Thrifty 30 progress report
Posted on July 1, 2009 by Richard Beddard
Filed Under Investing, Markets | Leave a Comment
In practice:
Good companies at cheap prices
Occasionally on Twitter investors, as opposed to people hawking porn sites, show interest in my tweets. So, when henrio83 asked ‘What’s happened to your thrifty thirty?’ I thought I should explain.
First, a quick recap.
Thrifty 30 is the name I gave a method of discovering good companies at cheap prices. It’s based on the ideas of Benjamin Graham, the long-dead father of value investing, who recognised the main risks facing investors are paying too much for shares and investing in financially weak companies and declining businesses.
Towards the end of his life he proposed a system that any investor could follow, which involved buying shares costing less than seven to ten times their latest profits, measured by earnings per share, in companies that own more than twice what they owe.
By avoiding the riskiest companies Graham figured he’d do well.
The correct PE ratio depended on bond yields, and investors could calculate a company’s financial strength by comparing its shareholders’ equity to its total assets. If equity was at least half of the company’s assets (what it owns) then its liabilities (what it owes) must be less than half.
As now, newspapers reported PE ratios and investors could easily find a company’s equity and assets in its annual report.
The system is thrifty because the companies are cheap, and not overly indebted and thirty because, for safety’s sake, Benjamin Graham advocated holding twenty, or preferably thirty, companies in a portfolio.
If that sounds like gobbledegook you can read my fuller explanation.
Last March I constructed two Thrifty 30 portfolios, one for Interactive Investor and one for Money Observer (PDF). I haven’t tracked their performance, although considering the stockmarket recovery I’d probably look like a genius if I did. That conclusion would be misleading for all sorts of reasons, but even it were true three months is not enough to judge a system promising 15% returns over five years or more.
I’ve been running a slightly longer but less rigorous test in the Share Sleuth column, also published in Money Observer. All but one of the companies I’ve featured in its first year have done OK, and three, EDI, Carluccio’s and ITE met or exceeded Graham’s 50% profit target very quickly. The only failure, so far, is Optare which, coincidentally is the only one that didn’t meet my Thrifty Thirty criteria. However, it’s also too early to judge Share Sleuth and the title of the latest column describing the first year of Share Sleuth ‘Triumph over adversity’ sets me up nicely for a slice of humble pie next year.
Since March I’ve been working out how to improve on Graham. That’s sacrilege of course. Graham is the pre-eminent value investor who invented the discipline, wrote the textbook, and inspired greats like Warren Buffett.
These days, with more data available to the private investor, it’s possible to substitute the long-term PE ratio, an invention of Graham’s by the way, for the one-year historical PE ratio and Piotroski’s F_Score for Graham’s measure of financial strength. Both measures have more potential, I think, judging from the academic research and are a good basis for reducing the market to a manageable number of Thrifty 30 candidates.
Most of the companies I’ve reviewed on the blog since March have met these criteria, and many of them, as long as they are still cheap enough, will feature in a new Thrifty 30 portfolio that I will compile and maintain when I get back from holiday in August.
And that, really, is the mission of this blog:
- To understand the stockmarket and how to profit from it, as I do in the posts categorised ‘markets’ and ‘investing’.
- To identify good companies at cheap prices, as I do in the ‘companies’ category.
All that’s missing is to prove it works, by:
- Running a model portfolio that earns market-beating positive real returns over every five year period of this experiment
Which is coming soon. Meanwhile, here are some companies that have financial year-ends in the last six months and currently meet my Thrifty 30 criteria:
Ggearing is Grahams original measure of financial strength, which I still keep an eye on, and EPS count is the number of years of earnings data used in the long-term PE calculation.
I derive the figures from data from Sharelockholmes.com and Sharescope. Readers interested in recreating Graham’s original screen can do it using the Sharelockholmes website (it charges a small monthly fee).
Here’s the long-term PE ratio for the whole UK market:
As you can see it’s stuck on 11, which looks cheap, but Jim, a reader from the United States sent me an email yesterday warning of complacency:
The following post links to an Excel spreadsheet that has a 10-year PE for the S&P 500 going back over a century… The data there shows that the average 10 year PE for the market over more than a century is just over 16. But it also shows that there are very long periods of time when the 10 year PE was quite depressed. For 10 years from 1915 to 1924 the average 10-year PE was just below 8 or less than half the long-term average. That’s quite a long time for stocks to be so dramatically cheap. For another 10 years from 1975 to 1984 the 10-year PE averaged less than 9.5. And of course there is the aftermath of the Great Depression: for 20 years from 1931 to 1950 the average 10-year PE was under 12.8. That’s forty years overall where the long-term PE was at *least* 20% below the century average, and sometimes over 50% below it. The low PE during the 70s and 80s is really not that long ago, and it was quite far below the average. To know that stocks may trade below 10 times their 10-year average earnings for a decade makes one hesitant to buy the market as a whole based on PE alone.
The Thrifty 30 isn’t an investment in the whole market, it’s an investment in the undervalued part of it. But you have been warned!
In theory:
The economy according to Clarkson
Add Jeremy Clarkson to my list of economists who know what they were talking about.
Nick Train, is the UK’s Warren Buffett, says the Investors Chronicle, but it doesn’t mention whether he measures up, in terms of performance.
George Soros: “When I see a bubble, the first thing I do is buy”
Business Post mails it
Posted on June 29, 2009 by Richard Beddard
Filed Under Companies | 3 Comments
In practice:
Business posts good results
The conundrum at the heart of Business Post’s (BPG) story is inexorably rising sales and range-bound profits.
I think it explains why, judging by the share price, investors have gradually tired of the company, even though it’s an innovator in a fairly solid sector: parcels, and mail.
From its recent annual report Business Post’s mostly business-to-business parcel service accounts for 45% of sales, mail accounts for 43% and specialist services like its courier service and pallet delivery account for 13%.
