Quality. You know it when you see or feel it. And according to my quality screen you can measure it. It produced 18 UK stocks that have the kind of characteristics that should feel less like plastic and more liked brushed aluminium.
Quality can be expensive: A single measure of quality—return on capital employed—plotted against the price to earnings ratio of the stock shows that as one increases so does the other. Stocks in bold with red markers are covered in this article. All but three of these are trading at P/E multiples of greater than 15.
18 quality UK stocks are too many to talk about. So, I have picked seven to cover here. They range in size from £168m to £3.7bn in market cap, and do not include a single FTSE 100 member.
Record (REC.L)
Record is a £168m market capitalisation specialist currency manager, at least for now. The company used to make its money purely by managing the risks that other funds and such had when they held assets in foreign currencies but had costs and clients using domestic ones. It has been expanding into asset management itself over the last couple of years.
As of now this FTSE Smallcap stock has the following quality characteristics:
- Sales 5Y CAGR 13.40%
- ROCE 5y average 33.49%
- Free cash flow 5Y CAGR 35.34%
- Free cash flow to long term debt 1,126.35%
- Net debt to equity -47.78%
The expansion is working. Revenues are growing and profitability is increasing, and if this trend continues, the company’s quality profile will increase as the ROCE 5Y average could creep even higher.
Cerillion (CER.L)
Cerillion is an AIM listed £386m market capitalisation provider of billing, charging and customer management solutions mainly to the telecommunications industry. It’s stock has the following quality metrics:
- Sales 5Y CAGR 15.34%
- ROCE 5y average 20.53%
- Free cash flow 5Y CAGR 34.97%
- Free cash flow to long term debt 296.17%
- Net debt to equity -63.13%
Strong investment in 5G and broadband infrastructure should create new opportunities for Cerillion in the telecommunications industry as these companies seek to monetise and manage new network assets. The growing market for eSIMs, open APIs, smart cities, and of course deploying AI driven technologies like large language models commercially are also expected to be boons for Carillons business.
Cerillion has an extensive ecosystem of software and solutions. It can integrate customers deeply into it by upselling. Once embedded, searching for other solutions and switching is difficult which. That, along with a good deal of customer satisfaction goes a long way in explaining the historical strength of the company’s recurring revenue stream.
Spirent Communications (SPT.L)
Spirent is a £1bn market capitalisation provider of automated test and assurance solutions for networks, cybersecurity and positioning, navigation and timing technologies. This FTSE 250 member has the following quality characteristics:
- Sales 5Y CAGR 5.96%
- ROCE 5y average 19.36%
- Free cash flow 5Y CAGR 19.36%
- Free cash flow to long term debt 495.02%
- Net debt to equity -40.31%
Like Cerillion, Spirent is betting that the 5G rollout will boost its revenues in general and particularly in India. But it is also looking towards increasingly complex and connected networks, cloud migration, cybersecurity as other increasing use cases for its products and services.
AJ Bell (AJB.L)
AJ Bell is a £1.32bn market capitalisation FTSE 250 member with £74bn of assets under administration. It provides retail investors with ISAs, SIPPs and dealing accounts inside which they can buy and sell stocks and shares, funds and other assets. It also offers its own funds and managed portfolio service, as well as a platform for investment advisors to manage their clients portfolios.
Customers are flocking to AJ Bell, both prior to the pandemic, during it, and they are still coming. More customers means more fees, and an efficient cost structure leads to the following markers of quality:
- Sales 5Y CAGR 16.74%
- ROCE 5y average 40.42%
- Free cash flow 5Y CAGR 26.92%
- Free cash flow to long term debt 470.51%
- Net debt to equity -58.99%
Assets under administration did dip in FY22, but that is at least in part a reflection of the decline in global markets. Since AJ Bell does not rely too heavily on fees as a percentage of assets under administration, this did not hurt its revenues.
Kainos (KNOS.L)
This £1.66bn market capitalisation company popped up on my quality screen with the following metrics:
- Sales 5Y CAGR 31.13%
- ROCE 5y average 42.94%
- Free cash flow 5Y CAGR 35.46%
- Free cash flow to long term debt 4,307.47%
- Net debt to equity -82.66%
Kainos is the main European partner for Workday, a US listed payroll, HR, and resource and information management software company. It is now also a North American partner. At first glance this is off-putting.
The company makes a lot of money, and is seeing the highest growth rates from deploying another companies products and services. What’s to stop another company ousting it, or Workday deciding to get rid of partners and do it themselves?
Well, these deployments are not plug and play affairs. Kainos has built expertise, and it already had experience from developing and deploying its own software platforms, which is still a robustly growing business. It also builds products and services around Workday’s offerings, which is a fast growing revenue stream.
And finally
Last up we have £2.91bn market capitalisation IG Group and £3.71bn market capitalisation Games Workshop.
| Games Workshop | IG Group | |
| Sales 5Y CAGR | 21.3% | 13.5% |
| ROCE 5Y average | 67.1% | 27.6% |
| Free cash flow 5Y CAGR | 23.5% | 39.4% |
| Free cash flow to long term debt | 233.5% | 185.4% |
| Net debt to equity | -14.3% | -34.7% |
Being bigger companies, I figure that many investors will be aware of them already. So, for brevity, their quality screen characteristics are in the table above.
DISCLAIMER: James J. McCombie does not own any of the shares mentioned. The Storied Investor has no beneficial ownership position in any of the stocks or securities mentioned. No comment in this article should be construed as a recommendation of, or opinion regarding the future performance of, any stock or security or collection of them mentioned herein. Opinions expressed are the author’s and do not represent the views of The Storied Investor.
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