ATH looks good on the surface
Posted on February 8, 2010 by Richard Beddard
Filed Under Companies | 3 Comments
A tale of two businesses
There are two sides to ATH Resources (ATH), the dirty business of open cast coal mining in Scotland, and the virtuous business of regenerating old deep mines.
Regeneration means washing contaminated spill tips, and landscaping the mines [See the corporate video]. Selling reclaimed coal offsets some of the costs, which is also funded by subsidies from Local Authorities and Regional Development Agencies.
Since regeneration produces coal, and because coal and coal mining are getting cleaner, the description of coal mining as ‘dirty’ and the inference that regeneration is clean, may be unfair. But according to its annual report, there were most definitely two sides to ATH in 2009, and it was regeneration that left a foul taste in the mouths of investors.
While its mines, despite a flood, grew sales and profits, ATH Regeneration had no projects in operation in 2009, and so it contributed nothing to turnover and lost the company nearly £2.5m. In 2008, regeneration contributed over £3m to profits of £13m.
Overall, earnings per share fell 32%, but the company paid off some of its debt and the attraction of ATH is the dip in profitability, and the share price, could be temporary.
Were it not for the flooding and bad weather, which halted production, ATH’s mines would have been more profitable, and regeneration is back in business too. ATH has finally secured planning permission, on appeal, to regenerate a mine at Langton, Nottinghamshire in 2010, two years after the project should have started.
Founder and chief executive, Tom Allchurch, thinks the company will return to growth because of the successful Langton appeal, and if he’s right the shares are cheap at seven times average earnings over the last six years (ATH listed in 2004 so we only have six years of earnings per share).
I’m not confident enough to take the risk, though, and add ATH to the Thrifty 30. The shares may well recover, but my goal is to put safety first and reject companies that I perceived as speculative. I think ATH is speculative.
In common with all resource companies, it must find new reserves to replace those it uses up. The chart below shows its probable and proven reserves of coal from mining and regeneration projects. Both probable and proven reserves are assessed for quality and quantity, but reserves are only categorised as proven when all planning permissions and permits have been granted.
Overall, replacement of reserves has kept pace with production, and ATH expects that to continue. But at Langton planning took much longer than expected, and although ATH has been talking about regeneration projects in Australia since 2007 they don’t yet appear in its list of probable reserves, let alone proven ones. It seems to have stopped talking about previously touted opportunities in France altogether.
Meanwhile the chart below shows how its financing the development of new operations and existing operations. Liabilities have increased (equity has decreased) relative to assets by about 10%.
An increase in a company’s dependence on external financing of 10% may not be problematic, but in absolute terms ATH’s ratio of equity to assets is only 32%. In other words 68% of its funding is liabilities. Although it cut its debt in 2009, total debt is 40% of total assets, or 107% of equity, and it has to make substantial provisions to make good its open cast mines after production has finished.
As I said, the shares look cheap, but despite its F_Score of 6, I’m not confident ATH is strong enough to join the Thrifty 30 at the current price. It’s disappointing, because as I could have mentioned in Friday’s blog on fluidity, cheap, dirty, unattractive companies often make the best long-term investments.
Thrifty 30 Updates:
The current Thrifty 30 portfolio
Following interim results, Paul Hooper, chief executive of Alumasc (ALU) bought 20,129 shares in the company at 95p, 10p less than the price when they joined the Thrifty 30. He was joined by Andrew Magson, finance director, (15,000 shares) and Richard Saville, non-executive director, (10,000 shares).
RM published an unexciting Interim Management Statement.
Weekend wisdom
Posted on February 5, 2010 by Richard Beddard
Filed Under Reading list | 5 Comments
Things to read and watch
From this week I’m increasing the blog posting schedule to three posts, typically on Mondays, Wednesdays and Fridays. Friday’s blog, ‘Weekend wisdom’ will be a collection of notes on the best things I read, or watched, that week and takes the place of the links that used to appear at the end of the Monday and Wednesday blogs on companies and markets. This way I can write a bit more about each link, and group them together so they add up to more than the sum of their parts.
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Food for China bears
Michael Pettis says China’s foreign reserves provide protection against the wrong sort of crisis. The risks China faces today are asset and capacity bubbles reminiscent of Japan in the 1980’s and America in the 1920’s when those countries had China-sized foreign reserves. We all know how their bubbles finished. Pettis is a professor specialising in financial markets at Peking University, and the author of The Volatility Machine, a book on emerging market crises.
The FT reports Chinese regulators are ordering banks to halt lending in an effort to reduce credit growth: “This sort of baby step tightening doesn’t look like much but when you’ve had such rampant credit growth, it doesn’t take much for it all to end in tears," says Soc Gen’s Albert Edwards. Alphaville says the Chinese government is also limiting IPOs by property developers and industrial companies to curb a growing real estate bubble and reduce overcapacity.
China Bear and short seller, Jim Chanos, doesn’t think the authorities will cope:
What’s interesting to me is that people who have complete disdain for government intervention in the economies and markets in the West, have complete faith in nine guys in a room, literally a politburo, being able to figure out this very complex and rapidly growing Chinese economy.
