to three years of declining earnings and to a big share price slump in 2017 that wiped out its previous few years of gains.
But the firm is on the mend with forecasts for a return to EPS growth for this year and next. And after a very strong recovery in 2018 so far, the shares are still up 55% over the past five years, despite the crisis period.
The first half saw a 17% rise in core EBITDA leading to a 35% gain for core EPS, so forecasts might even be a little conservative. P/E multiples might look a fraction high at around 18, but that could soon drop if Hikma really is back to sustainable EPS growth.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended AstraZeneca and Hikma Pharmaceuticals. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.