T 30 May review: all in bet on manufacturing

7 Comments

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  Mat Johnson May 6, 2011 at 3:55 am

  Richard,

  I think your missing the point with intrinsic value calculation. The aim is never to attempt to calculate the exact value of a corporation , but rather to formulate an extremley conservative estimate of the very least a rational buyer would pay for a corporation.

  With this figure in mind, you can then assess how much of a bargain the company is. In investment, as Ganon reminds us on several occassions, you are ideally looking for no-brainers, situations where the is a massive and obvious discrepancy between price and value.

  If you have a figure in mind and the price is much below this, then the stock is an obvious buy. If the price is too near to your conservative estimate, then you should look elsewhere.

  The true value of formulating an intrinsic value, is that it free’s you from the relative measurements such as PE as you are now actually looking at the absolute valuation.

  As the key question is what is the very least a rational buyer would pay for the company, you do not need a great deal of precision.

  As such people who critique discounted free cash flows are missing the point. You shouldn’t be aiming to calculate the exact value, Instead you use very conservative estimates which are below the companies actual past performance to calculate a lower ceiling, and it is this ceiling that is you price guide or margin of safety.

  The other advantage is being able to knock up a figure, is that you then have a good idea when to sell a corporation, instead of never knowing when is a good time to sell.

  A book I think you would find very useful is “F Wall Street” by Joe Ponzio. I think you would find is ideas about determining when to sell very interesting indeed.

  Best Wishes,

  M.J

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    Richard Beddard May 6, 2011 at 10:03 am

    Thanks for your comment Mat. I didn’t actually mean to criticise intrinsic value calculations, although at the level I’ve used them ( see: http://blog.iii.co.uk/category/ivp/ ) they seem like a lot of work for a little benefit. The assumptions I make are so general I might as well use relative measures of value, which are much less effort to calculate.

    I can see why an analyst in an investment bank, or an academic, might spend days or weeks analysing a company and calculating its intrinsic value but most private investors, myself included, don’t have the time.

    As to whether IV produces better results than relative measures combined with other non value metrics like gearing and the F_Score, the jury’s out I think. The records of analysts aren’t that impressive, well known value investors are thought not to calculate it (Buffett doesn’t, I think, Graham, who invented it, moved away from it in his latter years). Damodaran is, of course, an academic, and as an academic discipline I think it’s truly fascinating (he conveys this fascination rather well on his blog).

    If I were to use IV I’d absolutely use the approach you credit to Geoff Gannon (i.e. look for where there is a massive discrepancy). I’d argue, though, that where there is a massive and obvious discrepancy you shouldn’t even need to calculate the IV. It will be obvious from the relative measures and your appraisal of the business.

    Thanks for the F-Wall Street book recommendation. I’ll add it to my ‘wishlist’. I’ve come across Joe Ponzio’s blog before, but maybe didn’t pay enough attention.

    All the best,

    Richard.

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• Weekend reading: Commodities rout May 7, 2011 at 11:00 am

  [...] Thrifty portfolio is an all-in bet on manufacturing – iii Blog [...]

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  UK Value Investor May 7, 2011 at 8:11 pm

  Hi Richard

  Regarding your concentration in industrials and manufacturing, I see something similar in my current favourite GARP screen. Top of the list is a slew of support services companies like Mears, MITIE, Interior Services and Interserve. Mixed in are a bunch of construction related firms like Morgan Sindall, Balfour Beatty, Hill and Smith, VP Group.

  I think it’s quite likely that at any given time the same sort of companies are likely to be hurting in terms of share price at the same time for the same reasons. Unless you deliberately try to diversify (which I’m sort of trying to do at the moment with things like Reckitt Benckiser, JD Sport, BP and Robert Wiseman Dairies, in addition to owning Mears and Interserve) you’re going to end up with a big slice of your pie in one basket, to mix metaphors. Not that that’s a bad thing, but I guess there are some risks attached to it.

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  • 
    Richard Beddard May 9, 2011 at 9:15 am

    Hi UKVI, every time I think about diversifying for the sake of diversifying i.e. not adding the companies that seem best value to me but adding slightly more expensive companies because they’re different from the ones already in the Thrifty 30 I hesitate. I guess the basic fact is to beat the index you’ve got to do something different and the index represents maximum diversification (if you restrict yourself to shares within it).

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• 
  Calum May 8, 2011 at 4:17 pm

  There has been some research on the sector allocation for value strategies, the only public one I can find though is: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=213872

  The finding is that if you build portfolios based on within-industry value metrics (i.e you look at all beverage stocks at buy the cheapest P/B and short the most expensive P/B, for example) rather than market-wde metrics your returns are the same or slightly higher than market-wide but with far lower variance/risk (although the logic of that is somewhat dubious). In other words, the risk-adjusted returns are far better if you keep your sector allocations under control.

  My view is that looking back to 2008 you might have seen a lot of cheap financial stocks and expensive energy stocks when in fact it was the opposite. My concern has been that some consumer stocks are looking cheap i.e DEB or MKS or ARO (which I hold) but we are going to see them get even cheaper with fiscal tightening or whatever. I think it means concentrating on the underlying economics far more. However, as you say, some of the sector classifications are totally arbitrary esp. for “manufacturing”.

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  • 
    Richard Beddard May 9, 2011 at 9:38 am

    Hi Calum, thanks for your comment. That paper does sound a bit counter-intuitive, but I hope it’s right. I think it’s effectively what I’m saying. Value shares ought to be the least risky (if you’ve taken a holistic view of ‘value’ and bought companies that are cheap (i.e. risk of overpaying is low), financially sound (i.e. financial risk is low), in businesses that have a future (i.e. business risk is low) it doesn’t really make much sense to to diversify into companies where the risks may be higher. That said I run a portfolio with berths for 30 companies so I’m always going to achieve some kind of diversification.

    Regarding retailers. I must admit I’m wondering if that’s the next sector my value discipline will root out. There are a number of retailers popping up on my screens. I wouldn’t let crystal-ball gazing about issues like fiscal tightening put me off (fears like that are why the shares are cheap aren’t they?)

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