But the mail service has grown from a standing start in 2004 when Royal Mail gave up part of its monopoly. Then Business Post’s UK Mail division became the first company to collect and sort letters in competition with the Royal Mail, which still delivers them. Now Business Post collects 17% of the UK’s mail, 70% of which it describes as ‘statement’ mail, from just 1,000 companies.
By focussing on the really big mailers and using its parcel network to collect, UK Mail achieves economies of scale, but profit margins are not as generous as they are in the parcel division. Parcels earned Business Post £15.6m operating profit in the year ending 31 March 2009, while UK Mail earned £11.6m.
Overall Business Post’s profits haven’t kept up with sales, and ultimately its the profits investors are interested in.
The recession must also be weighing on BPG’s share price. Although Chairman and co-founder Peter Kane says UK Mail is more insulated than we might expect because companies keep sending out statements, the amount of junk mail it carries might fall as businesses try to cut costs. The parcel service depends on the levels of business between companies, and Business Post reported 10% lower revenues in the second half of the year.
Nevertheless, on a long-term price earnings ratio of 13 it’s drifting towards bargain territory and an F_Score of nine out of nine, reflecting improving profitability, falling indebtedness and rising liquidity, shows that so-far Business Post is doing well despite recession. The launch last year of imail, which prints, addresses and posts mail for business customers shows its still innovating.
Perversely there’s not enough bad news stalking Business Post to make it attractive to a contrarian. With a market capitalisation of about £150m, its big enough to attract press comment, and City coverage. The Investors Chronicle likes Business Post, analysts like it, and the directors are upbeat too.
They’ve persistently bought on the dips, the latest being Guy Buswell, the chief executive who first joined the company back in 1989. He bought 15,000 shares at 285p earlier this month, taking his stake to over 127,000 shares.
The good vibes are almost enough to scare a contrarian off. But Business Post faces competition too, sometimes in slowly declining markets.
According to Postcomm, the industry regulator, there are now 25 licensed mail operators and the market for ‘transactional mail’ (bills and statements) is shrinking at a rate of 3% a year as companies and their customers switch to online billing.
The direct mail market has also shrunk since 2003, so, while the mail is opening up giving companies like UK Mail, DHL, Fed-Ex, TNT and others a new opportunity, the overall market, for mail at least, appears to be increasingly competitive and shrinking slowly.
This must have dampened the spirits of investors expecting a mail boom. The question is, are they too dismissive now? I think they underestimate Business Post, but I’d prefer to see the price even lower in relating to earnings, a long-term PE closer to 10, just to be sure.
In theory:
The next bubble
What do you get if you combine a good economic story, a sunny outlook for profits, and easy money? Answer: A bubble, says Citigroup’s Robert Buckland, and Where do you get it? Answer: Emerging markets, or…
…Maybe green energy technology, reports Alphaville,
Stephen Green, chairman of HSBC and Anglican priest, says “There is something about the market system which is inherently unstable.” His new book, Good Value, is a moral defence of capitalism and globalisation exploring how to navigate their weaknesses.
The Economist reviews five books on the financial crisis, and decides the definitive tome has yet to be written.
It’s all Goldman Sachs’ fault, says Rolling Stone.
Scientific American reveals a specific site within the brain’s prefrontal cortex that is among the suspects in the financial meltdown.
Graeme says active investing is a negative-sum game. So do Eugene Fama and Kenneth French.
I’ve had many barney with Graeme, but I agree with his response to the FSA’s consultation paper on the distribution of retail investments, aka financial advice.
What’s driving the Chinese to save? So their sons can find brides.
£1.3bn in cash may not be enough to see British Airways through the recession.
Deficient Markets Hypothesis
Posted on June 24, 2009 by Richard Beddard
Filed Under Markets | 10 Comments
In theory:
As dead as a parrot
In his latest note, Soc Gen Analyst James Montier, compares the efficient markets hypothesis (EMH) to Monty Python’s dead parrot.
No matter how much you point out that it is dead, the believers just respond that it is simply resting!
Montier’s often pronounced EMH dead. In fact, he’s getting so frustrated he’s beginning to rant like John Cleese.
The shopkeeper refusing to accept EMH’s demise could be arch-exponent Burton Malkiel whose book, A Random Walk Down Wall Street is an investment classic now in its ninth (2007) edition. Malkiel, a professor of economics, and investor says the premise of his first edition, that:
…the market prices stocks so efficiently that a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed by the experts…
…has held up pretty well:
More than two-thirds of professional portfolio managers have been outperformed by the unmanaged S&P 500 Index. Nevertheless, there are still both academics and practitioners who doubt the validity of the theory.
Those of us who try and beat the market have a case to answer:
First, there’s an elegant and simple theory that states that if people behave rationally then they will pay more for good investments, right up until the point they are no better value than lower quality but cheaper investments. In such a world, the price would always be right and there would be no reason to invest in one company, over another. Catch-22.
Second, most investors who try to beat the market, fail.
I can almost hear Montier screaming. As I said last week, an alternative hypothesis, beloved of value investors and the emerging field of behavioural finance, is that investors aren’t rational. They herd, finding safety in numbers and bull markets, right up until they go off the edge of the cliff together in bear markets.
If you invest in the market through index trackers as Malkiel advocates, you’re tied into that daft behaviour. But judging by their records, the professional investors Malkiel talks about, make even dafter choices.
How can that be? Another academic, Mark Rubenstein, described the sub-par performance of professionally managed funds as:
…a nuclear bomb against their [the behaviouralists’] puny sticks… [they] have nothing in their arsenal to match it.
Montier says this observation is flawed because US institutional investors managed about 70% of the whole US stockmarket in 2007 and the composition of their portfolios mirror the whole market. Hence they’re doomed, as a group, to be average, or below average after they take their fees. In other words, they’re not as independent of the market as they’d like us to think they are.