[Fast Forward to 4:40]:
[Hat tip: The Big Picture]
Chanos, whose ‘China call’ sparked controversy in January, thinks:
The bubble that is going on in commercial and residential construction, infrastructure construction and manufacturing construction in that country is unlike any we’ve ever seen… This is a fixed asset investment boom and it is of staggering dimensions.
Kynikos, the name of Chanos’ investment firm, means cynic in Greek.
Talking of politburos, the Economist sheds some light on how credit decisions are made in China. It really does come down to nine guys in a room…
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Iffy communicator better in book form
Hank Paulson’s book, On the Brink, “offers plenty to keep the pages turning”, says the Economist. Since he was the Treasury Secretary at the centre of the financial crisis, it’s as inside an account as we could expect (more so, perhaps). Apparently it is both self-deprecating and jaw-dropping.
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Following the familiar
Momentum traders take note, Adam Alter and Daniel Oppenheimer of Princeton University, say companies with familiar names do better [PDF]. In one study, an initial investment of $1,000 yielded a profit of $112 more after one day when traded in companies with ‘easily processed’ names. Their research is based on one of the hottest topics in psychology today, according to the Boston Globe [hat tip: Seth’s], “cognitive fluency”, which can also explain why we think the most average faces are most beautiful, and watches that look like, well, watches, are the best.
‘Disfluency’, an ugly font, a cumbersome company name, or a difficult task, “functions as a cognitive alarm”, says Alter which is why asking couples to name ten things they really hate about their partners can make them feel better about each other but asking them to name a couple of things they hate can pull them apart.
Long-term investors, who prefer to buy unfashionable companies, might take the opposite view. Fund management legend Peter Lynch preferred companies with ridiculous names. This is from page 131 of One Up on Wall Street:
Pep Boys – Manny, Moe and Jack is the most promising name I’ve ever heard. It’s better than dull, it’s ridiculous. Who wants to put money into a company that sounds like the Three Stooges? What Wall Street analyst or portfolio manager in his right mind would recommend a stock called Pep Boys – Manny, Moe and Jack – unless of course the Street already realizes how profitable it is, and by then it’s up tenfold already.
That was 1989, he’s probably disappointed it’s plain Pepboys Auto these days. Mind you’ he’d have made his money on it a long time ago.
Have a good weekend.
Shareholders should pay as well as bankers
Posted on February 3, 2010 by Richard Beddard
Filed Under Investing | 3 Comments
Like turkeys voting for a cut in the dividend
In a speech last month, Andrew Haldane, executive director of financial stability at the Bank of England warned it could take many years for the UK economy to recover from its debt hangover. During that period we’d experience low growth as all sectors of the economy, consumers, companies, banks, and government pay back debt
The Government is doubly indebted since the credit crunch as it’s borrowed to stimulate the economy and bail out banks, while consumers and companies have barely started repaying it.
Meanwhile, investment banks have made a windfall trading financial products as prices have recovered after the crisis last year. In 2009 global banks are expected to make £60bn, as much as they lost in 2008, and their share prices have recovered over half their losses, more in the UK.
It’s that windfall that has given them the opportunity to reward traders with multi-million pound bonuses, which just about everybody, except the bankers themselves, considers unfair. Hence the Government’s super tax on bonuses, and a letter today from Lord Myners, the Treasury’s City Minister, to institutional investors imploring them to put pressure on the major banks to cut bonuses.
The argument as I see it, is relatively straightforward. Banks manufactured the debt mountain, watering down their own balance sheets to lend more and more to consumers and companies and trade in debt-related derivatives, the prime (excuse the pun) example being sub-prime loans to American homeowners. When the credit bubble burst, governments stepped in to avert a collapse in the financial system. It was government action that saved the banks,and created a vast opportunity for them to profit, so it seems most unjust that bankers should be the beneficiaries.
Especially since banks still need to repay debt. The issue is not just about fairness, it’s about practicality as Lord Myners said in his letter:
Public attention will focus on the decisions that boards make about bonuses. Many banks have earned large profits this year from remarkably benign conditions, conditions created through the interventions by governments across the world. These profits must surely be retained by shareholders in the business as capital.
Robert Peston points out one irony in Lord Myners’ letter. Since the Government owns 84% of RBS and 70% of the voting rights, he was, in part writing a letter to himself. Perhaps another thing he should have mentioned was a cut in the dividend shareholders will approve for themselves this year, or doing away with the dividend altogether (admittedly RBS didn’t pay a dividend last year, but plenty of banks did).
Haldane thinks that withholding bonuses and dividends would allow banks to repair their balance sheets and support lending, thereby boosting growth and ameliorating the debt hangover he is so concerned about.
And he provides the justification for it. Although global banks lost $60bn in 2008, they paid out over $60bn to shareholders. Between 2006 and 2007 net income for global banks fell 20% but dividends grew by 20%. Going back as far as 1965 Haldane notes banks have paid higher dividends than other companies in relation to their profits, in good times and bad, behaviour that is unlikely to support banking stability, he says:
It risks profits being distributed as dividends when they are most needed to augment capital ratios and boost confidence.
