Big name stocks for all seasons
Posted on November 4, 2009 by Richard Beddard
Filed Under Companies, Markets, Thrifty 30 | 3 Comments
Magic squared
Things are looking up for the stockmarket according to Edmund Ng, an Analyst at Morgan Stanley. In a research note published the day before Halloween, he recommended investors buy shares in quality, stable, growth companies that typically perform well in bull markets.
During the panic culminating last March, investors abandoned companies with weak finances, and poor profitability, worried they might not survive the economic crisis. The really wretched, like Woolworths, didn’t. But with Armageddon averted, or delayed at least, the survivors looked really cheap and investors gobbled them up in a recovery dubbed ‘the dash for trash’.
So far this year, Ng says, ‘value factors’ (explained in this table, published a couple of weeks ago) have beaten ‘growth’ and ‘quality factors’ by 25%, but that spread is narrowing, implying the dash for trash, or as Ng more politely calls it, the “value driven rally”, might be nearing its end. Also, he says, investors are favouring companies that are genuinely growing sales and profits, over those that are cost cutting.
It sounds like Ng thinks the market is entering the ‘Sweet summer of growth’ in Morgan Stanley’s model of the stockmarket cycle (click to enlarge):
That’s when companies that have grown profits and sales, and are expected to keep growing, do better than companies with low share prices in relation to the value of their earnings, sales, cash flow and assets. Psychologically it means investors are becoming more credulous, and less disciplined.
They’re prepared to pay more for shares because they believe they will do well, as opposed to paying less to ensure they get a good return regardless.
It sounds plausible, but whether the trend will continue is speculative. A quick glance at my own chart comparing the level of the stockmarket to average earnings shows it’s not particularly cheap, or expensive. In other words, the odds of a prolonged period of rising, falling or relatively stable prices looks pretty even to me.
Ng isn’t abandoning value though, he suggests two strategies:
The first, ‘Morgan Stanley Reliable Growth’, sounds a bit dubious as the words ‘reliable’ and ‘growth’ rarely go together when applied to companies. Nevertheless, he says his basket of robust growers like BAE Systems, BAT, Vodafone, Sage, Reckitt Benckiser, Next and Rolls Royce, has beaten the market by an average of 12% in the last decade and it’s currently cheaper than it’s ever been compared to the market.
Twelve per cent sounds good, but shares in general have lost money over the last decade so his second strategy, which made money in the 17 of the last 19 years with an average total return of 13% a year sounds more interesting, particularly for investors who don’t have a strong conviction the market will rise from here.
Strategy two combines Joel Greenblatt’s Magic Formula and Joseph Piotroski’s F_Score. The Magic Formula looks for cheap shares (a high earnings yield) combined with high profitability (a high return on capital) to identify good companies at cheap prices. The F_Score is a measure of financial strength I’ve described before in detail. Ng’s screen requires an F_Score of five or more out of nine.
While it’s easy to test data and discover spurious strategies that appear to work, companies beginning with the letter ‘A’ might also beat the market, the justification for basing a strategy on Greenblatt and Piotroski’s work is compelling. Surely cheap, profitable, financially sound companies are likely to do well in future. Better them than expensive, unprofitable, indebted companies.
The UK companies selected by Ng’s ‘Combo’ strategy are:
- United Business Media
- Tui Travel
- Burberry
- Thomas Cook
- Petrofac
- AstraZeneca
- GlaxoSmithKline
- Smith and Nephew
- Go-Ahead
- BAE Systems
- Smiths Group
- Rentokil Initial
- Intertek
- FirstGroup
- Misys
- BHP Billiton
- Cable&Wireless
- BT
- Centrica
He only screens the biggest, most heavily traded companies, so there are no small company bargains in this list, but in combining a value factor (the earnings yield in the Magic Formula) with a safety factor (the F_Score) it’s similar to my own Thrifty 30 screen.
I reckon Ng is right in his belief that his Combo strategy should make money in bull and bear markets.
Surely that’s the safest approach.
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Thrifty 30 candidates
Here’s the latest Thrifty 30 screen. As usual, much of the data comes from Sharelockholmes.com. Judging by the numbers the companies at the top are cheapest, and healthiest.
As I said last week, I’m putting the notes explaining the column headings on a special page, but until then, they’re at the bottom of this post.
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The twelve most significant factors
Talking of growth and value factors, CXO Advisory Blog has found a paper identifying the twelve most significant factors for predicting monthly returns.
Warren Buffett’s made “an all-in wager on the economic future of the United States”. His biggest acquisition ever is a railroad.
The best trades can be the ones not entered, moans Dividend Growth Investor, but nobody wants to hear about them.
As I was going to (buy) St Ives
Posted on November 3, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | 2 Comments
I wondered whether it would survive
It’s doubly ironic that St Ives (SIV) chooses to feature a direct mail campaign promoting Google Maps in its annual report.
Admittedly it also devotes pages to a giant carrier bag it made to promote Sainsbury’s Finance, brochures for the Brooklands Bentley car, a peelable front cover for Wallpaper* magazine inviting readers to remove the clothes of the cover model, the latest Dan Brown book, and a trade stand for GlaxoSmithKline.
But Google? A company that makes most of its money selling inkless advertisements, and gives people unfettered access to online books and magazines that St Ives might otherwise print, and music and video that St Ives might otherwise package?
That Google still needs direct mail is positive for a printer, I suppose, but in every other way, the Internet has probably worried St Ives shareholders since the shares peaked in 2000. Analysing St Ives is forcing me to reconsider the companies I’ve reviewed that profit from print.
Some print, some publish, and some distribute. St Ives prints and distributes. Unlike Haynes Publishing, it doesn’t own information, but like say Communisis, it stores and sends mailshots (and books etc.). Unlike, UKMail, it doesn’t actually deliver them.
Of these companies, I’ve only included Haynes in the Thrifty 30 portfolio although judging by the numbers at the time all of them were reasonably cheap, and strong.
Haynes, which publishes motor manuals, has adapted in recent years. It no longer prints its own manuals, and it provides its vehicle blueprints electronically too. While mechanics still need Haynes data I think it still has a business, Haynes just has to work out how to charge for it and how to deliver it.
Printers face a different problem. Digital media is replacing their product, and in their darker days they must wonder if they face extermination.
