When share prices rise to beat their index, it can be a sign that a firms underlying business performance is strong. Going with the best performers often delivers superior investment returns over backing cheap and fallen shares such as Tescoand BHP Billitonthat could be down because of business problems and operational challenges.
Lets look at Shire (LSE: SHP), Pearson (LSE: PSON) and Carnival (LSE: CCL), three of the FTSE 100s best share-price performers over the last 12months, to see how attractive they look.
Defensive growth
The pharmaceutical sector is doing well and theres 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 worlds 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 industrys 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 isnt 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 companys 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 Pearsons business, in North America and the UK, the companys two largest markets.
Despite the cyclicality inherent in Pearsons 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 doesnt pick up, its conceivable that the valuation could contract, which would drag on forward share-price progress.
Cyclical spurt
Carnival owns most of the worlds 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 Pearsons 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, its clear that an investment from 10years 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. Its 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
Tescos well-reported fall from grace left many out of pocket as the share price collapsed along with profits. BHP Billitons sinking share price showed us the dangers of cyclicality as commodity prices tumbled taking the firms 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?
Yes, I think it has. I’d be cautious about Pearson and Carnival because of their cyclicality, but Shire is well worth further research. As is another idea. If you click the link that follows, you can find out more about the story behind three hidden factors that our analysts think make this company a potentially lucrative investment for 2015. Growth flying under the radar can reward early investors well. You can follow this up right now by clicking here.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.