If UK banks had reduced their dividend payout ratios by a third between 2000 and 2007, trimmed bonuses by 10%, and not paid dividends when they had made a loss they would have salted away more money than the Government used in bail outs during the crisis.
The criteria I look at hardest when evaluating a company are its earnings, and the ratio of its equity to its assets. If the earnings are rising and the ratio of equity to assets is stable or rising, that’s a very good sign. It suggests that a company is funding its current profits from past profits, and not by borrowing more and more money. This derives from the most fundamental formula in accounting:
Shareholders’ equity = Assets - Liabilities
According to Haldane, the ratio of bank assets to equity rose dramatically in the twentieth century from single digits to over 20. Since the ratio of assets to equity is the inverse of the ratio of equity to assets, that’s a bad thing. If assets are twenty times equity, bank balance sheets look like this:
5% = 100% – 95%
In other words the bankers have robbed the banks, replacing their equity so they’re now funded by 95% debt, and bought off shareholders with high dividends over many years.
In assessing who should recapitalise the banks, we should consider who got them into this mess. Everybody except the bankers themselves seem to think they should pay. Why are we letting shareholders off so lightly? Or to put it another way. The government can pressure shareholders to make bankers do the right thing. Who can it pressure to make shareholders do the right thing and demand lower dividends?
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A sideways market is for stockpickers
To profit in a sideways market you’ve got to ignore the average, says Robert Hagstrom, and look for the variation within the market.
John Hussman says net profit isn’t the best measure of owner earnings, it’s the change in book value plus dividends. On that basis: “Investors now rely on the renewed attainment of bubble valuations in order to achieve acceptable returns.”
T30 constituent, Quadnetics’ interims leave us pondering the second half-year.
Titon: A breath of fresh air
Posted on February 1, 2010 by Richard Beddard
Filed Under Companies | Leave a Comment
‘aint no titan.
Like a detective might follow an unpromising lead just to rule it out, I started my investigation into Titon (TON) on Friday with low expectations. The uninspiring price chart is of little consequence, but what’s happened to profits over the last decade is.
Titon made a small loss in each of the last two years and before that recession-induced fall in its profits, their decline formed a more graceful curve:
Buying shares in an unprofitable manufacturer and distributor of domestic ventilators and window fittings when, by the company’s own admission the promise of an early recovery in house building is stuttering, is either a contrarian dream, or an investment nightmare.
But against initial expectations, I’m feeling a bit dreamy.
The good news is judging by Titon’s F_Score of six out of nine, the business appears to be stabilising. The bad news is of course, that it’s losing money.
More good news: Titon’s probably winked off most investors’ radars as negative earnings means no price earnings ratio. More bad news: unless it returns to profitability it will never get back on their radars!
Statistically, distressed companies like Titon are most likely to recover impressively when they are financially strong, they are staying afloat without relying on borrowing more money or raising it from shareholders, and profits, however bad, are at least improving. That’s what the F_Score shows. In cash terms Titon is profitable, allowing it to maintain a dividend (although the payout was reduced last year).
The absolute strength of Titan’s balance sheet is also a source of confidence. In its annual report for the year to 30 September 2009, it didn’t have any long-term debt (and a negligible bank overdraft) and shareholders had by far the biggest claim on the company’s assets (shareholders’ equity is just shy of 80% of assets). Virtually all of those assets are tangible, in the form of property (about two thirds of the property, plant and equipment), cash, and receivables (money owed by its customers). 
Titon shares are in bargain territory, they cost six times average earnings over the last ten years, and perhaps more importantly four tenths of book value. It’s so cheap, it’s quite close to being a ‘net net’, the ultimate Ben Graham value stock.
Graham liked to pay less for companies than they were worth. He’d discount any value they might add in the future (in the form of profits) and pay less than the accounting value of the company’s assets, minus its liabilities. Ideally, he’d only pay two thirds of the value of the current assets (those that could be most readily converted into cash, like stocks (inventory), receivables, and cash itself) minus total liabilities. Another way of expressing the calculation is net current assets (current assets minus current liabilities), net of non-current liabilities, hence ‘net-net’.
Here’s the calculation, so you can get a feel for the size of Titon (TON), because it isn’t a titan:
Price : Net Current assets =
Market capitalisation/(Current assets-Total liabilities)
4,117,000/(8,108,000-2,650,000) = 75%
Not quite 66%, then, but pretty cheap.
The size of Titon is another reason for investors’ lack of enthusiasm. The whole company has a market value of only £4m, implying that the shares may be difficult to get hold of (or sell later on) close to the quoted mid-price. In fact you could buy £1,000 worth of shares for 39.5p today, inside the spread of 38p-40p, so I’ve surprised myself and added unprofitable Titon to the Thrifty 30 model portfolio at that price.
Founded in 1972 by its current chairman, John Anderson, who owns 22% of the shares, Titon has survived this long. I’m hoping it’s going to find a way of being profitable in the low growth, or recessionary economy many anticipate. So far, by cutting jobs and overheads, it has survived. Now it’s looking to a new (and loss-making) joint venture in South Korea for growth, and the UK housing market for recovery. Meanwhile, I take comfort from the fact that I’ve almost snapped-up that rarest of things, an absolute bargain.