Many of the markets for printed material, from CD inserts, to magazines, to direct mail, are shrinking. Although potboilers seem to be holding out against the digital onslaught, and advertisers will probably keep sending us mail until the last person opts out, printers are scrapping over a diminishing pool of profitable businesses. To compete, companies must invest in modern equipment and shut down old and unproductive factories. Fluctuating energy and raw material costs add to the uncertainty, and costs.
I don’t think there’s any point in speculating on how much smaller the print industry will be in future, it seems only safe to assume that profits will be substantially lower and so, while a company is normally a bargain if it costs less than ten times average earnings, shares in a printer would have to be cheaper.
Thanks to recession, St Ives shares cost just 2.5 times its average earnings over the last ten years, or about thirteen times 2009’s profit figure, ignoring exceptional costs. But, also thanks to the recession, its F_Score is a borderline five out of nine.
While it doesn’t look like it’s going bust, St Ives is financially challenged.
In 2009, it lost money for the first time since it listed in 1985, if you include exceptional costs from the sale of its US and Dutch subsidiaries and the closure of two factories. Even ignoring those costs, profitability fell sharply from a 7% return on total assets to 2%.
Some of the decline is reversible. In recessions magazine publishers close titles, order fewer copies, and cut the number of pages in each one. During recoveries they expand the number of titles, their print-runs, and their publications. Likewise, in a recession retailers, which use printed materials to promote products in stores, fail or become more demanding, and when they recover, they grow.
But there are risks. Although St Ives reduced its debt, it still owed £33m at its year end in July. While it reduced its pension deficit, it still owed its pension scheme £38m, a figure that varies as the value of the pension fund and it’s obligation to current and future retirees fluctuates, and as St Ives makes monthly payments at a rate of £2.2m a year.
These liabilities are another drain on the company’s resources, especially if recovery is muted.
Like Wolseley last week. I’m tempted to add St Ives to the Thrifty 30 model portfolio. Investors may have overreacted to the combination of recession and the perception that print is dying. While I can’t conceive print will ever be a go-go sector, there may be a few puffs left in the old cigar-butt.
But I’m not sure I want to smoke it.
My stockpicking checklist has three items at the end of it. That:
- The company is financially strong,
- It’s not facing overwhelming competition, and…
- The shares are cheap and liquid.
While the shares are very cheap, I’m just not confident enough about the business of print.
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Being Warren Buffett
Following Evan Davis’ profile of Warren Buffett, the BBC has published interviews with Buffett, Charlie Munger, Susie (his daughter) and friends.
My thoughts on being Warren Buffett [podcast].
Just published: Value Investing – Tools and Techniques for Intelligent Investment by James Montier. Sneak preview here. He’s writing The Little Book of Behavioural Investing too.
Shorting the dollar and buying virtually any global asset is the mother of all carry trades, says Nouriel Roubini, and when the bubble bursts (have you heard this before) there’s going to be the mother of all crashes.
Martin Wolf reviews Andrew Smithers‘ book, Wall Street Revalued. Value matters in an ‘imperfectly efficient market’, he says, but not so you can profit from it.
What a difference five words make
Posted on October 28, 2009 by Richard Beddard
Filed Under Investing, Reading list | Leave a Comment
Dawkins dates earth, says God created it…
Before I bashed the Efficient Markets Hypothesis again last week. I looked it up in what must surely be the ordinary investor’s efficient markets bible, Burton Malkiel’s A Random Walk Down Wall Street. The book is in its ninth edition, and my copy has ‘Over 1 Million Copies Sold’ emblazoned across the top of it. It must have spawned thousands of passive investors.
Within it I read something extraordinary:
Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns. Shortly before he died in 1976, he was quoted in an interview in the Financial Analysts Journal as saying, "I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when Graham and Dodd was first published; but the situation has changed… [Today] I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost… I’m on the side of the ‘efficient market’ school of thought."
By way of background, the Efficient Market school of thought describes how stockmarkets fluctuate. It proposes that markets adjust instantaneously to new information and therefore it is not possible to profit from, say, analysing a company’s finances.
There’s no point in trying to buy a share you think is cheap because before you can place that order, quicker, wiser, better connected investors will have beaten you to it and increased demand for the share will have driven the price up to a reasonable value.
Malkiel thinks the hypothesis is true enough to dispense with analysing individual companies. Instead he promotes passive investments like index trackers and exchange traded funds that capitalise on the theory by capturing the market return, the best you can achieve according to the EMH, at the cheapest cost.
Today, I’m not going to bash the EMH again. I did it here, and here, and on Graeme Pietersz’s Moneyterms blog here (see the comments). Instead I want to examine Benjamin Graham’s change of heart. He’s a hero of mine, and of many an investor who thinks he can beat the market including Warren Buffet, who probably needs no introduction.
Benjamin Graham wrote the textbook on financial analysis, called Security Analysis, which has been continuously in print even longer than Malkiel’s book. Its first edition, published in 1934, predates the Efficient Market Hypothesis by about thirty years.
The notion that, towards the end of his life, Graham might have embraced EMH is as unlikely to me as Richard Dawkins proclaiming God created the World in 4004BC on his deathbed.
Unfortunately, Janet Lowe’s magnificent anthology of Graham’s writings and interviews, which I keep on my desk with A Random Walk and Security Analysis, doesn’t include the interview Malkiel refers to. But it includes others, published around the same time, in which he describes a very different change of heart.
I believe I have found the actual interview, though. From it, I have extracted the complete quote including information that had been replaced in Malkiel’s book with ellipses (…). I’ve marked the bits of the original quote that Malkiel, or his editors, cut in red:
In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the "efficient market" school of thought now generally accepted by the professors.
“To that very limited extent.” What a difference five words make. All writers, and most readers, and anybody who has been quoted extensively will know how dangerous the ellipsis is. Take certain words out of a quotation and it can change the entire sense.
I urge you to read the rest of the interview, because Graham didn’t embrace the EMH or think investors couldn’t beat the market average. It’s true he didn’t think the style of fundamental analysis conducted by professional investors, focused on forecasting future profits, was worth the trouble.
But he thought an investor could capture the inefficiencies of the market with a few simple variables, notably the price earnings ratio:
We are just finishing a performance study of these approaches over the past half-century–1925-1975. They consistently show results of 15 per cent or better per annum, or twice the record of the DJIA for this long period. I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public.
And he thought private individuals, ironically the intended audience of Malkiel’s book, not professionals, were well placed to do it.
Graham detailed his technique in an interview published in Medical Economics also in 1976, which I summarised in this blog post: The simplest way to select bargain stocks.
