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This stock is the perfect example of why you shouldn't sell when things get tough

·4-min read
Compass group
Compass group

Clouds have gathered over the global economy in recent months. High inflation, rising interest rates and geopolitical challenges have combined to persuade many investors that a recession is on the horizon. Some are responding by selling their holdings in an attempt to “de‑risk” their portfolio, which has contributed to a recent stock market decline.

In Questor’s view, selling shares because they could experience a challenging period is unlikely to be a sound long‑term strategy. Following it would mean continually selling stocks at the slightest prospect of tough operating conditions for businesses. Since such episodes occur with surprising regularity, these investors would struggle to hold any stock through the ups and downs of the economic cycle.

Sticking with high‑quality stocks has served this column well over recent years. A notable example is the contract caterer Compass, which was tipped in November 2017. Having initially generated big capital gains, its share price collapsed by 46pc in the early stages of the pandemic.

Since the latter part of 2020, though, it has made a solid recovery as schools, universities and sports venues have gradually reopened and workers have largely returned to offices.

As a result, its shares are up by 16.5pc since our original recommendation and have outperformed the FTSE 100 by 17.1 percentage points. The company’s third‑quarter results, which came out on July 26, showed that underlying revenue amounted to 109pc of its pre‑pandemic level, having grown by 43pc compared with the previous year.

Its latest quarterly results also included an upgrade to its full‑year sales guidance. This is the second consecutive upward revision to its revenue outlook in its past two quarterly updates. It now expects sales growth of 35pc, a 15 percentage point rise on the 20pc it forecast at the start of the year.

Alongside rapidly rising sales, which are benefiting from a relaxation of pandemic-induced restrictions, the business is growing its margins. Its underlying operating margin increased by 0.4 percentage points to 6.2pc between the second and third quarters. It is on track to reach roughly 7pc by the end of the year in spite of rising input costs. This prospect could prove particularly attractive to investors in an era of high inflation.

Many businesses are struggling to maintain, never mind raise, margins. Furthermore, Compass is a beneficiary of high inflation because it encourages firms to outsource their catering requirements in an effort to reduce costs and protect their own margins.

The company’s improving performance has enhanced its financial strength. Rising profitability led to net interest payments on debt being covered 17 times by operating profits in the first half of the year. A net-debt-to-equity ratio of 47pc suggests that it can employ higher levels of leverage to make acquisitions; it spent £115m on acquisitions in the first half of the year in an attempt to improve its competitive position.

With 66pc of revenue generated in America, the business is well placed to benefit from the stronger dollar that may persist while the US Federal Reserve plots a rapid path to monetary policy tightening. The company’s broad geographic spread – Europe accounts for 24pc of sales and the remainder is from the rest of the world – also reduces risk in an era of heightened economic uncertainty.

Although the prospect of a recession has risen, this column retains its upbeat assessment of Compass’s long-term investment potential. It is quickly returning to pre-pandemic levels of performance, in terms of sales and profitability, and has a solid financial position through which to navigate a potentially challenging operating environment.

Clearly, a forecast price-to-earnings ratio of 33 is extremely high. But with sales and net profits growing at a fast pace, and the company being well placed to overcome high inflation, there is further room for its share price to run.

So we will stick with Compass as part of a wider buy-and-hold strategy in spite of heightened risks to global economic growth. Hold.

Questor says: hold

Ticker: CPG

Share price at close: £19.08

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