An innocent among investment bankers

Beddard in the City

On Wednesday I attended a conference hosted by Soc Gen’s much quoted Analysts Albert Edwards and Dylan Grice. It’s a New Year ritual for many investment banks, and since Edwards has a formidable reputation, and I’ve learned much from reading Grice and his predecessor James Montier, I thought I’d emerge from my private investor bolt-hole and experience three hours in the lives of these analysts and the assorted City throng that follow them.

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Is the market looking forwards or backwards?

If it’s looking backwards, it’s not looking very far…

Shares in the typical UK company cost 15 times median earnings over the last ten years. That looks a pretty fair price, judging by my short run of data which starts close to the peak of the bull market in 2007 and includes the crash of 2008/2009.

Although the economic backdrop seems just as apocalyptic now, worries about solvency having moved on from banks to countries, the market seems much more sanguine.

One explanation is companies remain resolutely profitable, and on the whole recent results from companies in the Thrifty 30 confirm this.

Commercial vehicle hire company Northgate, gift wrap manufacturer International Greetings, lift component manufacturer Dewhurst, modelling and war gaming company Games Workshop, and carpet manufacturer Victoria have all been doing pretty well according to their latest statements. Most of them express reservations about the future due to the tough economic conditions, though.

Perhaps investors are looking backwards at recent profitability and forwards at the seemingly intractable problem of debt in the World’s more mature countries and assuming we will muddle through somehow.

That’s the extent of my analysis, as usual I think it is best to prepare for the worst and hope for the best, by keeping my head down and buying value when I see it.

The median ten year earnings yield is now over 9%, less than 1% shy of my 10% benchmark for value. Not every company on a yield of over 10% will be good value, some of them will be in precarious financial or competitive situations, but I reckon many must be.

That only adds to the frustration I feel at not having found any new companies for the portfolio last month.

Shipbrokers and the long shipping cycle

lessons from economic history

I urge you to read this *lecture (pdf) to the Royal Institute of Naval Architects, given by Dr Martin Stopford of shipbroker Clarksons two years ago. Not just if you’re interested in shipping, but economic history and globalisation. It’s convinced me to put his acclaimed book on my reading list.

Stopford describes the persistent trend in global development since the 1940s resulting in 50 years of GDP growth at an average annual rate of 3.6% and an average annual increase in seaborne trade of 4.3%. You’d have thought shipping would have been a tremendous business.

In fact the fortunes of shipbuilders, ship owners, and perhaps shipbrokers have been tied to to a long-cycle. It peaked in two bubbles in 1973 and 2009, and describes long periods in the 1980’s and the 1990’s when earnings from various types of ship were stuck in the doldrums.

It’s tempting to quote the text, and reproduce the charts at length, but I shall restrict myself to one quote describing the state of the shipping industry in the years leading up to 1973 because it is such a succinct description of an investment bubble:

By the late 1970’s, the independent ship owners were becoming more adventurous and started to order ships on their own account without tying themselves down to a charter. The shipping banks supported them because the ship mortgage came to be seen as sufficient security since ship prices always went up. This broke the link between supply and demand and resulted in a spectacular shipbuilding bubble which peaked in 1973.

The shipping bubble had firm foundations; the end of colonisation and growth of free trade, improved communications, the opening up of new energy sources and financial markets, reconstruction in Europe and the emergence of Japan. By 1973 though there was overinvestment and the oil crisis punctured the bubble.

It took two decades in which ships were scrapped at a fraction of cost before the demand for shipping once again overtook the glut created in the early 1970’s.

Replace China with Japan and the oil crisis with the financial crisis and we’re in a similar situation in 2009. Stopford believes the globalisation trend has further to run, but we’re entering a downswing in the long cycle and the results are likely to be relatively low returns from shipping for the rest of the decade.

That’s the awesome backdrop to any decision to invest in Clarksons or Braemar, both shipbrokers.

I don’t know if profits from shipbroking are as cyclical as profits from owning or building ships. So far profitability at Clarksons and Braemar has not fallen dramatically, but Stopford’s scenario seems to be playing out in Braemar’s most recent results. A decline in freight rates resulting from the oversupply of ships, and a subdued sales and purchases market, explain declining shipbroking revenues.

