The cheapest six stocks in November
Posted on November 18, 2009 by Richard Beddard
Filed Under Naked PE | 6 Comments
Investing at the extremes.
Here are the companies currently at the top of Dr Keith Anderson’s ‘six of the best’ tables of extremely cheap stocks.
All but one have appeared in previous selections. Johnston Press (JPR) now holds the record. It’s been in the top six a total of six times since we started publishing the tables in February 2007. Its first appearance was in May 2008, and its been a regular pretty much ever since. Johnson Service (JSG) has appeared five times, debuting in November 2007.
Findel (FDL) and White Young Green (WYG) appeared in our last table, published in August, and Dawson Holdings (DWN) first appeared in the table before (May). The only new entry is Punch Taverns, (PUB) which hitherto had not been listed for long enough to qualify for a Naked PE.
I’ve commented about some of the companies in this quarter’s table in Money Observer Magazine’s Share Snapshot column, which looks at the month’s highest risers and fallers.
In April, I wrote:
Fourth on our list of risers is Johnson Service, a shrinking conglomerate whose most visible component is Johnson Cleaners, the dry cleaning chain.
The shares rose 109%, after the company published its results for 2008.
Under John Talbot, a turnaround specialist, Johnson has paid off a big chunk of debt, a good sign since it was a debt fuelled acquisition spree that got the company into trouble. Mr Talbot seems confident, having bought shares throughout the year and again after the results.
But Johnson had to sell one of its most profitable businesses and raise money from shareholders, just to stay afloat. A recovery remains to be seen.
In September the company started paying dividends again and now the shares stand 18p above their 5p low in February. That may explain why Keith owns Johnson Service, but doesn’t own any of the more recent additions to the table. Typically these companies are in financial difficulty, and he thinks its best to wait until the share price has moved up through its 50 week moving average before gambling on recovery. Had he bought Johnson Service the first time it had appeared in the table, the shares would have cost him 68p
Table topping White Young Green is, perhaps, in the most trouble. Having breached its bank covenants, the engineering consultancy is swapping debt for equity and planning to give part of the company to employees to stop them leaving. Existing shareholders will end up owning just 15%. Although the shares are extraordinarily cheap, investors are receiving a much smaller claim on the future profits of the company in return, even assuming it makes a full recovery. That explains, at least in part, why the share price is so low in relation to past profits.
The Naked PE is a souped-up version of the traditional PE ratio. Instead of comparing the price to one year of earnings or profits, it uses the average of the previous eight years. It also makes adjustments to favour smaller companies and companies in growth sectors.
In theory, these adjustments should boost the predictive value of the PE ratio, which Keith verified by back testing portfolios of Naked PE shares. But the financial crisis has been troublesome for the Naked PE, as some of our portfolios have shown.
A year on, £6,000 invested in last November’s portfolio would be worth £22,806 including dividends. £6,000 invested in November 2007’s portfolio, though, is worth just £1,625 today. On its first birthday in November 2008 the portfolio was worth less than £1,000.
Running concentrated portfolios of extremely cheap shares has turned out to be risky during a financial crisis. When the market crashed in 2008 and the first months of 2009, companies on low valuations, as measured by traditional PE and price to book ratios, suffered badly. When the market recovered, they rebounded most strongly in a move pundits labelled ‘the dash for trash’.
Investors probably thought problem companies with heavy debts and low valuations might go bust in the depression many predicted, but as the economic news got better, or at least less worse, they bought the shares, anticipating their survival.
For extremely cheap shares, as measured by the Naked PE, the market’s verdict was even more extreme on the way down, and on the way back up.
-
New pages
Like the Naked PE, the Thrifty 30 method uses a long-term price earnings ratio, but marries it to measures of financial strength to try and weed-out the shares most unlikely to recover.
This week I’ve published four new permanent pages explaining the Thrifty 30, and the wider purpose of this blog:
I’ll update the charts and tables most weeks on Wednesdays.
