When share prices rise to beat their index, it can be a sign that a firm’s underlying business performance is strong. Going with the best performers often delivers superior investment returns over backing ‘cheap’ and fallen shares such as Tesco and BHP Billiton that could be down because of business problems and operational challenges.
Let’s look at Shire (LSE: SHP), Pearson (LSE: PSON) and Carnival (LSE: CCL), three of the FTSE 100‘s best share-price performers over the last 12 months, to see how attractive they look.
Defensive growth
The pharmaceutical sector is doing well and there’s good reason for that. The fundamentals of the market flow in a favourable direction to support an investment in firms involved in the industry. The world’s population is aging and increasing, and treatments for ailments proliferate thanks to persistent research and development. Such healthy progress with demand, on the one side, and the industry’s ability to supply, on the other, adds up to an attractive environment for pharmaceutical firms to thrive and produce their cash-generative magic.
Investing in harmony with the general economic, social and demographic trends isn’t everything, but it does count for a lot in investing. If we find the pharmaceutical sector to be attractive then we could do much worse than to consider an investment in Shire. The firm builds cash flow and earnings through research and development, and by acquisition, and specialises in behavioural health and gastro intestinal conditions, rare diseases, and regenerative medicine. The directors reckon 2014 was a good year and, with the strength of the company’s development pipeline, it seems likely Shire will make good progress in the years ahead.
Recovery in education
Pearson generates most of its business as a publisher in the education sector. 2014 was tough, say the directors, as cyclical and policy-related pressures affected education, and in turn Pearson’s business, in North America and the UK, the company’s two largest markets.
Despite the cyclicality inherent in Pearson’s business, share-price progress has been good as the firm executed what looks like a cyclical recovery in profits from post credit-crunch lows. Now, with the shares at 1458p and a forward P/E ratio running around 17 for 2016, the valuation looks stretched given predictions of just 8% growth in earnings that year. If earnings growth doesn’t pick up, it’s conceivable that the valuation could contract, which would drag on forward share-price progress.
Cyclical spurt
Carnival owns most of the world’s best-known cruise brands, but the salient point about an investment in the firm is that the business of running cruises is highly cyclical, perhaps even more so than Pearson’s set-up. Carnival shares might have put on a spurt recently, but if we scope back and look at the longer-term share-price chart, it’s clear that an investment from 10 years ago will have gone almost nowhere.
The ‘trick’ with cyclical firms is to invest, or trade, or speculate, to catch the up-leg of the economic cycle. It’s very hard to do that, though, and a buy-and-forget investment in the firm is an unattractive proposition. Cyclical companies such as Carnival have their uses for us investors, in terms of shorter-term trading, but I reckon we need to watch our positions closely and close a trade if in the slightest doubt about share-price progress, because the threat of reversal bangs at the door constantly.
Pick of the bunch
Tesco’s well-reported fall from grace left many out of pocket as the share price collapsed along with profits. BHP Billiton’s sinking share price showed us the dangers of cyclicality as commodity prices tumbled taking the firm’s profits with them. Rather than picking those fallen shares to bet on recovery has this search of high-flying share prices thrown up a viable investment alternative?