The likelihood we’re in a downswing in the long-cycle for shipping, and confirmation that shipbrokers are affected by it, leads me to question whether the 20% or more return on equity Clarksons and Braemar have achieved over the last decade can continue. Since that’s the basis for my earnings yield calculation, which makes both companies look very cheap, I’m disregarding it.

Defaulting to book value, Clarksons shares are on a multiple of 1.7. That looks expensive considering the uncertainty and, since I don’t like the big bonuses paid to executives, I’m most unlikely to add it to the Thrifty 30.

Braemar, though, is considerably cheaper. The shares cost 1.1 times book value and its diversification strategy may prove prescient.

I prefer to add companies (or remove them) soon after they have published their annual reports, but if Braemar’s trading around book value (305p), or better still below it, next May, I’ll be tempted.

Curiously, Duncan, aka Kelpie Capital, seems to have come to a similar conclusion.

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* Thanks to John Kingham, aka UK Value Investor, for telling me about it.

Market entering thrifty territory again

Message from the spurious statistics department: Median Long Term PE is 15

Assuming my median 10 year PE statistic tells is useful (there are plenty of objections to it, the main thing in its favour being it’s easy to calculate), the market’s entering thrifty territory again.

The highest levels recorded at the end of 2007, as the bull market peaked and credit was soon to crunch, were about 20 times earnings. The lowest, in early 2009, were below 10. Crudely speaking then shares are safer below the mid-point of 15, and riskier above.

Right now, they’re delicately poised at 15.

Look at the spreadsheet, you’ll see I’ve also started measuring the earnings yield. Although one way to calculate the earnings yield is simply to divide the PE into one and multiply it by 100, I calculate it slightly differently, dividing Average Return on equity by Price to Book Value.

Taking the median, I’ve excluded companies with negative Returns on Equity and/or negative Book Values because they produce meaningless results. Technically I’m measuring the median Earnings Yield of the subset of profitable companies that are not in negative equity, the pool from which I select companies for investment.

The average earnings yield is nearly 9%, only 1% below my thrifty threshold. So in this bleak market, where pundits are unable to see through the gloom, there’s joy for value investors.

Half the 495 companies that have produced positive returns over the last ten years and have positive equity are at or near thrifty territory.

Rejoice!

Monthly update: continuously reducing risk

The Thrifty 30 moves sideways, the market moves all over the place

Here’s the performance table:

Here’s the performance chart:

Here’s a familiar refrain:

A neighbour commented this morning that the stock market must be interesting at the moment.

I gave my usual reply, which is, I keep my head down.

Once a month I surface to update these charts and tables, viewing them with mild curiosity and resolving to take no action because of them.

Changes in performance in one month are a poor source of feedback, if, as I believe, in the short-term the market is, effectively, random and unpredictable. That’s why I don’t try to explain why a certain company’s price has risen, and another’s has fallen. Everybody is anxious about the state of almost every economy, which, as an explanation for the hyperactive and generally depressed state of the market, is both concise and about as accurate as I can hope to be.

I could expend a lot of time and energy attaching plausible-sounding reasons to share price movements, and plausible-sounding rationales for future movements. Almost always these will be wrong, because the financial world is too complex to predict, at least with modest resources. That doesn’t mean I’m sanguine about the market. The alternative to trying to understand it is to accept it’s risky and play safe.

So in keeping my head down, I’m not holding it in my hands and praying things will turn out all right, or blithely assuming it will. I’m continuously reducing the risk in the Thrifty 30 portfolio by ejecting companies that, because of their high prices or changes in their businesses, are too speculative, and adding new companies with strong finances and good prospects at low prices. If I don’t find any, I keep the cash.

This month I ejected Solid State, the portfolio’s best performer, which is why the portfolio table looks a little shabby. Its 146% return is an anonymous portion of the cash balance.

I’m confident In the long-term thrifty companies will make investors more money than investment in the broad index.

If the Thrifty 30 fails it will be because I picked the wrong companies at the wrong valuations, and not because I should have spent longer watching and wondering about their vibrating share prices.

Better get my head down.