Why should that be? Career risk, he says, explains the herding. To bet against the market is to stand out from the crowd. When, for a while, you do worse than the market, you stand out for the wrong reason. Clients withdraw their money and you risk going out of business before you demonstrate you can beat the market. As John Maynard Keynes said:
…it is better for reputation to fail conventionally than to succeed unconventionally
So professional investors are very rational. They do what it takes to keep their jobs, even if those actions don’t serve the long-term interests of their irrational clients, pension fund trustees, insurance companies, financial advisers, and, well, people.
If EMH is dying, Montier is doing his best to ease it into the coffin. He quotes a survey showing 67% of chartered financial analysts thought the marked failed to behave rationally:
When a journalist asked me what I thought of this, I simply said “About bloody time”. However, 76% said that behavioural finance wasn’t yet sufficiently robust to replace modern portfolio theory (MPT) as the basis of investment thought. This is, of course, utter nonsense. Successful investors existed long before EMH and MPT. Indeed, the vast majority of successful long-term investors are value investors who reject pretty much all the precepts of EMH and MPT.
But does it matter, beyond, the arcane arguments of academics and investors? Well, yes. If markets are irrational, then it’s adherents of EMH that have a case to answer, says Philip Coggan, The Economist’s Buttonwood columnist:
From this [the assumption that market prices are always right] developed the idea that bubbles cannot exist and thus that central banks should do nothing about rising asset prices. That belief may well have been dangerous. In particular, returns are not “normal”, in the sense of following a bell curve distribution. They are plagued by fat tails or extreme outcomes; failing to allow for these outcomes contributed to the recent crisis.
-
If the stockmarket was efficient, then computer algorithms would be better at trading than humans, says quantitative trading system designer Joshua Holden.
Seth Klarman explains the market’s short-termism. Fund managers who focus on long-term wealth creation should be rewarded but it’s actually those that do well in the short-term that get assets.
The Economist reviews “The Myth of the Rational Market” by Justin Fox.
Whatever next? Hedge fund managers are plugging their platforms into Twitter.
In practice:
The price isn’t right
Strictly not for EMH acolytes: The stockmarket is still looking cheap, although it’s not in outright bargain territory as it was, briefly, in March…
…Which may explain the glut of apparently cheap and financially sound companies. All of the following have prices less than twenty times average earnings and score six or more out of nine according to Piotroski’s F_Score:
The date as always is from two commendable services Sharelockholmes.com and Sharescope.
It’s about Chime
Posted on June 23, 2009 by Richard Beddard
Filed Under Companies | Leave a Comment
In practice:
One that almost got away
Could Chime Communications (CHW) be one of many companies that traded at incredibly cheap prices in February and March, but have since rebounded so strongly the value has all gone?
The share price fell below 40p, briefly, and it’s now well over a pound, partly because doomsday was cancelled, or postponed, sometime in April, and partly because Chime did so well in 2008.
Its ten-year price earnings ratio is less than six, much higher than it was, but still well inside bargain territory. Chime’s results to 31 December 2008 reveal an increasingly profitable, less indebted company which combined with the low share price is enticing, especially considering its bullish update in May.
Rubbing the noses of its bigger competitors, chairman Lord Bell announced double digit rises in sales, profits and margins over the first quarter in 2008.
You’d expect a PR and marketing agency to come up with good reasons to be cheerful, and here they are, straight from the annual report:
- PR. The results confirm that public relations is weathering recession better than advertising and market research. Chime’s Bell Pottinger division brings in 55% of operating income, which offset weakening performance in other divisions in 2008.
- Fear. Chime says never have corporate reputations been more important than now, when so many lie in tatters. The answer, apparently is corporate responsibility, communicated by Chime 24/7.
- Government spending. Chime trumpets a number of Government contracts including Hepatitis C awareness and saturated fat campaigns.
- Foreign revenue. Chime also represented Zambia’s new president Rupiah Banda in the election he recently won, a demonstration of the international sales that account for 60% of revenues.
There’s no shortage of colourful clients for the company that once promoted democracy in Iraq and defended Greg Rusedski against doping charges, but, set against these stories, and the equally impressive numbers, is the possibility, some would say probability, of a ‘double-dip’ recession. We’ve already seen what can happen to a company like Chime’s share price when investors fear economic meltdown.
Most media companies suffer in recessions, yet Chime has done worse in stockmarket terms than the media sector in general, despite other constituents, like TV companies and newspaper publishers, facing unprecedented competition from the Internet.
The conventional wisdom, never to be trusted, but borne out by Chime’s results, is that ‘reputation management’, as the PR industry is rebranding itself, is a growth business in the Internet age.
Admittedly Chime’s grown by acquisition – a common way to blow shareholder’s money - taking over at least 19 companies since 2000, four as recently as 2007, and it was rebuffed in May by Next Fifteen, another group of PR agencies and related marketing companies.
Chime made three more very small acquisitions in 2008, and it probably owes about £15m over the next five years for past acquisitions. If they perform well enough, it could owe more than double that in cash and shares.
During the dot.com crash, it almost paid the ultimate price for its expansiveness when profits collapsed and high levels of debt forced it to renegotiate its banking covenants and sell-off one of its companies.
Perhaps memories of its flirtation with insolvency still linger with investors. But Chime had no bank debt at its financial year end and its financial director says it’s keeping cash and its £32m debt facility as a bulwark against more economic distress.
It may have learned, and since Next Fifteen’s price had collapsed from almost a pound to less than 30p earlier this year, Chime’s approach seems opportunistic. If so, we can hardly blame it for chasing value, when that’s exactly what a value investor would do.
Considering shares in a company that has recently trebled in price, as Chime’s have (almost) is a sterner test because we know much of the potential in its low-price has evaporated.