-
Imagine an investment’s gone bust, then ask why
Jason Zweig gives some advice on avoiding confirmation bias, or the ‘Yes-man’ in your head. Imagine an investment’s gone bust, then ask why.
Finance theory is a crude approximation of reality, say chaos theorists.
Saj Karsan links earnings, profit margins and valuations to explain the link between the value of a company and the business cycle.
Gold is glittering, says Buttonwood, with all the preconditions of a bubble.
Buffett’s ‘lost his mind’, says arch value investor Bruce Greenwald. He’s paid far too much for Burlington Northern.
The hanging gardens of Alumasc
Posted on November 16, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | 2 Comments
Working hard for pensioners
Alumasc (ALU) might be a customer of Waterman, the engineering contractor I profiled last week.
It’s a a group of companies making building materials for large commercial and public sector property developments, and houses.
It also owns a precision engineering company, and a manufactures taps and other equipment for dispensing drinks in pubs.
About 70% of sales come from building materials, which you might expect to be in deep recession. But its recent annual report shows fairly resilient sales (down about 6%) and operating profits (down about 14%). Management says that’s because all but 10% of its building products improve the environment, they reduce energy consumption and manage rainwater.
This (left), for example, is not a meadow, it’s a close-up of a green roof. From sublime solar shields, to more mundane manhole covers and washroom cubicles, Alumasc companies sell a pretty diverse range of products.
Its claim that ‘sustainable’ building products is a faster growing market than building materials in general, seems to be supported in the segmental analysis of its results. Sales and profits of energy related products, the biggest single category grew, but ‘premium building products’ like scaffolding and interior casings, made a loss (click the chart for a larger version):
Alumasc Precision, its engineering company, also made a loss. Overall, Alumasc’s sales fell 13% and earnings per share, ignoring write offs and redundancy costs mostly on the engineering side fell 37%. It’s still profitable though, and considering it repaid some of its long-term borrowings and reduced the deficit on its defined benefit pension schemes in the year, I think it’s a potential candidate for recovery.
At seven times average earnings over the last ten years, its well inside bargain territory and with an F_Score of six out of nine, it appears to be financially strong. Although it loses points because its profitability has fallen, that’s hardly surprising when three of the four quarters covered by the annual report (October 2008 to June 2009) were recessionary.
My data starts in 1992, and despite booms and busts, the company hasn’t made a loss in that period although it’s significantly changed its mix of businesses. In 2000, the earliest annual report currently available on the company’s site, precision engineering turned over £91m and building products turned over £37m, a split that has since reversed.
As usual, there is room for doubt. Alumasc’s pension obligation is £76m, double the company’s market value. Large final salary pension schemes, while very good for staff, are an unwelcome complication for shareholders because the size of the obligation is not fixed. It swings around unpredictability as salaries, expected returns on the fund that pays the pensions and actuarial calculations of life expectancy, for example, change.
Alumasc’s pension fund is £12.5m smaller than the current calculation of its obligation and it’s paying about £3m a year on top of the normal cost of the pension (about £1.4m this year) to plug the deficit. Although we might expect profits to rise once it has funded its pension, that’s some years away, and there’s always the possibility the obligation could grow.
Alumasc also has £11m in long-term debt, about 13% of total assets or 37% of equity, and these liabilities add up.
Nevertheless, its diversity seems to be a strength. Its Interim Management Statement for the first quarter of 2010 reported stable levels of activity compared to the previous quarter with reduced demand from new commercial building projects mitigated by a modest upturn in new house building. Public Sector projects, and demand for brewing products and precision engineering were stable.
So I’m going to break an unwritten rule, to avoid companies with large pension obligations, and back Alumasc to trade its way through this recession.
Like Waterman, its exchange market size is below the £1,000 I notionally invest in each of Thrifty 30 companies. Also major shareholders, management and institutions, own a sizable chunk of the company, so I’ve checked to make sure that we could in practice buy £1,000 within the spread of 100 to 105p. We can, but only just, at 104.9p.
