Five Best of British stocks generating high returns

Can you make good returns from a highly concentrated selection of domestic-focused, UK-listed stocks? While reputation would suggest not, our Best of British screen begs to differ.

In the 13 years we have been following it, the stockpicking method has posted an average headline return of 10.4 per cent, or three percentage points per year better than a standard market tracker. Doubling down on the screen’s methodology and focusing on the five stocks that most closely match its demanding criteria would have yielded a 12.7 per cent compound annual rate of return, assuming all dividends were reinvested.

It's not quite the S&P 500, which has averaged a sterling-denominated annual total return of 15.9 per cent over the same period. But the screen's success shows that it is still possible to generate alpha from two unlikely sources: a frequently middling UK economy, and a fairly standard approach to quality factors. The price of this higher reward – a feature all too often omitted from a simple price comparison – has been wider variance of returns, as well as around 50 per cent more volatility than the market for UK blue chips. That said, recent form has seen the screen rip ahead of its benchmark.

In particular, the past year has been a vintage one for the Best of British method. Despite identifying just four stocks that met its criteria in October 2023, the screen identified three of the best performers in the entire index: meat producer Cranswick (CWK), car buying platform Auto Trader (AUTO), and high-street stalwart Marks & Spencer (MKS), which led the pack with its continued phoenix-like escape from retail obscurity.

Historically, the screen has struggled to find a broad spread of stocks that pass every test. More recently, the decision to focus only on companies that pass every test (rather than partial qualifiers) means the distinction between the all-stock and ‘top five’ versions of the screen is somewhat immaterial.

However, a few very solid years from the latter version during most of the refreshes between 2011 and 2019 means the all-time total return from the 'top five' version now stands at 374 per cent, while the total return from the full-complement selections stands at 260 per cent. Factor in an annual dealing charge of 1.5 per cent, and those returns dip to 290 and 196 per cent, respectively, versus 152 per cent from the FTSE 350 (every constituent of the FTSE 100 and FTSE 250 indices), from which its selections are drawn.

This set of criteria is among the most restrictive of any of our stock screens. Not only does the UK sales test trim 200 of the FTSE 350 constituents in one swoop, but even fewer companies pass the long-term earnings, momentum and return on equity tests.

In the case of both the long-term profitability test (and the slightly more passable future EPS growth test), there can be no real complaint. A limited selection pool is simply the price of filtering for quality. And while the momentum tests that appear in our screens can feel somewhat arbitrary – given the uncertain bearing of the past three months’ relative share price performance on the next year – we could make the argument that quality shares should be performing at least as well as the broader market. At the end of the day, other investors’ views on a stock matter.

The test I am least sure of is the requirement for a return on equity (RoE) of at least 10 per cent – superficially the hardest to pass. My objection isn’t to do with the hurdle rate, given that 10 per cent is probably the minimum you’d look for in a quality stock. Moreover, it’s because the data from FactSet here is at best patchy, and sometimes absent.

In the interests of broadening this year’s selections, which would otherwise be restricted to three-quarters of last year’s bunch – M&S, Auto Trader and Cranswick – I’ve manually gone through the stocks passing all but the RoE test.

Despite recording a 1,185 per cent total return over the past decade (and a RoE far above our minimum), high-flying investment trust 3i Group (III) doesn't make the cut. The fact that FactSet thinks that 98.5 per cent of its revenues stem from the UK is a function of its investment stakes and legal subsidiaries, rather than reflecting the true source of its earnings (now dominated by 3i’s majority ownership of pan-European discount retailer Action Group).

That leaves former screen star Rightmove (RMV), which easily passes the test, and card-maker Moonpig (MOON), whose failure to record a positive RoE is due to its rolling negative shareholder equity over the past year. With the denominator having turned positive at the end of its April-end financial year, I’m going to make an exception and admit the company, which as we recently argued in our investment ideas section, is starting to see the benefits of operational gearing, a customer loyalty programme and a smart push into some niche gifting categories.

That brings the full list of Best of British stocks to five. Details of each are included in the table below and in much greater depth in the downloadable spreadsheet. We'll check back in 12 months' time to see if this past year's beefy returns can be replicated.