Remarkably, though, the value doesn’t seem to have boiled away completely.
Next Fifteen (NFC), and larger rival, Huntsworth (HNT), also look worthy of inspection.
-
Surprise! Former Share Sleuth pick (PDF), Games Workshop (GAW) says that its profits are likely to be ahead of expectations, while Yell, not a favourite, could breach its banking covenants.
In theory:
Terrific telly
Watch the demise of Merrill Lynch and Bank of America on PBS, through the eyes of the bankers, John Thain and Ken Lewis. It’s terrific telly.
The Economist leads where blogging will follow, incredibly.
Jeff Matthews’ last word on this year’s Pilgrimage to Omaha reveals Charlie Munger, not Buffett, as the true star of the Berkshire-Hathaway festival. Here’s some of his worldly wisdom.
The How and Why of value investing
Posted on June 17, 2009 by Richard Beddard
Filed Under Investing, Markets | 8 Comments
In practice:
It’s not science, and it’s not about rockets
As a youngster, the “How and Why” books inspired me and I’ve just experienced overwhelming nostalgia browsing this website. I’m not alone. Definitely not alone!
How and Why books explained things, and to a boy who’s previous main source of wisdom had been the Valiant Annual, How and Why was a major step up.
So, in the spirit of How and Why, I’m going to explain How and Why I choose the companies I write about, as well as What, a list of companies that meet my criteria for investigation.
First, Why…
By going to the considerable effort of picking shares, and not, for example, settling for the slightly below average stockmarket performance promised (for minimal effort) by an index tracking fund, I’m expecting above-average returns over five or more years.
In theory, that’s very difficult to achieve because share prices are determined by people’s rational expectations. If we think a company will do well we buy the share, and its price rises. If we think a company will do badly we sell the share, and its price falls. Good companies, in other words, are expensive to own, which nullifies their attraction to investors.
In financial jargon, the stockmarket is efficient and there’s nothing to be gained by painstakingly researching shares. You might as well throw darts at the Companies and Markets pages in the Financial Times (better that than lists of companies on your computer screen).
Active investors, and, I think, the man in the street, know there’s more to share prices than rational expectations. Since the days of tulip mania, the suspicion has always been that mob-psychology is at work in financial markets. Companies, sectors and whole stockmarkets go in and out of fashion and it’s when the stockmarket is at its most inefficient, when share prices diverge from the underlying value of companies, that the stockmarket is most interesting and investing is most rewarding.
Then, investors can pay less for shares than they reckon they’re worth, and later, when the shares are popular again, they can sell them.
Successful investing isn’t about finding the best companies, its about finding the best companies at the best prices. It has a lot more in common with betting on horse racing than I like to admit, at least, if gambler Patrick Veitch, is right. Earlier in the year I heard him say something on Radio 4 that was so relevant to investing I scribbled it down:
Most people who look at horse racing are looking for something they like, something they think is good. And to win seriously at betting you’e not going for something that’s good, you’re going for something that’s underestimated.
It’s not rocket science. It’s not even, wholly, science. But that’s what makes investing so challenging. You have to spend your time in the company of unpopular shares, trying to work out which ones smell a bit, but will do well again, and which ones must be chucked out of the fridge before they kill us.
The way to do that is to put safety first…
Then, How…
…By focussing on companies that:
- Have long records of profitability
- Are financially sound
- Sell products and services likely to be in demand in future, and (of course) that…
- Are cheaper than they should be.
If that doesn’t sound like fun and you’d rather be chasing growth in China, then you’re probably not cut out to clean kitchens, or be a mortuary attendant either. It helps if you can find joy, where other’s find despondency, or a piece of yesterday’s half-eaten steak.
It’s also helpful not to have to rummage through the entire stockmarket, and I use three financial statistics to help me find likely candidates. Briefly:
- The Long-term price earnings ratio. This is the price compared to the company’s average profits over a minimum of five years, and preferably nine. Just like the regular price earnings ratio, a low PE is indicative of value, and higher returns in future, but the long-term PE works much better.
- The F_Score. A super-statistic that combines nine variables to measure a company’s financial strength. Companies with a high F_Score are profitable, have decreasing debt, and increasing liquidity. They’re unlikely to go bust and more likely to be getting out of trouble, than into it.
- Graham Gearing. Benjamin Graham, mentor to all value investors, liked to buy shares in companies that own more than twice what they owe (the ratio of shareholders’ equity to total assets is greater than 50%). While I’m not wedded to that ratio, I think the more liabilities a company has, the more risky it is.
The table below, calculated from data exported from Sharelockholmes and Sharescope includes companies with a long-term PE of less than twenty and F_Scores of six or more (out of nine), that have reported relatively recently.
They’re not all suitable. Stobart, the haulage company, only floated last May when it took over a listed property company. Five of the six years of profits associated with its listing, and used to calculate its price earnings ratio, are not relevant.
So I check each company’s history, its finances, its prospects, who else owns it, and write short summaries, linked in the table.
What…
Averaging the long-term PEs of all the companies listed in London derives a long term price earnings ratio for the market. As you can see it’s halved since 2007 before staging a small recovery in recent months.
That should mean there are plenty of companies at low prices, a fact confirmed by the number appearing in the table above.
It’s a good time to be a value investor.
In theory:
When’s an ETF a structured product?
Chart porn: Two economists extrapolate the future from the past and say we’re on target for a Great Depression.
Financial bloggers are increasingly sceptical about Exchange Traded Funds, Alphaville reports.
The Empirical Finance Research Blog, uncovers research that proves the US stockmarket is inefficient.
Roger Ebert, movie critic and wise old man, decries the shouting journalists.
The indisputably brilliant Moneyterms explains how a company can be technically insolvent but carry on regardless.