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Since I used Graham’s system as a template for the Thrifty 30 model portfolio, I’m keen to put the record straight. Graham thought investors could get a 15% average annual return by screening the market for shares on low PE ratios with sound finances.
I use the 10 year PE and Piotroski’s F_Score from the Sharelockholmes database every week to produce this table of Thrifty 30 candidates in the hope it’s of interest to fellow efficient market sceptics:
I am going to put the notes explaining the column headings on a special page, but until then they’re at the bottom of this post.
Plumbing the depths with Wolseley
Posted on October 26, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | Leave a Comment
I’ve caught a big fish in my net, and I’m not altogether happy about it. Wolseley (WOS) is the world’s largest distributor of plumbing, heating, and building supplies, Unless you’ve come across it as an investor you might never have heard of it.
The company owns an army of businesses that go by their own names, perhaps most famously Plumb Centre in the UK, but also Pipe Centre, Drain Centre, Build Centre, an insulation supplier, an equipment rental company and a bathroom retailer . It’s an even bigger fish in the United States, and operates multiple businesses in France, Scandinavia and Central and Eastern Europe.
From bathrooms to brassware and tiles to timber, Wolseley supplies the building trade.
It’s in the FTSE 100, words you won’t often see typed on this blog because big companies aren’t often sucked into bargain territory. On the rare occasion they are, I usually find some excuse to release them back into the wild.
Invariably, something’s gone drastically wrong. In Wolseley’s case its the noxious mix of recession and debt.
Mortgage defaults by homeowners in the US triggered the financial crisis that caused the recession we’re now experiencing. Many of those homeowners will have been living in houses plumbed, furnished and built with products from Wolseley companies.
The dire contraction in house sales in the US and the UK means Wolseley is selling fewer pipes, and making much less money from them, but its problems go beyond its customers.
Overconfident homeowners weren’t the only ones that lived beyond their means. Wolseley also borrowed to buy more businesses.
Its timeline tells of the company’s evolution from a manufacturer of Australian sheep shearing equipment in the 1880’s to a distributor of plumbing and heating equipment via car manufacture and other engineering exploits. But there’s only room on it for its principal acquisitions.
In recent years, many of those businesses have been gobbling builders merchants, truss manufacturers and hardware suppliers. It’s 2008 annual report (last year’s) documents 15 acquisitions, a disappointment in comparison to previous years, adding less than 5% to revenues compared to a its five-year average of about 12%.
Just like the housing boom, Wolseley’s expansion wasn’t sustainable and although the company made no acquisitions in 2009, it culminated last April in the disposal of 51% of Stock Building Supply, which was making heavy losses, and a humiliating and complicated fund raising. Through a placing, and a subsequent rights issue, Wolseley raised £1bn issuing new shares at the expense of existing shareholders.
Those actions may have saved the company. Ignoring over £1bn of losses that might be deemed exceptional it just about made a profit in 2009 and scores a middling five out of nine for financial strength.
That’s really borderline, though. Anything less than an F_Score of five is a definite no. Weak companies are more likely to go bust, and less likely to earn investors a good return. I don’t have much faith in a score of five when I have to ignore huge write-offs, restructuring costs, and provisions to achieve it.
Wolseley’s valuation too, is suspect. The shares cost less than seven times the average of its last ten years of profits, but that figure is only relevant if Wolseley will achieve a similar level of profit in future. I wouldn’t dream of trying to predict the future, but I suspect that Wolseley’s last ten years of profit are somewhat illusory anyway, reliant, as they were on a debt burden the company couldn’t sustain when the housing market collapsed.
Ian Meekins, Wolseley’s new chief executive, admits the recession has highlighted the cyclicality of the building trade and…
…the path to recovery is far from certain. In a number of ways the recent economic turmoil has redrawn the map in terms of future trajectories for our markets…
One of those pathways airbrushed from his map, I suspect, is a debt fuelled acquisition boom any time soon.
Despite these reservations I’m torn by Wolseley. So torn I’m actually making up my mind as I write these paragraphs. It’s in the kind of prosaic business that ought to recover, it’s shedding businesses not acquiring them now, and focusing on costs, cash flow and the customer.
But I’m in the business of adding financially strong companies at cheap prices to the Thrifty 30 model portfolio and wield two numbers to protect me from the weak (The F_Score) and expensive (The long-term price earnings ratio).
I’m not confident enough in either of them to add Wolseley today.
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And now for something a little different.
Instead I’m adding electrical contractor T Clarke (CTO) at Friday’s close of 139.5p. On a ten-year price earnings ratio of 10.5, its flirting with bargain status. Despite uncertainty in the construction sector, it, I think is a survivor. I profiled it in June, and its half-year results in August were reassuring.
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Here’s the current Thrifty 30:
First transaction: 9 September 2009
Valuation date: 23 October 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
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Bohemian bankruptcy
Andrew Smithers says the US stockmarket is 40% overvalued.
Peter Temple, says it feels like we’re in a bull market [iBall video].
According to new research by the Brandes Institute, value still beats growth by a large margin
Value investors Donald and Brian Yacktman reveal their investing process.
Graeme Pietersz, of Moneyterms, comes out in support of Bachelier after I blamed him for the state of financial analysis.
This is why I’ll never be a top-down analyst. It’s all speculation innit?
A review of the Thrifty 30. Thank you anonymous blogger.
And finally, can you spot our editor in chief, Freddie McDowell, in this production of Bohemian Bankruptcy, by Drag Queen?
Blame it on Bachelier
Posted on October 22, 2009 by Richard Beddard
Filed Under Editor's choice, Investing, Markets | 9 Comments
A random walk into recession
You’ve got to watch these two interviews with Benoit Mandelbrot:
Mandelbrot saw the financial crisis of 2007 coming, He couldn’t have told you exactly when or how it would happen. His achievement was simply in recognising that big, and sometimes destructive events do happen in financial markets.
Maybe that’s obvious, but its surprising how many people, and investment banks, forgot it applied to their investments in 2007.
In his book, ‘The (Mis)Behaviour of Markets’ published in 2004, and over forty years earlier as he studied sequences of prices, he found the the models of modern finance wanting.
These models dominate financial theory, but Mandelbrot says they underestimate risk. If people who buy and sell financial assets and derivatives use the wrong financial models, they too will underestimate risk, which is, of course, wilfully or otherwise, exactly what many of them did in the years leading up to 2007, 2000, 1987 etc..
