Five strategies to keep you ahead of the game in 2010

At the start of the year I identified five stock selection strategies investors should consider following in 2010 to generate superior returns.

My basic thesis was that the drivers to stock and market performance in 2009 were not sustainable and that successful investors would therefore need to fundamentally revisit their approach to picking shares.

My argument was based on the belief that expectations for economic recovery were too optimistic and that ultimately the problems of excessive leverage in the global economy would need to be addressed. With such a backdrop it seemed unlikely to me that risk appetite would remain at such elevated levels. As we approach mid year, I see no reason to change my view and below I provide a reminder of these themes and an update on some of the stock-specific ideas behind them.

First, I argued for buying quality companies with sustainable competitive advantage generating high returns. These companies normally outperform, and certainly do in the long run, but they were left behind in last year’s ‘dash for trash’. Both tobacco stocks listed in the UK, Imperial Tobacco and BAT Industries, fit this theme well and their share prices have had a much better start to the year. I prefer Imperial currently, mainly on valuation grounds.

My second theme was to buy stocks that you expects to deliver positive earnings surprises, that is, where consensus expectations are too pessimistic. Again this strategy usually pays off, but last year individual company fundamentals didn’t drive share prices. So far this year this strategy has also become successful again. One stock I highlighted then and still like today despite its recent outperformance is Virgin Media.

With this stock, we continue to believe the consensus is underestimating revenue growth which in turn will feed through to very strong cash flow generation, a key measure of corporate success. The recent deal with BSkyB looks a good one for both parties, while Rupert Murdoch’s attempt to buy 100% of BSkyB would also suggest that industry returns are set to improve. ITV is another stock I highlighted that fits this theme. Despite analyst and investor pessimism about the outlook for advertising revenues, ITV has been one of the most heavily upgraded stocks this year and this negativity has proved to be unfounded. Consensus expectations appear too low. ITV also fits the next theme quite nicely so far.

The third theme is to buy self-help situations, in particular where a new management team can turn around a good company that has been badly managed and where the financial performance should be much better. The skill is to buy the companies that can be saved and avoid the ‘value traps’. ITV has a new team in chairman Archie Norman and chief executive Adam Crozier. They come with very strong credentials and I believe they have both the opportunity and the ability to materially improve the company’s long-term fortunes.

Other stocks highlighted included Compass Group and Ladbrokes. At Compass Group the management team led by chief executive Richard Cousins continues to do an excellent job, delivering continued positive surprises for the market. The business today is in much better shape than four years ago when they took over and investors can expect a much improved outlook for revenue growth. Despite strong outperformance, the shares appear to remain attractive.