Shed: one step from the naughty step
Posted on June 15, 2009 by Richard Beddard
Filed Under Companies | Leave a Comment
In practice:
Good acquisition, bad acquisition
October’s interims and April’s finals seem to have stopped the rot at Shed Media (SHDP), with a near 20% rise in the share price since October, and adjusted profits up on a per share basis against the sixteen months ending 31 December 2007.
If it’s a turnaround, it’s a curious one because Shed makes TV programmes and its customers, broadcasters, are struggling to make money, due to increased competition from digital channels and Internet TV, and a major recession in advertising. Perhaps content really is king!
The Investors Chronicle makes the case for investing in TV production, including:
- Changes to the law allowing producers to retain rights, rather than hand them over to broadcasters,
- The increasing requirement of broadcasters like the BBC to source programming from independent producers, and…
- The UK’s leadership in exporting programme formats to foreign countries.
Shed, which is responsible for Who Do You Think You Are and The Sorcerer’s Apprentice (‘The Apprentice’ for child magicians). Last year it produced the sublime Oscar winning documentary Man on Wire and the ridiculous scary Supernanny series.
With a board of directors full of programme makers, Shed makes good programmes but can they make money out of them? If not, we may have to put the company on the naughty step…
I’m worried about its acquisitions:
- Wall to Wall, November 2007
- Twenty Twenty, September 2007
- Screentime Partners, September 2006
- Ricochet, November 2005
These companies produce many of Shed’s current hits. Twenty Twenty produces The Choir, Ricochet produces Supernanny, and Wall to Wall produces Who Do You Think You Are? Meanwhile the original Shed Productions’ big hits, Bad Girls and Footballers’ Wives, have been decommissioned in the UK, and the ‘On Air’ and ‘Coming Soon’ sections of its website are a little sparse.
Screentime is a distribution company, which Shed has renamed Outright Distribution.
By acquiring companies with hit shows Shed might have paid too much, distracted by the quality of existing programmes and failing to account for the possibility that in future the company they’re buying may not be so successful.
It would have bought profits, but at too high a cost.
On the other hand, Shed appears to be profiting from its ownership of catalogues of programmes it can sell around the world, and the means, Outright, to sell them. It’s growing revenues in the US, which are now 30% of total turnover and winning US commissions for UK formats like Who Do You Think You Are? Forty-four per-cent of its gross profits come from selling existing formats and programmes produced by Shed and other companies.
One way to adjudicate between these two ‘stories’ is return on assets. If Shed is a more profitable company (it generates more profit from its assets) after the acquisitions, than before, then one way or another the acquisitions were worth it.
Actually, when profits are buffeted by recession and a company has just doubled in size, calculating and interpreting ROA is not as simple as taking the company’s profit and dividing it by its total assets. Assets have increased during the years we are calculating, and profits may be temporarily depressed anyway.
So, the fact that I reckon Shed’s ROA fell last year might be a red herring, but it might also be an early sign of a flawed strategy.
Nevertheless, at well under ten times average earnings, the shares are in bargain territory, Shed is profitable in a recession, and has relatively low debt. I take heart from the absence of acquisitions in 2008 and feel slightly nervous that they are still prominent in its strategy, outlined in its most recent annual report.
Between them, directors own 44% of the shares, which gives them a big incentive to run the company well. It also gives them a degree of control, should they plan to take it private at a stingy price or otherwise trample on small shareholders.
In fact the non executive directors rejected an offer from a consortium including board members last year, and the talks ended in January with approximately 100p per share on the table, 60% more than the market value of the company then, and 50% more than its current value.
Despite its slightly unfathomable strategy, and because of its low valuation and financial strength, I think Shed could be worth 100p too.
-
-
Talking of management teams taking companies private at knock-down prices… This time it’s metal broker Wogen. Graeme was right.
In theory:
Is it a bull? Is it a bear? It’s a bull in a bear.
Allister Heath, editor of City AM, in a candid moment on the limits of the financial media: “Most journalists, unfortunately, followed the consensus view in the last ten years and in the City, there’s only a very small difference between consensus view and herd mentality… It’s quite hard to get original commentary or understanding when you behave that way.” (iBall video).
For the 1.6 trillionth time, says Paul Krugman, we are in a liquidity trap and not facing hyper-inflation. He fears a lost decade.
Simon Johnson tells us where we are now (Answer: Not in a very good place, but it’s lot better than where we’re going).
Is it a bull? Is it a bear? It’s a bull in a bear.
Professor Daniel Corsten says that many current business models were created in times of abundance and hadn’t been tested in times of adversity until now.
We’re going to live three and a half years longer, admit company pension schemes.
New media consultant Alan Patrick says TV will go the same way as newspapers, but the best content creators will do just fine.
There’s a bear market in Ponzi schemes!
How many economists does it take to start a flamewar?
Posted on June 10, 2009 by Richard Beddard
Filed Under Markets | 2 Comments
In theory:
It takes two, baby
Of all the bad jokes about economists my favourite doesn’t involve changing light bulbs:
- Q: Why did God create economists?
- A: To make weather forecasters look good.
Although our understanding of the economy, and the atmosphere, is sophisticated it doesn’t mean we can predict how they will behave, mostly because of the bewildering number of inputs, and the fact that each one influences the others.
But, I don’t remember a spat between two weather forecasters as intense as the one currently raging between Paul Krugman, Nobel Prize winner and professor of economics at Princeton University and Niall Ferguson, who’s professorship, in truth, is in history, not economics.
Krugman is a reconstructed Keynesian, so I feel I should support him as free markets are so obviously not self regulating. But Ferguson is a British exile, and presenter of the Channel 4 programme ‘The Ascent of Money’. Given their gladiatorial one-upmanship, sometimes I feel I should support him even though he seems to be an unreconstructed Monetarist.