The mis-modelling started longer ago than you might think. Mandelbrot blames the PHD dissertation of an obscure but brilliant French mathematician, Louis Bachelier. He published his ‘Theory of Speculation’ in 1900, but it was largely ignored until the 1960’s when academics had the computing power to study prices.
Bachelier’s mathematics is beyond me, (it’s in this book, and this paper [PDF]) but Mandelbrot’s main criticism is the assumption that share price movements are continuous and random where the probability of the next move being up or down is 50:50, the same as if you were tossing a coin.
In this ‘random walk’ extreme moves, equivalent of, say, a hundred sequential coin-tosses with the same result are so rare, they should never happen.
Mandelbrot, the mathematician who invented fractal geometry and applied it to finance, was self-taught and, perhaps, less inclined to follow convention. He recognised prices jump around all over the place. Sometimes wildly varying prices cluster around huge spikes.
Although he developed more convincing models than the random walk, Mandelbrot’s work, like Bachelier’s, was ignored. Perhaps it is ahead of its time. The architects of modern finance building on the random walk had developed mathematical tools to help construct portfolios and manage risk. Mandelbrot’s models:
… promised a great amount of work, and trouble, and effort.
He says,
And the other offered capital on which one could live for a while.
For the random walk to be an accurate representation of the stockmarket its proponents needed to explain why an investor can’t profit from new information, a company’s results say. If analysing financial information can lead to superior insights about future prices, then prices aren’t random, they’re predictable, at least to a degree.
Enter the Efficient Markets Hypothesis, proposed by Eugene Fama, a kind of umbrella of assumptions underlying modern finance theory. The EMH (which also stands for Emergency Medical Hologram in Star Trek, judge for yourself which is more plausible) proposes that prices adjust so quickly to new information that investors simply don’t have time to profit from it.
The hypothesis assumes that investors all have the same motivation, to buy assets for less than they are worth, and that they make judgements almost instantaneously. As soon as new information reveals a share is cheap, investors buy it and the price rises to a realistic level.
In fact, a long history of financial manias and panics demonstrates investors often loose sight of value, and there’s plenty of evidence that prices don’t adjust instantly to news. ‘Value shares’, where the price is low in relation to an accounting measure like book value, earnings, or cash flow, do better than the stockmarket average, which shows investors who take the time to evaluate companies can profit from that information.
These days, the EMH seems to be going out of fashion and investors’ attitudes are more likely to be defined by the degree to which they think the market is inefficient, and how much effort they are prepared to put into finding investments that are cheaper, or more expensive, than they think the investments are truly worth.
The financial pages and journals buzz with insight as to why such ‘anomalies’ exist. I think some of the best fall under the heading of ‘feedback’. The simplest example of feedback comes from behavioural finance and shows investors are seduced by rising prices into buying more shares (or properties, or collateralised debt obligations), which pushes prices up further, which induces investors to buy more, and so on.
It’s easy to see how, when feedback is operating in the market, current prices are dependent (to a degree) on past prices (as Mandelbrot says, they have memory), and they can move to extremes, the odds of successive price rises, or falls, increases.
The question now is whether successive attempts to advance financial theory will fix it. Or whether we need a new theory.
Mandelbrot:
Some brilliant persons still hope that by fiddling with the existing theory they will make it better and account for the data. I don’t think so, because there is a qualitative difference between a continuing varying process [a random walk] and [when] the most important events are the occasional jumps… So it’s better to start again.
It’s difficult for a practitioner, head buried most of the time in annual reports not equations, to referee this dispute, although I bet you can guess where my sympathies lie.
As Mandelbrot’s co-author Richard Hudson explained when I interviewed the two of them in 2004, well before the recent financial crisis:
Risk is the dominant theme in markets. We see that in the collapse of the internet bubble, we see that in every news event, we see that in 11 September - not the event itself but the way the markets reacted to it, we see that in the ‘87 crash.
As markets recover from the latest blow-out and investors emerge from crisis mode, we must remember that the odds of another crash with the potential to inflict losses so large we cannot fully recover are much higher than we might think.
People forget.
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Some anomalies, for you
Here’s my weekly list of financially sound companies at cheap prices. The data is from Sharelockholmes.com. Please remember I have not verified it unless the company has already been included in the Thrifty 30 model portfolio. Explanations of the column headings are at the end of last week’s post.
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The Horlicks Markets Hypothesis
Paul Woolley, founder of the Centre for the Study of Capital Market Dysfunctionality at the LSE, says professional investors make financial markets less efficient, “a complete Horlicks” in fact, not more efficient.
A transcript of a fascinating conversation with Benjamin Graham.
Yikes! Maybe I shouldn’t be too complacent about recovering manufacturers.
It’s official, technical analysis is a load of old cobblers. Tests on 5,000 trading rules over 49 countries confirm it.
In the board game Monopoly the bank never goes bust, and the game continues until every player bar-one goes bankrupt…
Casting around for value
Posted on October 19, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | Leave a Comment
In practice:
The contrarian’s sector
As contrarian ideas go, the auto industry is hard-core, yet, despite having added engineering consultancy Ricardo to the Thrifty 30 model portfolio last week I haven’t finished with the sector.
While some manufacturers have maintained their research and development efforts to design leaner, cleaner vehicles, shielding Ricardo from the worst of the recession, the market for castings, the lumps of iron in cars, and the parts machined from them, differentials and steering wheel knuckles for example, has collapsed.
Castings (CGS), the name of a company that manufactures castings and components, is operating at 50% of its full capacity. Perhaps one glimmer of optimism is that figure, announced at its Annual General Meeting in August, is up 10% since its final results in June.
It’s troubles are a case study in what recession can do to a manufacturing business. Financial commitments are sucking cash out of the company, while a collapse in the demand for cars and commercial vehicles means there’s less money coming in.
The company has yet to bring on-stream its new foundry, due to begin casting early this year, and has been forced to sell electricity it no longer needs, but agreed to buy, back to the market for £2.2m less than it originally paid. Meanwhile sales, mostly to struggling car and commercial vehicle manufacturers in the UK, Sweden and the rest of Europe, fell 13% in the year to March 2009.
That means profits, the difference between sales and costs, fell to levels the company has not experienced since the early 1990’s. Profitability, the return the company makes on its assets, declined from 17.2% in 2008 to just 6.6% in 2009 even if you ignore, as I have, the exceptional cost of making 350 employees redundant (£2.2m) and £3.8m the company believes it’s unlikely to retrieve from the administrators of various Icelandic banks.
