RM revisited

Never let the story get in the way of good facts

Nearly two weeks ago I profiled Thrifty 30 constituent RM (RM-) but quickly realised that some of the figures I’d quoted were wrong. I  published the correction you can see at the top of the article, finished off a blog about Titon, and then returned to RM to reconsider whether I was right to retain it in the portfolio.

As I pondered RM again, I felt more and more disconcerted. I had miscalculated the two financial statistics I lean on most heavily; the ten year price earnings ratio and Piotroski’s F_Score.

I quoted a 10y PE of 12, because the formula in my recently re-jigged spread sheet erroneously pointed to just seven years of earnings, and an F_Score of seven out of nine because I had incorrectly transcribed the total assets figure from RM’s accounts. In fact RM’s PE is nearly 15, and it’s F_Score only four out of nine. That makes RM look more expensive, and financially weaker than it did, although many of its F_Score failures are extremely marginal. They may not be significant.

As it happens I’m receiving another sharp lesson in accuracy, courtesy of the Open University. The course is the opening module of what, cobbled together with lots more modules, might become a maths degree.

Unit one of module one is most definitely stuff you learned at school, and although it’s easy, or perhaps because it’s easy, I’ve got most of the first eleven exercises I’ve attempted wrong, or partially wrong. I seem to be accomplished at misreading questions, confusing addition signs with multiplication signs, and calculating how many jewellery boxes a craftswoman makes in 48 days instead of how long it takes her to make 48 jewellery boxes.

The point is, when you think you know the answer, you often forget the question in the rush to complete the assignment.

I fear this applies to financial analysis as much as it does to calculations of how much fuel is required on a round-trip between Perth Glasgow and Edinburgh.

Humiliating though my mathematical errors are, the far nastier conclusion I’ve come to is I rushed the maths because I had already decided to hold on to RM. As a former teacher, who used to work for an educational publisher, whose children use RM Maths, who knows many, many teachers, and has a lifelong interest in education I let the story, the undoubted benefits of IT in education, take precedence over the analysis.

Since that’s the opposite of what I’m hoping to achieve, a fulsome confession seems appropriate.

I ejected RM from the portfolio earlier this afternoon at just under 168p, the bid price plus 25% of the spread, my way of simulating a sale price since you rarely achieve the mid-price quoted by the stock exchange but usually do better than the bid. I added RM to the portfolio a year ago at 161p so it’s made us a little money including a dividend of about £8.50 in July, and another of about £32.10, which will be paid on 4 Feb.

One number I got right, is RM’s return on equity, which has been consistently over 20% in recent years. But I think I may have misinterpreted that figure. There are two things about RM’s return on equity we need to establish; whether it’s sustainable, and how much of it is due to leverage.

Not much, on the face of it as RM only has £11.5m in long-term debt, which is under 6% of the value of all its assets. Add in the money it owes customers and suppliers and it’s £12m pension deficit and total liabilities are 68% of total assets (another way of saying that is the company’s assets are worth three times its equity – see the blue bars on the chart). If RM were funded completely by equity, its return on equity would be the same as its return on assets, a more mundane 8%. It also has £25m in non-cancellable operating lease payments (rent for office space) to make over the next five years, which do not appear on the balance sheet.

Although RM entered the 2000’s earning more than 20% return on equity, it wasn’t able to achieve it in 2002, 2003, and 2004.

The trouble is RM faced similar problems in the first half of the decade to those it faces today, namely the end of big infrastructure projects to re-equip our schools and devolution of IT procurement to schools.

History may not repeat itself. As I mentioned in the blog RM has growth opportunities in the US, a bigger market which for once is behind ours, and it’s more diversified owning significant businesses in classroom resources, and marking and assessment.

I think, because of the leverage it employs, RM is tuned to perform when school, and particularly IT, budgets are expanding. But leverage works both ways, depressing profit when a company is going through difficulties. That fact alone excludes RM from the ‘buy and hold forever’ category, in which I may previously have absent-mindedly placed it.

I would hold the shares if they were obviously cheap, but on fifteen times ten year earnings, they aren’t.

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Make the past your crystal ball

@GeoffGannon says “Make the past your crystal ball”, Warren Buffett does.

Watch Pesto’s excellent explanation of the banks’ role in the financial crisis before it disappears from iPlayer tomorrow.

In Memoriam: Sunny Day Investor, a rare and illuminating UK value investing blogger, has quit, and removed his blog from the ‘net.

UK Value Investor, on the other hands, has had a makeover.