They disagree about what rising bond yields tell us in the US, but also by inference in other highly indebted countries like the UK. It sounds incredibly dull, but actually, it seems, that everything depends on bond yields.
The disagreement started in the flesh at a symposium organised by the New York Review of Books last April, and they’ve pursued it in columns, letters pages, and blogs in the weeks since.
Ferguson is worried about government debt. He says that when governments borrow money to spend their way out of recession, as John Maynard Keynes prescribed, they neutralise the monetary medicine they’re also administering, in the form of lower interest rates. That’s because, when you raise finance by flooding the market with bonds, prices fall, and yields, or interest rates rise. Meanwhile, by borrowing so much to achieve so little, nations put their own creditworthiness and economies at risk, so bond yields rise to compensate investors.
Krugman says there is no contradiction, because the monetary medicine isn’t enough to put upward pressure on interest rates. For that to happen, demand for investment, and therefore borrowing, must be restored. But people in countries like the US and UK are over indebted so they are saving instead. That saving ought to be translated into investment but there’s nowhere for the money to go. Property markets are “flat on their backs” and businesses don’t want to invest because we’re not spending.
In normal times, cutting interest rates and printing money by buying debt and crediting bank reserves is inflationary, but these aren’t normal times. Banks aren’t lending those reserves.
When the private sector won’t lend and borrow, the government must step in says Krugman.
So why are bond yields rising? Economist and FT columnist Martin Wolf explains bond yields are ‘normalising’. They’re rising because back in March, when it felt like large sections of capitalism might collapse, they were exceptionally low. Then, the only investments that looked safe were those backed by the government, so prices rose, and yields fell. Now government borrowing has filled the gap, and the economy seems to be recovering, bond yields are rising to normal levels and not because investors fear inflation.
The disagreement hinges on ‘normalisation’. Two weeks ago Russell Napier told me that’s what economists would say about bond yields, until, almost unnoticed, they creep above normal levels, into the danger zone, at around 6%. Then stockmarkets crash as businesses labour under high interest rates and inflation, and investors switch out of equities and into high yielding government bonds.
It seems that policy-makers face the Butler-Miller paradox, named after the two economists who identified it, where the authorities stimulate the economy when inflation is falling to compensate for increased saving . When that store of saving is released, as people start spending again, policy makers must hike interest rates, restrict the supply of money and cut spending to restrict the double stimulus. It’s either that or unleash runaway inflation.
The question is will politicians, central bankers and their advisers have the skill and courage to do it?
Napier’s argument, and I suspect Ferguson’s, is they won’t, until it’s too late.
One thing’s for sure, economics is interesting again. My ‘A’ level teacher presented the big economic ideas as a battle between Keynesian and Monetarist schools. Thirty years of free market ideology sidelined the Keynesians, but now, after the havoc caused by bubbles in unrestrained markets, they sense their opportunity.
The extreme scenarios, the kind of stagflation that Ferguson and Napier see ahead, and the deflationary depression that Krugman and Wolf think we must avoid, would be terrible for the stockmarket. The choice is between the ruinous ‘70’s and Japan’s lost decade in the ‘90’s.
Somehow we must walk the tightrope between the two, which probably means it’s a good thing that economists and historians are slugging it out, however dogmatic they appear.
Here’s a blow-by-blow account:
- Round 1. Krugman and Ferguson head to head at the Metropolitan Museum of Art. Also in various corners: Nouriel Roubini and George Soros.
- Round 2. In his blog, Krugman says Ferguson is living in a Dark Age of macroeconomics, in which hard-won knowledge has been forgotten.
- Round 3. Ferguson warns Krugman that he’s in thrall to the long dead Keynes. Borrowing and spending will lead to insolvency or inflation.
- Round 4. Ferguson writes to the FT, accusing Wolf, who’s in Krugman’s corner, of ‘insouciance’.
- Round 5. Krugman produces a chart to show Ferguson that rising government borrowing is only offsetting falling private borrowing.
And, in an aside, Krugman notes that of the major European countries Britain, whose reaction to the crisis has been most aggressive, is expanding again (very weakly), while France, Germany, Italy, and Spain are still contracting.
Like rising bond yields, Krugman, who praised Gordon Brown for defining “the character of the worldwide rescue effort”, sees this is a good sign, but are we storing up more trouble?
Listening to Tory promises to cut spending, and Labour promises to keep investing during Prime Minister’s Questions today, it seems that politics is getting interesting again too.
Why investors are forgiving Alexon for Dolcis and Bay Trading
Posted on June 8, 2009 by Richard Beddard
Filed Under Companies | Leave a Comment
In practice:
When diworseification pays
I don’t usually find inspiration for good companies at cheap prices in Money Observer’s tables of highest risers, and biggest fallers. The tumultuous price movements of the shares are often indicative of rampant speculation, and not the kind of dull but worthy companies I favour.
Nevertheless, Alexon (AXN), a ladies’ clothing retailer, is at a critical point, and judging by the doubling, and redoubling of its share price before and after its full year results in April, investors are betting on its continued survival.
The first doubling, from around 15p to 30p may have been due to takeover speculation.
The redoubling happened after the company learned that a credit insurer, Euler Hermes, had ceased covering its suppliers, should Alexon be unable to pay them. Apparently guided by Alexon’s auditor, which drew attention to its loss-making Bay Trading stores in the preliminary results on April 22, Euler Hermes feared Bay Trading might drag the whole group down, leaving it to pick up the tab for Alexon’s creditors.
Without credit insurance, suppliers might limit Alexon’s credit, or demand cash up front - cash that Alexon would have to divert from its other six brands. Since that, along with the cost of returning Bay Trading to profitability, might put the rest of the company at risk, Alexon put Bay Trading, a separate limited company, into administration.
That is, judging by the share price, good news. Investors must believe that the company is better off without Bay Trading, though management presumably didn’t think so. Alexon, whose creditors remain uninsured, had embarked on a recovery plan.
