Highlights from this week’s Investors Chronicle

Buy: BT Group (BT.A)

BT is championing its new sports coverage as regulators grant fast-track process on £12.5bn EE deal, writes Theron Mohamed

BT’s acquisition of EE, the UK’s largest mobile group, was granted a fast-track process to a more detailed probe by the Competition and Markets Authority this week, meaning it can skip some of the initial phase of work. However, the antitrust watchdog warned the transaction could lead to less competition in the mobile market.

The news comes as BT unveiled an expanded TV offering featuring top-tier European football as it moves towards selling lucrative “quad-play” bundles of TV, broadband and both fixed-line and mobile telephony.

BT will need to recoup the estimated £390m annual cost of broadcasting, producing and advertising its Champions League football matches. Nonetheless, analysts think it could net over £100m in additional cash profits from selling TV bundles and upgrading existing customers. There’s plenty of room to grow: BT had only a 6 per cent share of the UK pay-TV market at the end of 2014, says Strategy Analytics.

Broker Jefferies expects earnings per share of 31.23p in the year to March 2016.

Although competition regulators are looking closely at BT’s EE deal, the group’s new sport packages and rumours of a takeover approach from Deutsche Telekom promise to lift BT’s growth rate and share price respectively. At 444p, its shares are up 6 per cent on our buy tip (419p, 11 Dec 2014) and trade at an enticing 14 times forecast EPS.

Buy: Fuller, Smith & Turner (FSTA)

The pubs group continues to offer great growth potential in spite of the beer tie being cut, writes Harriet Russell

Chief executive Simon Emeny admits he is “not a fan” of the incoming market-rent-only legislation, which removes the beer tie between parent company and pub, though Fuller’s 203-strong tenanted estate falls well below the regulation’s 500-site threshold. Mr Emeny says Fuller’s prides itself on the relationship it has with tenants, a standard he feels was undervalued by the previous coalition government.

The company’s tenanted estate did well last year. Like-for-like profits rose 5 per cent, with total profits up 2 per cent to £12.6m. During the year, Fuller’s offloaded two pubs from this division and moved three over to its managed estate.

The larger managed pubs and hotels division pushed total sales up by 15 per cent to £214m, and grew operating profits by 11 per cent to £25m. Reported earnings per shares were slightly down on the previous 12 months, which had seen a £3.4m corporate tax gain. Comprehensive income was further weighed down by an £8.3m actuarial loss on the pension scheme, which was closed to future accrual in January.

Analysts at Numis expect pre-tax profits of £38.5m for the current financial year, giving EPS of 53.5p, up from £36.4m and 50.8p in the year to March 2015.

At 1,082p, the shares are up 8 per cent on our original buy advice (1,000p, June 12 2014). That still equates to a toppy forward price/earnings ratio of 20 times, but the fact that Fuller’s is unlikely to be affected directly by next year’s law change might explain the recent momentum behind the shares.

Hold: Energy Assets Group (EAS)

Smart meter provider has been powered by big contract wins, but its high rating means it’s time to switch, writes Emma Powell

EAS, which provides gas and electricity metering services to the commercial sector, increased its managed meter and data asset portfolio by 123 per cent in the 12-months through to March.

This was achieved primarily through the acquisition of 150,000 meters from smart metering outfit Bglobal Metering in April 2014. But the group’s full-year figures also reflect a strengthening organic growth story. Recurring revenues, which now represent nearly two-thirds of the group total, came in at £23.3m, an increase of 38 per cent on the previous year. Adjusted cash profits grew by an impressive 29 per cent to £19.4m.

Energy Assets secured a number of big contract wins last year, including a deal with British Gas to install advanced “smart” meters to half of its UK gas customers. This could offer significant opportunities for long-term recurring sales, according to management.

Numis gives an adjusted earnings per share of 29.3p for the 2016 March year-end, against 25.2p for 2015.

The government’s requirement for domestic and commercial businesses to have installed smart meters by 2020, should provide ample opportunities for growth, and once they are rolled-out nationally, an enlarged maintenance market will present further scope for expansion, according to chief executive Phil Bellamy-Lee. However, this is adequately reflected in a share price covering 20 times forward earnings.

Stock Screens: Cash Magic

In the two years since I came up with my Cash Magic screen, it has produced impressive returns writes Algy Hall. The 30 stocks selected by the screen last year generated a total return of 19.3 per cent between them, compared with 5.9 per cent from the FTSE All-Share, the index from which they were selected. And this builds on a strong first-year performance (35.2 per cent versus 9.2 per cent from the index), meaning the cumulative total return now stands at 61.4 per cent over two years, compared with the FTSE All-Share’s 15.6 per cent. If I add in a 1.5 per cent charge to take account of dealing costs and spreads, the cumulative total return is 56.6 per cent.

There are two clear inspirations for this screen: a reader request for a screen using the cash-return-on-capital-invested (CROCI) metric, and the screening methodology used by US hedge fund manager Joel Greenblatt. The Greenblatt methodology is very well suited to creating a screen that is highly focused on a given fundamental, such as CROCI. That’s because his screening method provides a wonderfully succinct way of getting to the nub of fundamental analysis — identifying shares that can be bought for a price that undervalues the quality of the underlying business.

To make a comparison between value and quality, Mr Greenblatt employs a ranking system. Each stock is ranked based on the ‘value’ on offer and then is separately ranked based on the underlying business ‘quality’. The rankings are then added together to create a combined ranking and those stocks with the best combined rankings are the ones to buy. The real beauty of this ranking system is that it allows for shares in high-quality companies with good but not excessively cheap valuations to rank alongside very low-priced stocks in businesses that are of not such high quality. By doing this, it blends the twin investor concerns of value and quality very neatly.

In the case of Mr Greenblatt’s famous Magic Formula, his focus is on an earnings-based measure of value and a measure of a company’s efficiency at producing those earnings from its asset base. CROCI, which is the metric used in my Cash Magic screen in response to a reader request, is a measure of a company’s efficiency at producing cash from its asset base rather than earnings. Specifically, the ratio looks at cash profits — known in investment jargon as earnings before interest tax depreciation and amortisation (Ebitda) — as a percentage of a company’s capital employed. Capital employed is a company’s total assets less its current liabilities, which is a shorthand way of measuring the capital a company needs to conduct its day-to-day activities.

Given that CROCI measures the underlying quality of a company’s operations based on its ability to produce cash, I use a valuation measure based on free cash flow as a gauge to how cheap or expensive the company’s shares are. The valuation metric I use in the Cash Magic screen is much like a free-cash-flow yield, although turned on its head. Free cash flow (FCF) can be considered to be the amount of cash left over to reinvest in the business or return to shareholders following all the cash demands made on the company in the course of a year.

As such, FCF can be thought of as the cash-flow-statement equivalent to post-tax profit (the E in EPS) in the income statement. A key difference between the valuation measure I use for the Cash Magic screen and a traditional FCF yield is that rather than comparing FCF with a company’s market capitalisation, I compare it with a company’s enterprise value (EV). EV takes account of a company’s debt and cash position by subtracting net debt from market capitalisation. This means companies with high debt look less attractive on this valuation ratio, while those with net cash look more attractive. The formula is simply: EV/FCF.

When I originally conducted the Cash Magic screen I back-tested the idea and the results of this suggested a portfolio of 30 shares was likely to produce the best results from this screen. This neatly fits with Mr Greenblatt’s recommendations for the Magic Formula screen, although he suggests a 20-stock portfolio could give adequate diversity, too.