What price a stock bounce? The boom that has analysts scratching their heads

Amid warnings that some shares have risen too far, Mark Leftly takes a critical look at the FTSE, and its market sectors
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The Independent Online

A leading FTSE chief executive groans when asked the question: "How big is the company now? About 130th on the Ftse?"

His group has been performing well through the financial crisis, with revenue and profit continuing to grow fast. As other companies stared into the abyss, this company has been slowly climbing the ranks, allowing management to dream of a FTSE 100 place in the not-too-distant future.

"No, we've slipped back to 150-to-160ish," he sighs. "Some housebuilders have bounced back and overtaken us. Who would have thought it, housebuilders? Do investors know that there is a housing crisis?"

There are plenty of examples in that sector: Taylor Wimpey has grown nearly 300 per cent since March to approaching 40p, while Barratt is back above two quid after languishing at less than half that for six months.

Similarly, Lloyds Banking Group surprised some seasoned observers with its rally on Wednesday, when shares grew 9 per cent despite the announcement of a £9.7bn charge for bad debts. However, there are at least some explanations for a bounce in these stocks: the housing market has shown signs of improvement, while Lloyds pointed out that its merger with HBOS will result in £1.5bn a year of cost savings to 2011.

What analysts are scratching their heads about are stocks that are booming despite little discernable good news. As investors find little reason to save cash in a low interest rate economy, so they appear to be taking punts on stocks showing little upside.

It is as though, argues one analyst, investors are ignoring the figures and are willing to take risks on the back of the FTSE's recent storming rise. Buying shares is back in vogue, and the FTSE's rally has gathered such momentum that stocks everywhere are benefiting.

Here are five examples of stocks that suggest that during this boom, now might well be a good time to announce bad news.

Retail: DSG International

Electronics retailer DSG was badly hit in the wake of the Lehman Brothers collapse, falling from a 12-month high of 69p in September to just 9.5p in December. There have been several rallies since, with the most recent taking it from 20p on 8 July to nearly 30p last week. Investors seem to be oblivious to what was a poor set of annual results in June, with sales in its UK divisions falling 11 per cent to under £4.23bn. UK profit was down nearly £100m to £58.7m, while the overall group collapsed from £225.6m to £50.5m.

"There has been a big fall in profits, UK pressures, DSG is still losing money in Italy, and there are still general pressures on big ticket items [such as electrical goods]," says Nick Bubb, analyst at Pali International. "Management has got to turn all of that around."

Industrials: Cookson Group

Cookson, a supplier of materials including ceramics and precious metals to industrial groups, has had a rough year. In October, there were 500 job losses, followed by 700 in January and 600 announced just three months ago. Yet the company's share price has been broadly on the up since November. Most notably, investors continued to snap up shares after a worrying admission in its half-year results last week: Cookson could be in breach of its debt covenants, or terms, the next two times they are tested, on 31 December and 30 June 2010. Revenue also fell by one-third to £929m, though all divisions remained profitable. Shareholders weren't worried and at close of trading the same day stock was up 7.5p to 372.6p. An engineering analyst says: "The general attitude to risk has really turned around recently, and we think some stocks have risen too far. Cookson looks to be an example of this, considering its share price has gone up three times since March."

Leisure: SABMiller

Brewer SABMiller is on a tremendous run, hitting £13.88 on 31 July, a year high after falling below 800p in October. The company is in a relatively strong position, with May's full-year results showing group revenue up $1.5bn to $25.3bn. However, there are factors of which investors should be wary. Sam Hart, Leisure analyst at Charles Stanley, points out that the Peroni and Tyskie brewer faces "significant headwinds" from losses in currency conversions and higher commodity costs. "SABMiller hedges forward commodity costs by 18 months," explains Hart. "Which means that they've missed out on the fall in spot prices, particularly grain." Hart believes that SABMiller has gained from positive market sentiment towards the company's exposure to growing markets in Latin America and Eastern Europe. A management statement at the end of July, which referred to the global downturn impacting consumer demand, has led to a very slight fall in the share price since.

Support services: Ashtead Group

Since mid-June, Ashtead's share price has risen from just under 55p to nearly 75p. In some ways this isn't surprising. Ashtead, which supplies construction equipment in the UK and US, announced a strong set of annual results in June, with pre-tax profit at £87.4m, against a loss of £86.6m last year. However, investors appear to have ignored analyst forecasts, which have been cut following a trading statement in May when the company admitted profit next year would be "below the board's earlier expectation". Consensus figures suggest that pre-tax profit will be around £25m, below previous estimates of around £45m. Mike Foster, analyst at Fairfax, suggests that the group could even "struggle to break even" by 2012-13, when the recession should really start to bite. At the moment, Ashtead is still performing well because it has work from public-sector contracts, but they are likely to start drying up.

Mining: Xstrata

Since March, when shareholders overwhelmingly voted in favour of a £4.1bn rights issue, Xstrata has been on the rise, with shares moving from 193p to nearly 870p at one point last week. The famously acquisitive mining group has also benefited from its stated intention to pursue a "merger of equals" with Anglo American – long the ambition of Xstrata boss Mick Davis. But Charles Kernot, mining analyst at Evolution Securities, is recommending investors reduce their stakes in Xstrata, warning that at $13.1bn, its debt level is still high. "Debt remains a risk should there be any hiccup in the global economy," says Kernot, adding that it appears that Xstrata will have to pay a premium if it wants to merge with Anglo. "The deal might end up being 60 per cent Anglo and 40 per cent Xstrata – and then the argument is that Anglo is in fact taking over Xstrata." And so Anglo's shareholders, rather than Xstrata's, would be the main beneficiaries.