Alexon shares are still cheap at less than three times average earnings over the last ten years, but can it really be a good company? I mean, financially sound, and in a business that will remain profitable.
Over the last few years that’s looked increasingly doubtful. Alexon diversified into menswear and shoes in 1999, through Style Menswear and Dolcis, but sold them off having failed to turn them into consistently profitable businesses. Both subsequently went bust. It decided to hang on to Bay Trading, it’s ‘value’ brand - also bought in 1999, but the consequence was the same.
In the last four years its write offs have reduced shareholders’ equity, the accounting value of the company after having allowed for its debts and other liabilities, from over £100m to under £5m, or just 7% of total assets.
In practice, shareholders don’t own much, if anything, beyond a share in the potential of Alexon to make profits in future, should it have one.
This is, I think, where the story could turn from horror to redemption. Alexon is now left with five home-grown brands, Dash, Ann Harvey, Kaliko, Minuet Petite, and Alex & Co along with the original brand, Eastex, which it acquired as long ago as 1947.
Each brand sells ladies’ clothes to a fairly well defined niche, Ann Harvey to ladies with a ‘large silhouette’, Minuet Petite to the petite, and Eastex, for affluent mature women. Since my wife doesn’t fit into any of those categories, I asked her about its more youthful and mainstream brands, Kaliko and Dash, and drew a blank. She’d heard of Dash, but then, so had I!
Excluding a hefty loss as it wrote-off its investment in Bay Trading, and even heftier provisions against future losses on unproductive, or onerous, leases, Alexon was profitable to 31 January 2009 according to its recent annual report. On the surface it was financially strong too, with no long-term debt and positive cash flow exceeding its profits. It scores seven out of nine on Piotroski’s F_Score, which is reassuring.
According to it’s own projections made after the withdrawal of credit insurance, it should be able to continue as a going concern.
I’m wondering if Alexon is a classic case of diworseification, as defined by the legendary fund manager Peter Lynch. Instead of raising dividends, he said profitable companies often prefer to blow the money on foolish acquisitions, only to regret it later. His advice (from One up on Wall Street):
From an investor’s point of view, the only two good things about diworseification are owning shares in the company that’s being acquired, or in finding turnaround opportunities among the victims of diworseification that have decided to restructure.
Alexon looks like it’s a victim of its own ambition, but not necessarily current managements’. Chairman Richard Handover joined in March 2008, and chief executive, Jane McNally joined in June last year. Of all the directors, only Robin Piggott, the finance director remains from Alexon’s expansive days.
But Alexon’s sales are falling, and last time I followed a situation like this, when credit insurers removed cover on SCS, an apparently profitable sofa-seller, and it raced to bolster collapsing sales before it ran out of cash, shareholders lost everything. Alexon has the buffer of a £12m overdraft recently negotiated with Barclays, but the bank can demand the money back any time, and the facility must be renewed next May.
So despite the recovery potential, I think Alexon’s too speculative. If the shares are still cheap when credit insurance is reinstated, or the company has survived without it for some time, it will be a safer bet.
In theory:
Dancing on the grave of the Efficient Markets Hypothesis
Joe Nocera has a chat with Jeremy Grantham and Burton Malkiel, then dances on the grave of the Efficient Markets Hypothesis.
Freeman Dyson says climate change models can’t predict climate (anyone see any parallels with finance?), so we shouldn’t believe the scenarios scientists paint.
In attempting to simplify the economy, the Wall Street Journal succeeds only in demonstrating how complicated it is.
CVC sells more of its stake as Debenhams raises money to pay back the debt its private equity backers loaded it with.
The market’s a ‘buy’ according to the venerable Coppock indicator. But Coppock doesn’t work, says Buttonwood.
Bubble rekindled
Posted on June 3, 2009 by Richard Beddard
Filed Under Investing | Leave a Comment
In theory:
Don’t investors ever learn?
Where was the great revulsion? The feeling of utter despondency at the bottom of bear markets, when just about everybody capitulates and a consensus forms that things can only get worse.
For a week or two, back in March, the collective mood was very gloomy but then something happened. Markets around the world rallied strongly.
It’s a disappointment for value investors who may have thought they had a year or two to pick up really good companies at bargain prices, but behavioural investing guru and Soc Gen analyst, James Montier, thinks he knows what’s happening.
At the end of the dot.com crash in 2003 the US authorities by-passed revulsion by rapidly cutting interest rates and creating cheap credit, stoking speculative bubbles in the housing and stock markets. Now, they’re trying the same trick again, only the stimulus is greater.
Don’t investors ever learn?
Apparently they do. Using laboratory markets, where returns (dividends) are predetermined by researchers and subjects trade fake shares, experimental economists have shown that bubbles develop. They’ve also demonstrated that experience of a laboratory bubble doesn’t inoculate participants. Far from it, when people participate in the experiment for a second time, a second bubble of similar magnitude occurs, only this time it happens more quickly. Typically, participants explain that experience told them a bubble would occur, but they thought they’d be able to sell before the ensuing crash.
Only when you run the experiment on participants for a third time do they act more rationally, and the prices of the laboratory shares begin to reflect the returns on offer.
We can see this back in the real world, says Montier. It was the younger fund managers who piled into technology, media and telecommunications shares in the late 1990’s and 2000 according to this study (pdf).
Not having learnt the lesson between 2000 and 2003, once-bitten investors were suckered into the bull market of 2003 to 2007. But now we’re twice-bitten and share prices, at least in the US, have returned to ‘fair value’, will we shy-away from a third bubble?
Not necessarily, says Montier in a report he sent out today.
Vernon Smith, the ‘godfather of experimental economics’ and Nobel prize winner in 2002, set out with his collaborators to break the results of preceding experiments by producing a bubble among participants who’d already experienced two laboratory bubbles.