It’s an unholy run of luck, and perhaps poor judgement, although its difficult to blame management for fixing electricity prices at a time when they were soaring, and increasing capacity at a time when demand was rising. It seems unreasonable for investors to expect companies to predict recessions, when we’re so bad at it.
These decisions would have been unforgiveable though, had they had mired the company in debt it would be unable to repay in the event of recession, but Castings had no debt at all, and £16m in cash at its year end in March.
Looking beyond its current problems, Castings seems to be a role model for British manufacturing. It’s been profitable throughout the last two decades, apparently by investing heavily in automating and modernising its foundries and machine shop. It’s not cut its dividend since my data started in 1992.
Since buying good companies going through rough patches is the modus operandi of the Thrifty 30 it ought to be a shoe-in for the portfolio but, investors appreciate Castings will probably endure and prosper again and so the shares aren’t dirt cheap. They cost 11 times its profits averaged over the last ten years, just outside bargain territory.
Although there are signs that demand is returning as vehicle manufacturers run out of stock, it won’t necessarily return to former levels soon. If, as many pundits predict our path out of recession will be just as bumpy, but much slower than our path into it, it could take years for Castings to recover the levels of profitability it experienced as recently as 2008.
I think it will though. Chairman and former chief executive, Brian Cooke, has been there since 1960 and owns 4.5% of the company, so he’s experience and motivated.
I’m adding Castings to the Thrifty 30 portfolio at Friday’s close of 191p.
Here’s the portfolio:
Notes:
First transaction: 9 September 2009
Valuation date: 16 October 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
What I don’t know
Many of the companies are in business sectors that do particularly poorly in recessions. Dewhurst, which makes components for lifts, is another manufacturer. Holders Technology and Solid State supply manufacturers of electronics. Ricardo helps car manufacturers design better vehicles. Dart’s most important business, Jet2.com is an airline, perhaps the most exposed of all to the economy. OPD is a head hunter.
In theory, because these companies appear to have the financial strength to survive, the portfolio should explode into life as the economy recovers. Since I don’t know when that will be, or how long it will last, I’ve got to buy them now, or risk missing out. The price for prescience, is of course, that things might get worse before they get better, which is the curse of the value investor.
In theory:
Invest in the cheap and ugly
What a great interviewee Bruce Greenwald is. One question, all the answers on Ben Graham and value investing.
Investing in cheap stocks would have got you into trouble in the crash of 2008/9, but you would have saved yourself [a bit] , if you’d have been careful about balance sheets.
Whichever side of the fence you sit on, Michael Moore’s, or the investment banks’, you’d better be aware that the gap between rich and poor is increasing – around the World.
Yves Smith is on Moore’s side.
So is Alan Greenspan. The former chairman of the US Federal Reserve, hitherto famed for his laissez-faire approach to central banking, advocates breaking up the banks.
Alphaville reports that although Gold ETFs are glittering, they may not actually be invested in gold, which leaves the investor vulnerable in erm…. a meltdown.
Mark Hulbert says that even the best humans can’t improve on mechanical systems for market timing.
LOL 
Recovery is underway, because Google says so.
Reward, without the risk
Posted on October 15, 2009 by Richard Beddard
Filed Under Editor's choice, Investing, Markets, Thrifty 30 | 3 Comments
In theory:
The holy grail
Contrary to conventional notions of risk and reward, buying shares in safe companies really does improve returns. That’s the message from a research note published last year by Morgan Stanley.
It published an alluring chart, which depicts what goes on over a stockmarket cycle (click on it for a larger version):
The story is familiar to practicing investors. At stockmarket extremes, psychology drives the market and overconfidence or lack of confidence pushes prices to highs and lows. In between the peaks and troughs the performance of companies, and their valuations matter more.
The percentages are just opinion, but the investment styles that do best in different phases of the market are fact, at least judging by the last stockmarket cycle. Morgan Stanley demonstrated that cheap shares do best in the early and middle stages of bull markets. Growth and momentum are most important at bull market peaks and a fourth factor, the strength of company balance sheets, is critical for performance in bear markets:
Click on the table for a larger version.
To make a killing, all you’d have to do is consistently identify which phase of the market you are in. If that were possible you could adapt your strategy, and the investment ratios you use. In the early stages of a bull market you’d buy shares with low prices compared to their book values, annual sales, or profits. As the bull market peaked you’d gradually switch to momentum, buying shares that have recently gone up in price, and growth, companies which are expected to grow their profits impressively. In a bear market you’d switch to owning companies with low debt.
You’d be the perfect herd-anticipator and by deftly switching from one style to another you’d avoid being trampled when the herd changed direction.
While this is the kind of game investment banks might play, I don’t think such deftness is possible. Although we know whether the market is cheap or expensive, who can say with any precision when the inevitable correction will come? When investors will lose their confidence, or regain it.
The Morgan Stanley team came to another conclusion, though, that is much more useful. Looking at returns since 1990, financially strong companies do better than the market average over whole cycles. Since weak companies are surely more risky, this flies in the face of the convention that to get more reward an investor must take more risk.
One of Morgan Stanley’s measures will be familiar to readers of this blog. It’s Piotroski’s F_Score. The other is Altman’s Z-score. These calculations determine financial health. Generally speaking companies that score poorly for profitability, productivity, debt and working capital are more likely to fail. Companies in the opposite situation are more likely to succeed.
Morgan Stanley found that companies with a Z-Score of one or less did 4% a year worse than the stock market average between 1990 and 2008, which is good reason to avoid them. Companies with F_Scores of seven or more out of nine did 2.5% per year better, which is good reason to consider them.
The bank has subsequently reported even more impressive results for the Z-score because we’ve just experienced a major bear market, when balance sheet strength is the critical factor. At such times, companies with low Z-scores do up to 15% worse than the market average.
Totting up the influence of Morgan Stanley’s factors at the bottom of the table (The Top ten factors…) is an interesting, though admittedly unscientific exercise.
Five of the top ten factors in early-stage and four of the top ten in mid-stage bull markets are value factors but buying cheap shares leads to negative returns at the peak of bull markets and in bear markets. Over the cycle, value scores six, growth scores two, and balance sheet (safety) factors score seven.
I can see why cheap shares might do badly in bear markets. At the peak of a bull market shares are generally expensive. Most shares left on low valuations will be the really smelly ones that not even exuberant investors touch. They’re not really good value, they’re cheap because of the palpable probability they’ll go bust. They’re loaded up with debt and business is going nowhere. They’re cheap and nasty. They’re the Woolworths of this world.