Oh, and we’ve just converted our garage. On close inspection I swear the windows have Titon Trimvent Select Xtra R16 ventilators 
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Tales of the unexpected
Jorma Korhonen, successor to China-bound Anthony Bolton, says China hype is, “one of the biggest capital allocation mistakes ever”.
In the 1990’s, Aswath Damodaran valued emerging markets in a completely different way to developed markets. Not any more: “Developed market investors who have become lazy over decades of stability need to wake up and use techniques that emerging market analysts and investors have used for that same period. Emerging market investors and analysts who have made their money by playing the macro and government forecasting game have to start thinking more seriously about company fundamentals and value”.
The size of the recovery was even more unexpected than the size of the crash that preceded it says Andrew Haldane.
Thrifty 30 company, T Clarke, issues a benign trading statement.
Haynes still worthy
Posted on January 27, 2010 by Richard Beddard
Filed Under Companies | 4 Comments
A belated check
I picked Haynes (HYNS) in July 2008 to be the first company profiled in a new column, Share Sleuth, for Money Observer magazine. Then, the shares cost £1.72. Luckily, as I hadn’t finalised the Thrifty 30 methodology then, it fits, so it was one of the first companies I included when I started the Thrifty 30 last September. Today the shares cost £2.15.
The motor manual publisher’s interim results are due out tomorrow (See the ***Update below), so it’s a bit late for my review of the full year results, announced in September. But, I intend to review every Thrifty 30 member yearly on the publication of their annual reports to check that the companies are still sound. It would take some pretty dramatic news in Haynes’ interims to change that.
The only news emanating from Yeovil since last September is that sales fell in the US and rose in the UK, its two largest markets, in the first quarter of this financial year, and John Haynes OBE is stepping down as chairman 54 years after he built an Austin 7 Special and wrote his first book about it. The new chairman is the current vice chairman, J Haynes, who I assume is his son.
The two are related, and since John Haynes has a majority shareholding including 9m ‘A’ shares, 55% of the voting rights, which can only be owned by family members, he can anoint pretty much anybody his successor.
Investors like a company’s management to own a meaningful stake but can be leery when they are in control lest they vote through measures against the interests of smaller shareholders. If you worry about that, the chairman’s enthusiasm for the shares at their lows in 2008 and 2009 will be doubly disconcerting. Over the course of the financial year he bought nearly 400,000 of the ordinary shares taking his ownership to almost 800,000.
I think It shows confidence (and a good sense of timing), and since the company was already controlled by the man who bears its name, it makes little difference. In any case, John Haynes has been a good steward of the brand he created, judging by the company’s performance over the last decade.
The chart shows profit and the ratio of shareholder’s equity to assets, relative to their levels in 2000. In May 2009, the balance sheet date of the last annual report, the company was in good financial health. It had an F_Score of eight out of nine, and its ratio of equity to assets was 66%, meaning the value of the company’s liabilities, what it owed, was only 34% of what it owned.
In 2001, Haynes made a small loss. It had bought Sutton Publishing in the UK and Chilton in the US but economic slow-downs on both sides of the Atlantic meant retailers were destocking its titles, just as Haynes had acquired more. Since then it’s jettisoned Sutton, which was a general publisher, and sought instead to make the most of its reputation in motors and DIY, taking the manual format into brave new territory like sexual health, fitness, and manuals for hardware you might only work on in your dreams.
Destocking has re-emerged since 2007, and may explain the dip in Haynes’ performance over the last few years. Although Haynes thinks more people are buying its manuals and repairing their own cars because of the recession, so far it hasn’t been enough to offset the actions of retailers equally keen to conserve cash.
An alternative explanation for declining motor manual sales is that cars are more reliable and complex these days, so we’re more likely to employ a mechanic than buy a manual and maintain our own cars. That’s why Haynes bought Vivid in 2008, a Dutch supplier of motor schematics and data to European garages and workshops over the Internet and on DVD. Vivid accounted for less than 10% of Haynes’ sales in 2008 but it gives Haynes an opportunity to augment Vivid with its own data and launch new electronic products in many languages, that may not be profitable as print publications. Meanwhile, it’s invested heavily in its digital printing presses in Nashville which should enable shorter print runs and keep relatively unpopular titles in print longer.
The recession is officially over for now, so it will be interesting to see whether Haynes says there has been restocking since it last commented in October. Short of a disaster tomorrow, though, on a 10 year PE of eight, Haynes still deserves its place in the Thrifty 30.
***Update:
The results are out, and there are no bombshells. My biggest concern, which I didn’t mention in the article, is the pension deficit which increased by nearly £5m to about £15m. The interims don’t mention the overall size of its pension obligation but at in May 2009 it was £25m so it must be creeping up towards the value of the company. If you value the A shares at the same price as the ordinary shares, that’s about £35m and for no better reason than you must draw the line somewhere, that’s the point at which I let the size of a pension obligation worry me.