I’ve added it to the Thrifty 30 portfolio, which you can now find here, on its own permanent page.
-
The essence of a free market economy
John Kay says “the essence of a free market economy is not that the government does not control it. It is that nobody does.” The essence of our economy is that capitalists control it.
‘How Markets Fail’ by John Cassidy promises to be a good primer on the financial crisis, and the development of economic thought.
Bankers already know the most important lesson from the financial crisis. It’s ‘Don’t invest your bonus money with Bernie Madoff’.
America’s declining, says John Plender, but it’s not falling. It’s decline is relative to China and other emerging markets, not absolute.
Brian Yacktman, says buy and hold is not dead, you just have to buy at the right time.
Dylan Grice points out that herding is not the wisdom of crowds. Wise crowds think independently. Investing is a kind of groupthink.
Overthinking It, blames boy bands and Madonna for America’s declining oil production. It must be so, the decline is correlated to the falling number of songs from recent decades in Rolling Stone magazine’s list of 500 greatest songs.
Value Investing: Tools and Techniques for Intelligent Investment
Posted on November 11, 2009 by Richard Beddard
Filed Under Investing, Reading list | 12 Comments
Read this book!
If you knew nothing about the stockmarket but happened upon Value Investing the old-fashioned way in a shop, you’d probably return it to the shelf sharpish. Certainly after reading a little of the preface.
James Montier’s on a crusade against the financial orthodoxy: Efficient Markets, Modern Portfolio Theory, the Capital Asset Pricing Model and Discounted Cash flow models. He thinks they’re wrong and lead investors astray, and also he thinks there’s a better alternative: value investing.
For investors grappling with the big questions though, how to reduce risk and increase return, when a company’s shares are cheap or expensive, and why cheap value shares do better than expensive growth shares in the long-run, Montier has answers.
Value investing is a throw-back. It predates the ideas Montier attacks. Benjamin Graham, an investment manager and finance professor who in 1934 literally wrote the book on security analysis, is Montier’s hero (along with Keynes and Sherlock Holmes). Graham’s premise was that the stockmarket in general, and the market in individual company shares, fluctuate around their true value. To win in the long-run investors should buy when shares are cheap and sell when they’re not.
If value is how you beat the market, behaviour is why. Investors like Graham had always known that share prices are determined in part by the facts, how profitable a company is, how strong its finances are, and by speculation, how it might do in future. When times are extremely good, or extremely bad, the speculative element takes over and prices rise to unjustifiable highs and fall to unfathomable lows.
It’s a pattern we all recognise, even in the recent financial crisis, and the property and technology booms that predated it, but few of us capitalise on it. Psychologically, It’s tough to contemplate buying when fear grips the market and prices are low, or selling when all around you are confident and prices are rising. For a professional investor it can be suicidal to go against the crowd wrongly. At best you’d lose clients, at worst you’d lose your job.
Montier adds rigour to this philosophy, drawing inspiration from research by behavioural psychologists and economists unknown to Graham and the earlier generation of value investors. He uses the number-crunching capability of the two investment banks he worked for to demonstrate time and again that value strategies not only beat the market, but, for example, delivered positive total returns even in bad markets like Japan over the last two decades.
Since value investing reliably beats the stockmarket, it’s difficult to see how it’s more risky as finance theory claims. And since Montier has the statistical evidence and an explanation, in behavioural finance, he’s championing what appears to be a better gaggle of ideas about what makes a good investment.
The title of the book, is a misnomer just like the title of Montier’s earlier book Behavioural Investing. Value Investing is as much a book about behavioural investing as Behavioural Investing was about value investing. The disciplines go together, they’re the ‘how’ and ‘why’ of successful investing.