They’d have deteriorating balance sheets.
A strategy that combined value and safety, apparently the major factors that drive returns, ought to do very well in the long-term. Piotroski established that, the Morgan Stanley team demonstrated it in another report published in April, and I’m trying to achieve it with the Thrifty 30.
In practice:
Predicting the market
Currently shares cost about fourteen times average earnings (profits) over the last ten years. They’re not particularly cheap, or expensive. If you put my arm behind my back and thrust it so far it was about to pop out of my shoulder socket I’d probably squeal that we’re in a kind of mid-stage bull market. However, I’m haunted by the same doubts haunting many an investor, that this year’s remarkable rises are a reprieve, and the long-term trend is down.
Regardless of the state of the market, and probably because I don’t think you can say much about the future with certainty, my policy is to buy when there is the opportunity to do so.
Currently there there are plenty of cheap companies with good finances, candidates for the Thrifty 30 model portfolio:
As usual the data used to calculate this table comes from the Sharelockholmes.com database.
The companies near the top of the list are generally cheapest, strongest and most liquid but all of the companies are, subject to checking the data and confirming the investment case, candidates for the Thrifty 30. Some (marked T30) are already in it.
10yPE
It’s easy to get carried away by a company’s prospects and pay too much for a share, reducing the return. The Price earnings ratio compares the price of shares to the profits (earnings) of the company. In theory, because profits belong to shareholders and will be returned to them as dividends or invested in their company to produce more profit in future, the more profit for every pound invested, the better the investment. Since a single year of profit may not be representative of a typical year, because companies have good years and bad years, I use the average of the past ten years of earnings to calculate the 10 year PE. Academic research indicates it’s a better measure of value and by restricting the Thrifty 30 to companies with 10 year PE ratios of less than 20, I’m protecting it from the most expensive shares in the stockmarket.
10yCF
Just as the PE ratio compares the share price to accounting profit, the Price to cash flow ratio compares the share price to cash profit. I’m including it as an experiment. Some investors and analysts think cash flow is more trustworthy measure because accounting profit is more easily manipulated. While that’s true in one particular year, because accountants can shift profit from one year to another to make bad years look better, in the long-run it shouldn’t make much difference. Nevertheless, I might be suspicious of a company that had a considerably higher price to ten-year cash flow ratio than its ten-year PE.
FS
Piotroski’s F_Score is a measure of financial strength, like a credit score. It rates companies highly if they are profitable, profitability is improving, they are paying off debt, consuming less cash as they operate and relying on their own profits to fund their business. Needless to say, unprofitable companies raising funds from creditors or shareholders score less well. Statistically companies with low F_Scores are more likely to go bust, and earn investors lower returns. By restricting the Thrifty 30 to companies with F_Scores of five or more out of nine, I’m protecting the Thrifty 30 from the weakest companies in the stockmarket.
GG
Graham Gearing is a blunter measure of financial strength. It compares what the company owns (its total assets) to what it owes (its liabilities – bank debt, pension liabilities and so on). I named it after Benjamin Graham, who invented the measure. Graham thought companies that owned more than twice what they owed (total liabilities are less than half of total assets) were financially strong.
NMS(£)
Market makers only commit to supply a certain number of shares at the price quoted by the stock exchange. That number is the Normal Market Size. Traders wishing to buy or sell in greater quantities may have to pay more, or sell for less. They may not even be able to trade at all. NMS is a measure of liquidity, or how readily a share can be traded. The more liquid it a share is, the better.
Ricardo engineers value in awful auto sector
Posted on October 13, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | 1 Comment
In practice:
Diversification: good, diworseification bad
I fell in love with Ricardo (RCDO) when I saw the artwork on the front cover of its annual report:
The bold, calm design oozes technology, quality and environmental concern, which represent a big danger for investors in the automotive engineering consultancy.
It’s easy to get carried away by the promise of fuel efficient engines, and entirely new hybrid, hydrogen and electric vehicle systems, and the company’s new interest in the other end of the electricity grid, putting power in through wind and waves.
We need to improve or change the way we travel, but, if the shares are expensive, the company is financially weak, or the business isn’t already performing, then, however alluring the future, the shares are too much of a gamble.
The obvious danger, is the state of the auto industry.
Wild swings in fuel prices and a collapse in credit have decimated demand for cars and, along with environmental legislation, increased costs, in what chief executive Dave Shemmans describes as a ‘perfect storm’.
Two of the big three American car makers are in Chapter 11 bankruptcy protection, factories are closing, workers are working shorter weeks and car sales are propped up by government funded scrappage schemes.
Since car makers are Ricardo’s biggest customers, these events explain the dramatic fall in its share price between October last year and March this year.
It’s recovered since, but the shares are still reasonably cheap, costing twelve times average annual profits over the last ten years.
As the recession ends, though, many of the problems reverse. Demand recovers, companies increase production and investment. At first, still nervous about whether an incipient recovery will last, they may favour using the expertise of consultants, rather than developing it themselves.
If Ricardo can tough it out, it should do well.
Unfortunately its F_Score, a measure of financial strength, indicates otherwise.
Normally a score of four out of nine would rule Ricardo out of the Thrifty 30 portfolio, because it implies a significantly increased risk the company will go bust or suffer a long-term decline in profits.
But, some of Ricardo’s individual scores are marginal, or irrelevant, so I think the company is much stronger than the number implies.
Long-term debt has risen from £3m in round numbers to £4m which counts against Ricardo, but £4m is only 2% of total assets so I think it’s insignificant. Likewise Ricardo issued a small number of shares and if you strictly apply the rules, that’s also negative.
If a company must raise funds, either by borrowing, or by selling more shares, it’s a sign of weakness, particularly in a company going through difficult times. In the case of Ricardo, though, the increase in debt is incidental and so is the increase in the number of shares, which were issued not to raise funds, but reward executives.
Arguably, the company is more profitable than last year so they probably deserve a reward, although the F_Score says it is slightly less profitable. The discrepancy depends on whether you compare profit to average assets or assets at the beginning of the year, but either way, unlike its customers, Ricardo was making healthy profits in a very tough environment.
Its apparent weakness, but probable strength, is an important reminder to interpret financial statistics, and when, as in the case of the F_Score, the statistic is an amalgamation of other statistics, to decompose it into its components first.