The best performing part of the business is general book publishing, mostly transport related, for example biographies of Stirling Moss, Ross Brawn and Jenson Button, and manuals on the Apollo 11 and Thomas the Tank Engine, but also books published under a license with the Daily Mirror using its picture archive, for example Jackson Unveiled. Sales were up 18% but Haynes doesn’t say how significant they are relative to the core motor manuals.
There’s no restocking in America, but overall sales and profits are up on the first six months of last year.
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Small print destroyed the free market
Dan Geldon says the heirs of Hayek and Friedman created a market free of government intervention so they could clog it up with complex legal arrangements that allowed them to maximise their profit.
What’s the use of active fund managers in an efficient market? They reward good management with a high share price and punish bad management with a low share price. No wonder John Bogle’s angry. They haven’t even got that right.
Don’t worry about the population time bomb, says Hans Rosling, we know how to stop population growth. Stop people in impoverished countries dying.
It makes you laugh: Credit Suisse fined for not being in control of its own algorithms.
An expensive Treatt
Posted on January 25, 2010 by Richard Beddard
Filed Under Companies | Leave a Comment
Not a penny chew…
A nearby sweet shop still sells sweets out of jars, gobstoppers and sherbets, and glitzy foreign chocolates in glass drawers and luxurious packaging that remind me of a bygone era.
If Treatt (TET) were a sweet it would be one those exotic chocolates, or maybe a Turkish delight. Some of the ingredients it makes for flavours and fragrances, end up in confectionary as well as air fresheners, cosmetics, shampoos, soaps and soft drinks, but its the company’s origins in the spice trade, importing cloves from Zanzibar and cinnamon leaf oil from the Seychelles that appeal most to me. Although Treatt listed on on the stock exchange in 1989, it was founded over a century earlier by RC Treatt.
Its specialty is the distillation of essential oils, peppermint, lime, lavender, orange and eucalyptus, for example, and organic fair-trade oils from its newly acquired subsidiary Earthoil. There’s an indisputable market for these oils, given Treatt’s long history and the huge number of products that use them, but it seems like a competitive one with revenues dependent on the vacillating prices they fetch. In 2009, the price of orange oil, which contributed 17% of Treatt’s revenues, halved although the company gained from a stronger dollar, the principal currency it uses to buy raw materials, sell its products and denominate its bank accounts.
Tiny Treatt, with its market capitalisation of £33m, could teach much bigger multinationals about international trade. It has an established subsidiary in the USA, a newer one in China and sources its oils from all around the globe. It makes only 15% of its sales in the UK, with the rest spread pretty evenly between Europe, the USA and the rest of the world. Its ten biggest customers accounted for just over 40% of sales in 2009, and diversity may have protected it during the recession. The company says increased demand in the Far East helped it raise sales overall in 2009, despite pressure closer to home.
According to its annual report, Treatt did very well in 2009. The company’s F_Score is seven out of nine which means its basic accounting ratios are moving in the right direction. Although profit margins fell slightly, the company is more profitable in cash terms and less indebted than in the year before. Over the last ten years, though, its progress has been up and down, and came at the cost of a deteriorating balance sheet:
This chart shows the percentage change in profit (earnings per share) since 2000 and the percentage change in the ratio of equity to assets or the value of the shareholders’ interest compared to what the company owns. Although the lines fall below zero, these represent declines relative to 2000. Throughout the period Treatt was profitable, and, except in 2008, the company owned more than twice what it owed.
It owes a lot more than it did in 2005, though, when the ratio of equity to assets was 70% and it had only about £2m in bank debt:
This chart shows current liabilities (in £’000s repayable within a year) broken out into the categories listed on the balance sheet, alongside non-current liabilities (bank loans and a small deficit on Treatt’s pension fund, primarily) and shareholders’ equity. Together they comprise all the company’s funding. The money Treatt has invested in Earthoil and improving its factories and IT systems over the years has largely come from a bank overdraft (green in the chart), which has grown from nothing in 2005 to £10m in 2009.
Although Treatt still passes both my tests for financial strength; it’s F_Score is above five, and it owns more than twice what it owes, its increasing indebtedness makes me a little leery of the share price, which is 15 times earnings averaged over the past ten years. Investors willing to pay that much must believe the investment will earn higher average profits in future, and while that may be so, I’m not inclined to take it for granted.
In a moment of weakness, I might pay over-the odds for a Belgian truffle in a sweet shop, but Treatt’s share price recovery in 2009 means it doesn’t fit the thrifty remit of the Thrifty 30 portfolio. Early last year it was a bargain, and if the essential oils business is as volatile as I think it is, we’ll get an opportunity to buy one day. For that to happen either the price must drop, or new borrowing must stop. Preferably both.
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Chicago school
Eight links in one: John Cassidy’s series of interviews with Chicago economists including Eugene Fama, inventor of the efficient markets hypothesis, Richard Thaler, one of the founders of behavioural economics, and Raghuram Rajan, who warned of a financial blow up in 2005. The Chicago School, as it became known, under Milton Friedman was the origin of the free market ideas that swept Western economies in the 1980’s and 1990’s, and has to an extent, recognised in varying degrees by its current members, been discredited by the recent economic crisis. Today, the views of Chicago economists are much less homogenous.