Value Investing is a collection of Montier’s weekly strategy notes, sent to institutional investors, and the odd journalist like me. Sadly, he’s stopped writing them now but you can get a flavour by searching this blog, or reading the extracts on publisher Wiley’s website.
As each chapter was originally a discrete article aimed largely at an audience of institutional investors well-versed in finance, Montier occasionally assumes a level of understanding beyond that of a typical private investor.
Perhaps he’s a little impatient too. You can feel the hysteria as he damns efficient markets. It reminds me a bit of Richard Dawkins who recently published The Greatest Show on Earth, a book about evolution. Dawkins starts with a rant against creationists, people whose faith denies the existence of the theory Dawkins understands to be fact. He calls them history-deniers, as Montier might call proponents of financial orthodoxy value-deniers.
Both men, I sense, would rather spend their time expounding, or practicing, the theories they know to be true, but find themselves continuously drawn into defending them from claims they know to be spurious. There is a difference though. Dawkins is on farmer ground. Evolution is hard science. Finance only aspires to be, so perhaps Montier’s opponents deserve a little more respect.
He’s at his best in the majority of chapters describing the tools and techniques of value investing. Frankly, I’ve not read any book, that comes close.
There are books that tell you ‘how’, and there are books that will tell you ‘why’, and there are books that comment on today’s markets, but this one does it all. Most of the chapters are from 2008, and 2009. That’s about as current as a book can get.
But there’s a gap in the market for an antidote to A Random Walk Down Wall Street, the classic defence of financial orthodoxy written for the lay-man. That’s a book I’d love Montier to write. Since his next book, The Little Book of Behavioural Investing, is aimed at a broader audience, he may be headed in that direction.
On the other hand, in his new job at GMO he’s practicing investing, not writing about it, so perhaps he’s responding to the ideas that deny investors can consistently beat the market as a footballer might respond to his critics “on the pitch”, by making lots of money.
-
The only good economists are dead economists
Is the Efficient Market Hypothesis to blame for the financial crisis? Only a little bit, says Graeme.
Can we rely on the maths of modern finance? Not entirely, says Morningstar, because the correlations and measures of volatility the models use from the recent past, don’t necessarily hold in the future.
People have stopped talking about ‘green shoots’ but perhaps in low inventories, there are some. Jeff Matthews thinks so.
Saj Karsan advocates average earnings as a guide to future profit, one-year’s earnings could be affected by infrequent items or a temporary downturn or upturn.
Like Morgan Stanley, Anthony Bolton thinks the time to switch from value to growth is coming.
How can this be a bubble, says Jim Rogers, when prices are so low?
Dilbert says: buy what you hate.
Minsky, Mises, and Holt understood what the current crop of economists don’t, says Rolfe Winkler, that debt drives economic cycles. The problem is, they’re all dead.
Backing bombed-out Waterman to rebuild again
Posted on November 9, 2009 by Richard Beddard
Filed Under Companies, Thrifty 30 | Leave a Comment
Not the best company, but…
"The patterns of boom and recession in the British economy and the post war history of commercial property developers have shaped the Waterman Group to a considerable degree."
Waterman’s history is pretty fascinating. Founded by Harold-Waterman in 1952, the engineering consultancy helped rebuild Britain after the Second World War and develop the City of London in the 1970’s and 1980’s. Then it clung on to the coattails of globalisation going wherever, it seems, there’s an office complex, station, motorway or hospital construction project to manage, design or plan.
Cleared bomb sites, Elephant & Castle. Source: Ingenuity and Engineering: The waterman Story [pdf].
But as property prices collapse in recession, building projects are cancelled or delayed reducing the income and profitability of the engineers working on them. Waterman survived in 1992 by cutting its workforce in half and closing many of its offices. In 2009, it’s bust time again.
The pattern of boom and bust, may have shaped the company. It’s also shaped the share price (see chart), and, no doubt, etched itself into the minds of many investors.