How did Ricardo do so well, when its customers are faring so badly?
Mindful of the pressure to increase fuel efficiency, and concerned to maintain competitiveness, some manufacturers have maintained their research and development budgets.
Meanwhile, possibly as a reaction to 2004 when a recession in the automotive industry led to the cancellation of three projects and losses at Ricardo, the company, which will be a hundred years old in 2015, began diversifying.
In its financial statements, Ricardo separates its operations into two segments, technology consulting and strategic (management) consulting. The second is a product of its diversification policy, and accounts for less than 10% of sales (£10m, against £123m for technical consulting). While strategic consulting is profitable, it’s still a pretty small business.
Three charts on page 10 of the annual report show order intake for the year, by territory, sector. and product. The company’s biggest territories are still the UK, Germany, and the USA from where over two thirds of orders come, but the company is diversifying into Russia and Asia.
Likewise, the biggest sector (54%) is still passenger cars, but this year the fall off in demand for cars was partially offset by defence (15%), commercial vehicles (23%) and motorsport (8%).
In terms of products, it’s still a pretty car-oriented company (see chart). Wind and wave turbines, don’t seem to feature at all in its 2009 order book, despite the artwork on the annual report.
Diversification is risky, because the company is changing. Whether it works in the company’s, and investors’, favour depends I think, on its speed and extent.
I gain confidence from Ricardo’s ‘one company’ philosophy and think most of what it calls ‘diversification’ might equally be labelled ‘growth’. The car industry is global, so moving into new territories is growth, likewise it seems a fairly short hop from passenger and commercial vehicles to military ones. Why shouldn’t Ricardo apply the expertise it’s gathered developing vehicle transmissions to transmissions in wind turbines? Strategic consultancy was a home-grown development of its technical consulting.
I think this could be an example of good diversification, as opposed to diworseification, a phrase coined by the fund manager Peter Lynch. Companies that diworseify, blow money on expensive acquisitions in unrelated businesses that fail to live up to their price tags.
Finding successful companies in depressed sectors is one way of tilting the odds in your favour, because prices are generally low, so I’m putting Ricardo in the Thrifty 30 portfolio at Friday’s close of 255p.
Here’s the portfolio:
Notes:
First transaction: 9 September 2009
Valuation date: 9 October 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
What I don’t know:
I don’t know how long this recession will last, and therefore whether Ricardo’s profits will rise or fall next year. Management thinks the first half of the year, which it’s already in, will be tough, but expects to recover in the second half to June 2010. Obviously the first half is fast becoming fact, while the second half is more speculative.
I’m not an engineer. So when I write sentences like “Why shouldn’t Ricardo apply the expertise it’s gathered developing vehicle transmissions to transmissions in wind turbines?” I expect a thousand engineers to email me with their reasons
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We all love Peter Lynch (audio).
In theory:
Capitalism: The Ponzi Scheme
The Economist’s Buttonwood gets pretty close to saying capitalism is a Ponzi scheme.
Analyst Dylan Grice, says we’re going the way of Rome in 300AD, and the first great inflation.
Simon Johnson, blogger, academic and former chief economist of the IMF, says Barack Obama missed his moment to break the power of the big investment banks (video) and prevent the next great depression.
Legendary capitalist Warren Buffett honours his mentor Benjamin Graham.
Moneyterms defines the F_Score.
Guarding against ego risk
Posted on October 7, 2009 by Richard Beddard
Filed Under Investing, Markets, Thrifty 30 | Leave a Comment
In practice:
Up fell, down dale
I’ll start today’s blog more or less where I finished Monday’s appraisal of Anite, a profitable software company, with strong finances that is maybe, kind of, but not certainly, cheap.
Like most value investors I think much more about safety, than I do about returns, taking the view, contrary to conventional thinking, that the fewer risks you take, the greater the rewards that follow.
There are three big risks, by which I mean factors we can know about now, that make it less likely that we will do well out of a share:
- The shares are expensive
- The company’s finances are so poor it could go bust, and…
- …Its business is deteriorating irrevocably. It’s product is, say, obsolete.
If any of those risks apply, then it’s a bad idea to invest, even in a portfolio of up to 20 to 30 shares like the Thrifty 30. Arguably, you wouldn’t be investing, you’d be gambling because you wouldn’t have much confidence in the outcome.
But, if the company is well financed, it’s product is in demand, and its shares are cheap, very likely it’s a good investment.
Running down Coniston Old Man on Saturday, and especially running along the shores of Coniston Water, I began thinking about a fourth factor that can influence an investor’s returns, and fittingly in the blustery conditions, it’s much more slippery.
I was running in an organised event, one of a series of four Lakeland Trails.
The typical course profile is a simple mountain-shaped ‘V’. The race sets off up a fell, and somewhere around half way it turns down. Coniston added a small variation to the formula, the last few kilometres being flat. Other races are more ‘W’ shaped, or ‘WWW’, but this isn’t a blog about the economic outlook.
As we trailed up the fells I chastised the organisers for leading us up the steepest section of the course single-file along a narrow path. All it took was for one runner to walk, and the rest of us were stuck in a time-sapping procession. If these people didn’t want to run, I shouted internally, why had they entered a race?
Then, up on the fells the field stretched out, the path broadened and a friend, a proper fell runner, joined me. My spirits lifted, I strode out, galloping past the halfway mark.
But running fast down rocky slopes for mile after mile can be a leg-sapping experience, especially for a runner who’s done most of his training in Cambridgeshire. Gravity ensures that you don’t realise how much life has been leached from your legs until the downhill ends, but running along the flat Cumbria Way that day I realised the battery had gone flat, and the tyres. Stopping myself falling on my face with every new step was an effort.
Every ill-disciplined runner has stories like this. The hubris and the subsequent shame of an ill-judged race. The very people I’d mocked on the way up, cantered past. Who knows whether they scoffed at me, perhaps they weren’t so uncharitable.
While receiving my athletic comeuppance I began thinking, probably deliriously, about the stockmarket and in particularly the wisdom of setting up a model portfolio in September when the market had already risen 45% from its March lows.
Many of the shares I’d picked, I’d previously identified at lower prices so perhaps I was in a similar mindset to the one I experienced as I exuberantly began the descent from Coniston’s fells.
Frustrated that I had not started the portfolio earlier I ‘bought’ all of the companies I’d uncovered (eight of them) that still fitted my criteria.