Putting investing heroes in their place
Posted on January 20, 2010 by Richard Beddard
Filed Under Markets | 2 Comments
[This is a transcript of a podcast originally recorded in October. If you prefer to listen to it, it’s here .]
I’m grateful to a colleague of mine, Peter Temple, for writing an article that’s reminded me of the debt I owe another Peter, Peter Lynch.
It was Lynch’s book ‘One Up On Wall Street’ that inspired me to invest. His ‘can do’, anti establishment approach gave me the motivation to pick shares for myself, rather than relying on someone else to do it.
As the manager of Fidelity’s Magellan fund, perhaps Wall Street’s biggest and most successful in the nineteen eighties, Lynch was particularly aware of the constraints institutional investors worked under, and the freedoms private investors enjoyed.
One quote, in Peter Temple’s article reminds me of how straightforward Lynch could be. He said:
"The person that turns over the most rocks wins the game [and] to me, an investment is simply a gamble in which you have managed to tilt the odds in your favour."
I think that’s a fundamental truth, whatever kind of investor you are. A successful investor identifies what, generally speaking, makes a good investment, and then restricts himself as far as possible to that kind of investment.
The better your criteria, the better the odds of an investment working out.
And the more companies you look at, the more rocks you turn over, the more likely you are to find such investments.
Lynch also led me astray. The criteria he used served him well in the mother of all bull markets, but, in his books, at least, he put too much emphasis on profit growth, and too little emphasis on the financial strength of a company, for his ideas to survive the bear markets of this decade untarnished.
I know now that companies have all sorts of liabilities, from overdrafts to pension funds, that Lynch’s books overlooked, and that growing profits cannot be taken for granted.
Perhaps the best piece of advice Lynch’s books gave me, was his admonition that an investor should be able to articulate the reasons he’d invested in a share in two minutes, in words a child could understand.
He would do this himself, muttering these two minute monologues under his breath, or repeating them to colleagues as if rehearsing a script that he might one day run by a broker, or the management of company.
Admittedly I’ve learned more about balance sheets, financial strength, and long-term price earnings ratios, all critical pieces of my investing armoury, from other investing heroes.
But I think Lynch would agree, that’s how investors are made. Not in the image of one great investor, but borrowing from them all.
Incidentally, I’m reading ‘Learn to Earn’ for a second time. It’s a book Lynch wrote for teenagers and novice investors, and this time I’m reading it with my son. Maybe some of the Lynch magic will rub off on him.
You can read Peter Temple’s article about his namesake at tinyurl.com/peterlynch, that’s l, y, n, c, h.
Gold is not for Grandma
Posted on January 18, 2010 by Richard Beddard
Filed Under Markets | 5 Comments
[This is a transcript of a podcast originally recorded in December. If you prefer to listen to it, it’s here Since then the gold price has been down and up, but it’s pretty much where it was.]
Contrary, to the popular conception, value investors are optimists. Yes, like vultures we lurk around troubled companies where bad news, falling profits and lay offs abound, but that’s because we think the news will get better one day.
And when it does, there will be rich pickings because the price investors will pay in the market for our shares will be higher.
We find reason for hope, in companies the investment mainstream has abandoned.
Speculators in gold, on the other hand, are either pessimists, or gamblers hoping to make a profit from other people’s pessimism.
This could be the year gold went mainstream as two hedge fund managers, feared and revered in equal measure, embraced it. John Paulson’s company, Paulson & Co is launching a gold fund in January and David Einhorn told his investors last January that his company’s hedge funds had bought gold.
They achieved fame and ignominy betting against subprime debt and investment banks during the credit crisis, and having got that call right they’re now expecting to profit from the potential economic decline of the USA.
Until recently, Einhorn was a confirmed optimist, saying in a recent speech:
I favoured my Grandma Cookie’s investment style of investing in stocks like Nike, IBM, McDonalds and Walgreens over my Grandpa Ben’s style of buying gold bullion and gold stocks.
Grandpa Ben bought gold for the last thirty years of his life because he feared the debasement of the dollar and inflation. And for thirty years he’d been wrong.
But, in his January letter Einhorn declared:
To everyone’s dismay, we believe that some of Grandpa Ben’s predictions are playing out.
And:
Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself.
This story has caught on. It panders to our fears, and speculation of a new gold bubble to rival the last peak in 1980 is infecting bloggers and analysts.
Gold prices have tripled in the last five years and risen 50% this year. As I say in my blog today, rising prices coupled with a credible-sounding story and incredible valuations are a perfect back-story for the kind of self-fulfilling prophecies that become speculative bubbles.
But that doesn’t make gold a good investment, not unless you still think dot.com companies were in the late 1990’s.
The problem with pessimism, and the reason gold has been such a poor investment, is that gold does well in crises and then people forget about it.