At 40p, the share price values the company at just over £12m, yet it made sales of £122m in the year ending 30 June 2009. It made profits of nearly £3m even after £2.1m of restructuring and redundancy costs and a £2.8m provision against bad debts, money it’s owed but doesn’t expect to receive, and write offs, costs it no longer expects to recoup.
Bad debts and write-offs are a sign of crisis, but so far the company seems to be coping. Profitability is down, but Waterman (WTM) is profitable and its shares are very, very, cheap. They cost just four times its average earnings over the last ten years.
Perhaps investors are fearful it will suffer the fate of White Young Green, another consultancy which, unable to pay its debt, must swap it for equity. It’s also planning to give part of the company to employees to stop them leaving. Existing shareholders will end up owning just 15%.
Perhaps they think the provisions in 2009’s results are just the beginning, and many more projects will falter as clients get into financial difficulty. The provisions Waterman made in January, though, are actually £1.2m less than the maximum of £4m the company forecast in a statement in May.
I think Waterman is in better shape than its paltry stockmarket valuation indicates. Unlike White Young Green, it has relative modest debt. In June it had reduced its long-term borrowings from about £15m to about £12m or 12% of total assets, and interest was covered three times by operating profit.
The worry is that even that much debt is too much and expanding overseas hasn’t given it the diversification it hoped would insulate it from the busts of its past. In 1992 it had no debt, and so far it’s projects in Ireland, Russia and UAE that are causing the trouble.
Still, at this price, I think Waterman is a good bet. From the perspective of its past, busts are normal, yet investors have panicked. This table comparing Waterman’s valuation and financial strength with some of its peers sums up the situation:
RPS looks like the strongest company in the group. Like Waterman it has an F_Score of six out of nine, but it owns more than twice what it owes (Shareholders’ equity is 68% of total assets, therefore liabilities are only 32%). Investors are paying through the nose for RPS though. At 23 times long-term earnings, the speculation is all in the price.
White Young Green is, unsurprisingly, dirt cheap, but it completely fails my tests for financial strength.
Only Waterman appears cheap and financially sound. It’s probably not the best company, but it’s the most underrated and should be the best investment.
It’s so cheap, I feel uncomfortable adding it to the Thrifty 30 model portfolio. To go against the crowd this defiantly will either look heroic or stupid in a few years time but contrarian investments are by nature uncomfortable so I’m adding Waterman at Friday’s close of 40.5p, a buy price I confirmed with my broker this morning.
I checked because Waterman has a very low exchange market size (£410) suggesting it might be difficult to buy quantities even as small as £1,000. Fortunately, it’s not, but its apparent illiquidity could still put off larger investors, another reason for the company’s unpopularity.
First transaction: 9 September 2009
Valuation date: 6 November 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
-
Goldman, forever blowing bubbles
Will they ever learn? Despite the catastrophe of the original Nifty 50, Goldman Sachs are touting not one, but two, new Nifty 50s, this time in BRIC countries.
John Mulligan likens UK gilts to Ponzi schemes. Verdict: they’re not as safe as houses.
…And when he’s not bashing gilts, Mulligan’s repurposing his successful STAR stock picking formula, to international companies.
Saj Karsan explains why Buffett ’aint no ordinary value investor, and cautions us not to ape him.
Eugene Fama, father of the Efficient Markets Hypothesis, puts up a defence of the model that many people hold responsible for the financial crisis. How can EMH be responsible, when the majority of investors disbelieve it?
Easily, says Justin Fox, author of The Myth of the Rational Market, policymakers believed in efficient markets, and the academics who constructed the hypothesis didn’t disabuse them.
Here’s an anomaly: According to Dylan Grice’s BAAH index, sectors covered by many analysts herding together tend to do worse than sectors covered by few. Sheep.
Buttonwood’s nervous about China, bureaucrats don’t allocate capital better than markets.
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.
-
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.
-
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.
-
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.
-
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.
-
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.
-
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
-
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 | 10 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.
-
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.
-
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.