But, since rising prices will have sucked some of the potential out of these shares, and worse, many commentators fear it’s a sucker’s rally anyway, perhaps this portfolio will suffer the fate I did in the race and limp home to an unsatisfactory result.
I tell this story not just because I enjoy wallowing in self-doubt but also because I read that private investors are piling back into the stockmarket, I hope not out of frustration that they hadn’t done so earlier.
Such ‘ego risk’ belongs to a subset of risks pertaining to the investor, rather than the investment. Like complacency, sloth, pride, gullibility and a host of deadly and dangerous sins, it blinds us to the more prosaic risks I mentioned earlier.
As for the Thrifty 30, I’ve protected it as much as I can:
- The companies must meet my criteria (see the checklist), so even if the stockmarket is no longer cheap, they should be.
- Two thirds of the portfolio is still in cash, so perhaps I haven’t been egotistical enough and…
- I’ll be entering all four Lakeland Trails again next year, plus the Great North Swim, so there’s plenty more opportunity for me to learn another lesson about humility.
Let’s hope it’s the mountains, and not the markets that dish it out.
_
As I said in my inaugural podcast, which sounds a bit like it was recorded using a tin and a piece of string, the level of the stockmarket does not tell us much on its own. It’s only when we compare the price of the market to what we’re getting in return, company profits for example, that we can tell whether share prices are cheap or expensive.
Very broadly speaking, when the market price is between about ten and fifteen times earnings (implying an average return of between 10% a year and just under 7% for UK stocks), shares are a reasonable long-term investment. Below ten, they’re a bargain, and above 15 investors should be cautious. It’s creeping up towards 15, but it isn’t there yet:
Which is probably why there’s so much disagreement about which way the market will go next. Since the answer is, obviously, either way, Business Week’s cover this week is especially clever (turn your monitor upside down to appreciate it fully, Hat tip: The Big Picture).
In theory:
Another lesson in humility
‘Iron’ Mike Tyson could teach investors a thing or two about humility.
Just in from Princeton Press, ‘This Time is Different‘ by Reinhart and Rogoff, which "guides us through eight astonishing centuries of government defaults, bank panics, and inflationary spikes."
Bedlam Asset Management says a big fraud is brewing in Exchange Traded Funds.
The New York Times exposes the looting at the heart of private equity, but doesn’t go far enough according to Yves Smith.
Robert Fisk says the dollar is doomed as China, Russia, Japan, France, and Gulf oil states prepare to price oil using a basket of currencies and gold.
Bluematter explains Keynes for dummies.
Thrifty Anite tests resolve
Posted on October 6, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | 1 Comment
In practice:
A little patience, a lot of profit
Anite (AIE) presents something of a dilemma. The figures are very enticing. For financial strength, the company scores a perfect nine. It’s cheap too, the share price is just eight times its average profits over the last ten years. Beneath lies a more complicated story, though.
The company engineers and licenses software. It’s main focus is testing mobile ‘phone handsets and networks. About a third of its revenues, and a slightly larger proportion of profit comes from software for the travel industry, managing reservations, administration, accounting and marketing for tour, cruise, ferry and rail companies.
Both businesses serve big names in their sectors, Vodafone, Samsung, Thomson/First Choice, and TUI/MyTravel for example. By licensing the software, implementing it, managing it and sometimes hosting it, Anite reduces the time it takes to develop new mobile ‘phone models, monitors and analyses the performance of mobile phone networks so operators can increase efficiency, and automates holiday and travel bookings.
But for the last two years earnings have been running at about half the level they were in the previous eight years, and management expects them to dip again in the half year to October.
A decline in earnings is often a good reason to consider a company for investment, if it’s likely to be a temporary decline. That’s when investors can profit, buying shares cheaply, as others with less patience sell. A little patience can lead to a lot of profit when a company recovers.
In its annual report, and a statement in September, Anite gives a number of plausible reasons for a temporary decline:
- Recession in the mobile and travel industries, and reduced investment by customers.
- Lost sales when TUI took over another customer, MyTravel, and when two customers, First Choice and Thomson, merged.
- The delayed adoption by mobile phone networks of 4G LTE, the next generation data network.
It is a sign of strength that Anite is still profitable while telecoms and travel are in recession, and customers are holding back on investment rather than expanding. But there is room for doubt.
Anite is investing in 4G LTE, which will compete with wireless network hotspots for mobile internet users, and the company admits there’s no way of predicting the take-up of the next generation handsets it will test. It plans to regain lost revenue from tour operators by persuading customers to upgrade to its newest system and annual licenses. We don’t, of course, know to what extent this will happen.
More scary, perhaps, is Anite’s evolution from what chairman Clay Brendish describes as a “troubled and fragmented IT services company’ to a ‘focused international software company’, a deliberate strategy that seems to have frustrated investors because it’s taken so long.
It might not be over. While Anite touts the growth prospects of its testing divisions which it thinks are less open to competition, it’s more sanguine about travel, and may sell it off, as it sold Anite Public Sector in 2008 and Anite International, ten overseas IT consultancies offloaded from 2004.
Shrinking is often good business, if a leaner, less indebted, more profitable company results. Anite’s F_Score suggests that it could be all of those things, it’s certainly stronger than it was last year, but the fact that it is a different business, it acquired Nemo, its network testing division, in 2006, means its long-term earnings record is not very useful as a guide to future earnings.
Since that’s the basis of Anite’s low ten year price earnings ratio of about eight, I have less confidence in its apparent cheapness than its financial strength. Based on its more recent record, its price earnings ratio is more like twelve.
Nevertheless, I think the mobile telecoms and travel industries have a profitable future so two of the three foundations of a good investment are in place. The company’s financially strong and its businesses seem viable. The third, its valuation, is more speculative, but the shares could be in bargain territory and if they’re not, I doubt they’re overpriced..
Sometimes you can’t have everything, and although Anite’s shares have a mountain of worry to climb, they’re going in the Thrifty 30 model portfolio at Friday’s close (35p).
Notes:
First transaction: 9 September 2009
Valuation date: 1 October 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
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In theory:
Complexity economics
John Maudlin says that the simple cause and effect economics we read about, is no match for reality.
The Manual of Ideas reveals Joel Greenblatt’s reading list.
Gregory Speicher examines when to sell.
Greenbackd uncovers two papers that indicate stockmarkets on low price-to-asset values perform better.
The Economist reviews books about Keynes.
Latest iBall episodes- An error has occurred; the feed is probably down. Try again later.