Its value comes from the fact that it has little value, apart from scarcity. So, in a depression, when demand for copper, iron, oil, and all the stuff industrialists make things with is down, unproductive gold, which is used in jewellery but little else, is not affected. People buy it because they think it’s a safe place to park their wealth until the economic ill-winds blow over.
Companies also suffer and it ceases to matter that gold doesn’t produce wealth because nothing much does.
Not all companies are equal, though.
In Japan, which has suffered two ‘lost decades’ to deflation, the stockmarket declined 4% a year between 1990 and 2007. But companies with low share prices compared to their book values rose by 3 per cent per year.
Sadly, I don’t have any data for the performance of value shares in inflationary periods, the alternative horror foreseen by hedge fund managers, but the stock market in general fared badly in the 1970s. Although the FTSE-All-Share rose an average 7% a year between 1964 and 1979, inflation rose 10% a year.
In real terms shares lost a third of their value.
I reckon value shares would have done better. The stockmarket in general may depend on prosperity but value investors are more like the book collector who buys the first edition of a rare book in a garage sale, and sells it on eBay. The general state of the book market is less important, than the fact the he found a bargain.
Of course, the pessimists may be wrong; our economies may walk the high-wire with inflation on one side and deflation on the other. That would precipitate a rush out of gold, I suspect, into more productive assets.
I don’t know what price granny paid for IBM or Nike, but maybe she was a sharper cookie than even her grandson appreciates.
Dewhurst still pushes the buttons
Posted on January 13, 2010 by Richard Beddard
Filed Under Companies | 5 Comments
Keeping the faith.
I first spotted Dewhurst (DWHT), a year ago when its shares cost 185p. The company featured in the February 2009 edition of my Share Sleuth column (PDF) in Money Observer, and they were in the first group of shares included in the Thrifty 30 portfolio when I started it in September, added at a price of 238p.
The publication of its 2009 annual report is an opportunity to revisit the reasons for favouring Dewhurst and see if they still apply at the current price of 250p. As with all Thrifty 30 companies, the basic case is it looks like a good company, at a cheap price.
In particular I liked its:
- Price. At 185p the shares cost eight times average earnings over the previous ten years, well within bargain territory.
- Financial strength. With an F_Score of seven out of nine and no debt at the end of the year it looked like it was in recession busting good health.
- Profitability. Dewhurst had been profitable for 28 years. Instead of succumbing to the low cost competition from abroad it relocated some of its manufacturing to Hungary and found a way to compete on quality and price.
- Prosaic products. Lift buttons, keypads for ATMs and traffic bollards aren’t as exciting as iPhones but there’s a big, established and unglamorous market for them.
This chart sums up the first part of the case for Dewhurst, that it is a good company:
It takes two elementary measures, earnings per share for the company’s performance, and the ratio of shareholders’ equity to total assets for financial strength, and plots them on the same chart. Profits have increased by 200% over the last decade, despite, or rather because of the relocation and modernisation of its factories, and Dewhurst’s done it without taking out a huge mortgage. In fact the company owns more than twice what it owes (shareholders’ equity is 64% of total assets, therefore liabilities are only 36% of total assets), much the same as in 2000.
Although average profits rose (because 2009’s profits replaced 1999’s, which were much lower), Dewhurst’s price rose too and the shares are no longer as cheap as they were. At 250p they cost 10.5 times average earnings, right on the upper limit of bargain territory.
Meanwhile its other virtues are intact. It’s still churning out buttons. It’s latest being the weatherproof US97-EN Pushbutton (left) and the antibacterial US95-AB Compact 3 Pushbutton.
It’s been profitable for 29 years now. The company celebrated its 90th birthday in November, although it traces the most recent phase in its history back to the acquisition of Thames Valley Lift Company in 1994.
And frankly, it’s a relief to read an annual report in which a company clearly explains what it actually does. Dewhurst is about producing better, cheaper buttons and other lift components more quickly. It’s not the most glamorous of niches, but Dewhurst is dedicated to it.
If we were to go by the numbers alone, Dewhurst is a textbook Thrifty 30 company, which is why I like it so much. But there are two nasties, and one of them has got worse. It has a defined-benefit pension deficit, a liability that escapes the F_Score, my preferred method of testing financial strength, that has risen from £4m to over £6m.
The value of pension funds, and the obligations they must meet are a bit of black box, governed by complex actuarial calculations that are beyond me. My own rule of thumb is not to worry if a company’s other liabilities are small, unless the overall size of its pension obligation is bigger than the market value of the company itself. That’s not a recognised red flag, just a personal reminder not to ignore big pension deficits.
Dewhurst’s pension obligation now stands at £24m, while its market value is about £19m. The company could make its shares more attractive by closing its defined benefit scheme, but five of the directors are members so that would be a bit like turkeys voting for Christmas because nasty number two is 71% of the shares are not in public hands.
By persisting with a defined benefit scheme, management may be acting in its own interests rather than minority shareholders’, but in most respects its done a fine job. So fine, in fact, that I’m happily overlooking the pension fund and the immediate outlook which in the words of Richard Dewhurst, its chairman and biggest shareholder, sounds dismal:
…short term 2010 is likely to be more challenging than 2009. The economic climate means there is no let up on the pressure on prices and costs. Project related demand is beginning to tail off as few new projects have been started in the last year. We are also likely to be affected by the coming squeeze in UK public finances, as directly and indirectly the public sector is an important proportion of our UK sales, but it is difficult to predict the degree and the timing of the impact.