When they ran their experiment for the third time they halved the number of shares, and doubled the amount of cash each participant had. They also increased the variance of the dividend returns. The experimenters hoped this would stimulate speculation even among experienced participants, and so it did:
The bubble wasn’t quite as big as the bubbles produced by the same participants when they were less experienced but as you can see from the grey line, at one stage prices were almost double fair values (red line, which plots the expected dividend return over the remaining periods in the experiment).
Back in the real world again, Montier concludes that governments’ economic tactics to mitigate recession, slashing interest rates and printing money, could be the kind of shock that Smith and his collaborators created in the lab:
…I have no idea if the current policies of the Fed and other central banks constitute a large enough liquidity shock to reignite a bubble. But it certainly seems as if many market participants are now focusing upon the policy response as a key source of optimism. If this is indeed the case, then perhaps Smith’s latest work could sound a warning bell about the risk of yet another bubble (and, of course, yet another crash thereafter).
Human beings. Bonkers, aren’t they.
In practice:
UK still cheap
By my reckoning the UK market is still cheap. Its long-term PE ratio of 11 is only just over half its level two years ago. Even in March, when it fell to eight, it wasn’t as low as you might expect in a calamitous bear market, though. Long term charts of the US stockmarket show the S&P500 as low as 5 in the Great Depression, and now near its average of about fifteen.
A cheap market throws up many opportunities. Here’s a list of companies that meet my basic criteria:
- Cheap shares with price to average earnings ratios of less than 16, and…
- Financially strong companies, with F_Scores of six or more.
In theory, a broad selection of companies like this should make low risk, market-beating portfolios over three to five year periods, and I’ll be writing about many of these companies in the weeks and months ahead.
As usual the F_Scores are from Sharelockholmes.com and I calculated the Long-term PE ratios from earnings data exported from Sharescope.
-
Peter Hearn, OPD’s founder and biggest shareholder, is taking the company private just weeks after I decided the company was too risky. Investors may have made a quick buck as the shares rose from around 40p to the offer price of 57p, but the company’s admission that it might otherwise need to raise funds and dilute existing shareholders reveals the risks they were taking.
T Clarke in bargain territory
Posted on June 1, 2009 by Richard Beddard
Filed Under Companies | Leave a Comment
In practice:
The old ones are the best
Forget London 2012 for a moment. T Clarke (CTO), which claims to be the nation’s oldest electrical contractor, wired up the BBC Broadcasting Centre at Wembley for the 1948 Olympics. It installed electricity in the Tower of London in 1900, in the Beatles’ HQ at Savile Row and Abbey Road Studios in 1968, and the London Eye in 2000. Oh, and it’s wiring the new Olympic Stadium.
The original Tommy Clarke, who I presume is the bloke in the middle of this picture, won his first contract 120 years ago in 1889.
Pat Stanborough, chief executive, is standing down this year. He’s been an employee since 1964, and his replacement, electrical engineer Mark Lawrence, just 41 years old, has worked for T Clarke since he was 17.
If longevity is evidence of a strong business that can adapt to change, then T Clarke is one. Electrical wiring may not seem inspiring, but it was in 1889. That year Edison submitted his patent for insulated wire, so T Clarke can claim advertising its speciality, “wires encased in fire-proof material, etc.”, was like selling nanotechnology today. No doubt wiring the London Eye, or The Pinnacle, soon to be London’s tallest building, is just as challenging as lighting the Savoy Theatre, the first public building to be lit entirely by electricity – by, you guessed it, TC.
It’s difficult for me not to be nostalgic about T Clarke, especially as it’s wrapped its 2008 annual report in anniversary memorabilia and the company earned me a good profit between 2003, and 2006 when it was completing a national expansion programme and I owned shares.
Since then, investors seem to have reappraised the company, though. Instead of being strong in London with growth potential and a reputation for quality, it looks like a national contractor slugging it out for contracts in a poor market. Until last year, profit margins shrank as turnover grew and although T Clarke nearly doubled its earnings per share in 2008, the trend in profit growth is erratic.
The future feels particularly uncertain because nobody really knows when the recession will end, but a major slump in the commercial property market is already apparent. T Clarke’s profits in 2008 were probably earned mostly on contracts agreed before the recession started leaving it a gap it can’t completely fill now, and the company may find it increasingly difficult to collect payment from some of its customers.
On the plus-side, T Clarke is still hammering home its traditional virtues of quality and service, the order book is healthier this month, than it was at the end of the year and the company hasn’t made a loss since 1996.
Unsurprisingly, after what the company describes as an ‘exceptional’ year, it’s financially strong. It’s F_Score is nine out of nine, demonstrating improving profitability both in accounting and cash terms, no long-term debt and cash in excess of its overdraft.
The shares are cheap too. They cost less than ten times T Clarke’s annual average profits over the last ten years, putting them in bargain territory.
Perhaps now investors are less expectant, and the price has fallen from 290p in 2005 to under 120p, the shares are worth considering again, although, with predictions that the “next big milestone” in this recession will be a wave of bankruptcies in the commercial property sector and T Clarke likely to favour skilled and motivated employees over short-term cost cutting should things get worse, there’s plenty to worry about in the next year or two.
In theory:
The shape of things to come
Gillian Tett, cuts through all the nonsense about ‘V’, ‘U’ and ‘W’ shaped recoveries and predicts it will take the form of the shorthand symbol for ‘bank’ (left).
Peter Temple thinks the recent rally is a mid-bear market recovery and expects months of downward drift, hence his model income portfolio is a third in cash.
Marc Faber predicts hyperinflation in the US, with 100% confidence.
Meanwhile, Pimco’s Paul McCulley says the best explanation for the mess we’re in is Hyman Minsky’s Financial Instability Hypothesis, which is more than thirty years old. If you own an interest-only mortgage, read it.
