CIS Portfolio Q4 Screening

Introduction
This was the third quarterly re-screening since the portfolio was started and I have to say it was one of the hardest so far. Firstly I had to fight typical behavioural biases as I was tempted to apply some valuation constraints and thereby take some profits in some of the big risers. However, since I have not done this up to now and the behavioural bias I'm trying to avoid is selling winners too soon, I resisted the temptation again this time, although perhaps I will apply them with a full re-screening at the annual stage. Any way the other reason I avoided this was that using the 80 threshold on the Scores also suggested a rather excessive 6 sales, 2 of which seemed reasonable, 2 which seemed 50 / 50 and 2 which didn't seem to make that much sense. Thus for this quarter I went with 75 as the cut off which meant the 2 sales that seemed reasonable to me went ahead which I'll discuss in the next section.

Quarterly Screening
As discussed above having used 75 I avoided selling Jupiter Fund Management (JUP) and Maintel (MAI) where there didn't seem to be that many changes or much justification for selling them, although the portfolio has two fund managers which might have justified selling Jupiter for diversification reasons. While the potential sales which I suggested were 50/50 trades would have been in Next (NXT) and Utilitywise (UTW). I say 50/50 because in the case of Next we know that trading is likely to have been weaker due to the mild weather this winter. The shares however have been weak in advance of the update this week, which is likely to be binary in so far as it could either be received badly or come as a pleasant surprise if it is not so bad. On balance I was therefore happy to retain it for now as it was only purchased last quarter, it remains a well managed business with good financials and the valuation is now more reasonable. In the case of Utilitywise as it has been such a volatile and disappointing stock for the portfolio I was personally itching to sell it. However, the recent update and further major supplier agreeing new terms suggests that some of the worries that have dogged it might be easing. So they both remain in the portfolio for now and as ever time will tell if that was a wise decision or not.

Sales
The two stocks that were sold as a result of scoring lower than 75 were Diploma (DPLM) - CIS 72, which has been flirting with the sale threshold for a while. It finally succumbed as they have seen downgrades, the valuation is no longer as attractive and their current forecast growth is now lower. I would say though that it remains a good quality, well managed business, so I wouldn't put you off running with it if you hold it as this sale is just as a result of the mechanical screening process. In a similar way IG Group (IGG) -  has also been sold as their dividend growth and cover scores have deteriorated, as have their estimate revisions leading it down to a CIS of 71.

Purchases
To replace these stocks I selected two of the highest scoring stocks which meet the normal screening criteria. The first one in an entertaining investment karma kind of way, given my recent comment about missing out on 50%+ gains in gambling stocks, is a stock called Zytronic (ZYT). This maker of larger robust touch screens is one which I bought myself last year and have made 50%+ on, so perhaps I shouldn't beat myself up too much if I do miss out on some CIS portfolio stocks? The reason I bought it and the CIS Portfolio didn't was because it failed the £50m market cap screen during most of last year, but I decided to buy it myself as one of the rare occasions when I stray into sub £50m market caps if I think the investment case is compelling. Thus, given it is up over 50% since I bought it, I would have a natural behavioural bias against buying it up here close to its all time high. But again as this is a mechanical process designed to overcome behavioural biases and as it is over a £50m market cap now with a CIS of 99,  I allowed it to buy it, even though the valuation is not as cheap as it was, but it is still reasonably attractive nevertheless.

The second purchase is a stock that I have featured in the past, Easyjet EZJ, which I suggested getting on board back in June 2015 when it was sub 1600p and which subsequently hit my 1800p target where you could have taken a decent profit out of it. However, as it now also scores 99 on the CIS and has some attractive valuation metrics I feel more comfortable about this purchase at 1740p. They seem well placed with their continuing expansion, low oil prices and increasing consumer incomes although I guess the increased terrorist threat recently could perhaps take the edge off of their progress. On that basis it will be interesting to see how these two buys pan out and whether the comfortable or the uncomfortable turns out to be best and if I'll regret not doing the other sales.

Summary & Conclusion
A difficult set of decisions for me this quarter in what is supposed to be an automatic detached process. However, I guess that underlines the fact that even with a quantitative system you still have to have some input into the trades that come out of the process and have some kind of sanity check unless you are going to follow the output blindly. In this case I have tried to apply some common sense as any fixed selling threshold might just throw up lots of marginal trades which might then cost so much that you will trade away your profits in frictional costs. Thus I have compromised to a certain extent to keep the trading costs under control as these now total around 1% of the starting capital so far, although the quarterly re screened portfolio has outperformed the original portfolio so far. So perhaps I have got the balance right as if I had allowed all the possible trades along the way with a fixed 80 score and strict valuation thresholds this may not have been the case.

This now leaves the Portfolio with a weighted average exposure to the CIS of 91 and some reasonable looking valuation stats of P/E Y1 14.7x, dividend yield Y1 3.2%, EBIT/EV yield of 8.4% and the forecast dividend growth for the portfolio is 11.5%. In terms of sectors as I have allowed it to go where it finds good scoring stocks and it therefore remains heavily overweight in Consumer Cyclicals and Industrials. While surprisingly perhaps for an income portfolio it has nothing in Energy, Basic Materials, Consumer Defensives, or Utilities, although as it is more of an income / growth process may be that is not such a surprise. In any event I tend to think more about what each of the individual companies bring to the portfolio and how they fit together rather than obsessing about sectors. I therefore try to avoid having two identical stocks in say the house building sector, while accepting that another stock like Howden say might be different but is exposed potentially to the similar economic sensitivities as a house builder, which at present are positive and worth being exposed to.

So there goes another quarter, hope you are finding the CIS Portfolio and the Scores useful in your investing and good luck for the year ahead.

Postscript
We have had the Next trading update today which was OK in the circumstances of the recent mild weather. Nevertheless they guided towards the bottom of their previous range as a result. Thus although not a profits warning as such it will lead to a few more small downgrades which may well reduce the score a bit more. Against that though they have announced another special dividend and the shares have fallen to around their indicated buy back price. So presumably they may resume some buyback which may support the price from here. Their outlook is for sales and profits growth in the range of 1 to 6% for the coming year which seems fine, if a little dull. Will continue to hold for the CIS Portfolio until the next quarterly / Annual screening due at the end of March / early April.