The problem is that even if the construction industry picks up, Dewhurst is likely to be a late beneficiary as lifts are installed towards the end of projects.
The discipline of value investing is to stick with good companies until the market recognises them and the value comes out. We may have to be patient with Dewhurst if 2010 turns out as tough as it sounds, but that’s no reason to dump the shares now.
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Decline of deep value
Blll Mott says manufacturing is benefitting from the weak pound, but the sector is too small to turn the economy around.
Is it a sign of the times? Deep value is getting thin on the ground so Greenback’d is spreading his wings.
Making room for RM
Posted on January 11, 2010 by Richard Beddard
Filed Under Companies | 1 Comment
Not so IT
As any parent knows, school has changed since our day. Yes kids still refuse to wear coats even though it’s minus five degrees outside, but the roofs have tiles on them, kids loosen their straps so their rucksacks hang around their bottoms instead of knotting stumpy ties, and parents are more involved, whether or not we want to be.
Every day ‘Parent Mail’ reminds us about grey uniforms, disco fundraisers, and money for school trips. Dinner money has gone, replaced by the ‘cashless catering card’, a euphemism for giving kids a blank cheque to buy expensive fizzy drinks and bacon butties. Needless to say the card needs more topping up than a kettle on busy day at a building site.
But the barrage of email and top-ups is just an inkling of the technological change in the classrooms and offices of schools and colleges in the last two decades. These days teachers use interactive white-boards instead of overhead projectors, or chalk. Administrators employ School management software and students and teachers organise their work and collaborate using Learning platforms that promise to replace the homework diary and school report.
In the UK, RM (RM) has been at the forefront of these changes. It started out in the 1970’s as an electronics distributor to computer hobbyists and, as Research Machines, designed computers for schools. The first was the RM-3807 in 1977.
In the 1990s, it diversified into networks and then curriculum software, programmes that teach and test students. Since 2003, it’s diversified again into into administering and marking examinations for exam boards and government departments, and, most surprisingly perhaps, traditional classroom resources, not all of which boot up, or even need to be plugged in.
The reason for this seems clear just by looking at the segmental report in the notes to the accounts. Learning Technologies, by far its biggest division by revenue, makes less than double the profit of its much smaller Education Resources division (click table for full-sized version).
Learning Technologies is closest to the original RM, supplying IT infrastructure to schools and whole authorities, here and thanks to the acquisition of Computrac in 2008, in the south east of the United States. It’s a reliable, low-margin business, divisional profit is about 4% of divisional revenues compared to about 10% for Educational Resources and Assessment and Data Services, the third and smallest division.
Surprisingly, the one activity that seems resistant to computers is learning itself and the growth in learning resources has not come from IT. Light box, RM’s curriculum software, is in long-term decline and contributed only £9.4m of the division’s £63m revenues. The two acquisitions RM made in 2009, art and craft supplier Pisces Art, and furniture maker Isis Concepts perhaps shows where management’s priorities lie.
Once RM’s IT expertise was its biggest asset but as technology has matured and competition has increased, its entrenched position in UK schools has become a channel through which it can market almost any educational product or service. Whether or not this means, as the company foresees, growth in all areas of its business, remains to be seen.
So far it’s done a reasonable job since competition from other computer hardware sellers forced it to diversify. The chart shows the percentage change in RM’s profits and financial strength since 2000, the negative axis just shows that profits fell and then recovered after 2003 (the company didn’t make a loss). Meanwhile its financial strength hasn’t declined markedly although it stepped tentatively into long-term debt in 2009, borrowing about £8m (5% of total assets) to finance its acquisitions. It’s raised its dividend every year since it floated in 1994, except in 2003 when it paid the same dividend as the year before.
The shares cost twelve times average earnings over the last ten years, which looks cheap for a company with a record as consistent as RM’s. But RM looks more like a mundane supplier of equipment to UK schools these days, than a flashy IT company, and schools are increasingly well equipped with IT anyway, which is why the company is looking towards America’s apparently less well endowed classrooms for growth. It also seems likely that funding for schools will suffer as the next government cuts spending on public services.
Nevertheless I think RM is a solid company, at a cheapish price, with a toehold in some promising markets. The extraordinary turn around at Educational Development International has shown there is money to be made in assessment and marking, and it may well be a good time to buy shares in RM when expectations are low. I’ve added it to the Thrifty 30 model portfolio.
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Invincible markets theory
Quoting Benjamin Graham, Jason Zweig says markets may be inefficient but they are still invincible.
Rumours of Europe’s decline are overdone, says Paul Krugman.
Saj Karsan says Apple and RIM are great companies, but that doesn’t make them great investments.
The newspaper business is bizarre, says Robert Peston, and he spent two decades working in it.
The Economist answers Malthusians. We’re not breeding like rabbits anymore.
