The not-so Thrifty

In practice:

Not like the good old days

Sadly my plan to create a model portfolio of good companies at cheap prices, the Thrifty 30, by going back through the companies I’d profiled in the last year-or-so and including those that still fit the template, is snagged on the rusty nail of exuberance.

Since investors have enjoyed a summer a love, most of the companies have risen in price. I wish I’d created the Thrifty 30 back in March. There’d have been more companies to put in the portfolio, and it would have benefitted from all that lovin’.

Having risen from a low of eight times earnings, UK shares, as a group, are now no longer particularly cheap. This week I’m going to confuse the chart by introducing a new measure, the market’s ten-year price earnings ratio, currently 14. I’ve only measured it twice, this week and last, and you can just see the line starting at the right edge of the chart.

The ‘long-term’ price-earnings ratio I have been reporting for the last couple of years has risen to 13, five points above its low in March and seven points below its high in December 2007. It may have been a little higher than that earlier in 2007, before I started measuring it.

Both ratios are median PE ratios of companies listed in London.

• The ten-year PE compares the price of a company to the average of the last ten years of profits for each company, so only companies with ten years of profits qualify.
• The 1-9 year PE compares the price of a company to the average of up to nine years of profits for each company, so companies with shorter stockmarket records are included.

Since most listed companies have been listed for a while, the two PE ratios should be very similar.

In time, I will probably switch to the ten-year PE because it’s a purer measure, but, for now, I’ll chart both as the history of the 1-9 year PE shows what happened to valuations during the financial crisis and the data is from different sources so each validates the other.

Right now, in rough terms, shares are approaching ‘fair value’, which explains why some of the bargains I’d identified before, no longer exist.

As promised, here are the not-so thrifty. Companies that were once cheap enough to merit inclusion in the Thrifty 30 but now I’m not so sure. For safety’s sake I’m leaving them out.

No longer Thrifty:

Since I wrote about them, the prices of Education Development International (EDD), Carluccio’s (CARL), ITE (ITE) and Victrex (VCT) have risen into speculative territory. Although they are probably very good companies, the probability that they are good investments is lower.

The prices of shares in these four are twenty or more times earnings. Victrex and EDI have long-term price earnings ratios of well above twenty.

Other things being equal that implies an annual return of 5% or less, unless these companies are much more profitable in the future than they were in the past. Maybe they will be, maybe they won’t, but I think it’s too big a gamble to take.

Shed Media (SHDP) is more tricky. Its price has risen 30% to 86p, but its seven-year price earnings ratio is just under 13. The shares are cheap enough to include in the Thrifty 30, if the company inspires enough confidence.

Shed announces its interim results later this month but encouraged investors with a statement in July that promised increased sales and profits.

More exciting, for traders with a short-term mentality at least, was an announcement the day before. The company revealed its executives are talking to private equity groups about a buy-out again.

The share price, therefore, is inflated by takeover speculation and investors with longer memories will remember this has come to nothing before.

If the buy-out succeeds, there may be some short-term gains, but that’s risky and not a Thrifty 30 trade. If it fails, the shares might fall into bargain territory again. Of course, they may not. After Thrifty 30 constituent OPD’s botched buy-out the price has soared, at least temporarily.

Weeks after I wrote about Celsis (CEL) in July it too was bought out by private equity at a premium of about 25% to the price I’d have ‘paid’ had I included it in the Thrifty 30 model portfolio then. I think its new owners got a pretty thrifty deal, which means, unfortunately, it’s not available now.

Still Thrifty:

Here’s the current members of the Thrifty 30 at yesterday’s close:

Notes:
The first transaction in the portfolio was on 9 September 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends are credited to the cash balance

Commenting on performance two weeks after starting a long-term portfolio would be ridiculous, so I won’t, except to say that the dead weight of cash will be a big influence until I’ve included more shares in it.

In fact, I won’t be able to say anything serious about performance until oooh, September 2014 as I’m aiming for a 15% annualised return over any five period.

And here’s the list of Thrifty 30 candidates, companies that, judging by the numbers alone, meet the Thrifty 30 criteria for value and financial strength.

Please scroll down to the bottom of the spreadsheet for explanations of the column headings. Some of the data is from Sharelockholmes.com, some is from Sharescope and some is mine. The companies are ranked so that the cheapest, strongest, most liquid candidates with the most up-to date financial data are nearest the top.

Maybe Thrifty:

I’m still plundering my back catalogue, as well as scouting for new companies like Solid State, the most recent inclusion in the Thrifty 30 last Monday.

Looking back, these companies may still be Thrifty: Delta (DLTA), Electronic Data Processing (EDP), Huveaux (HVX), Laird (LRD), Porvair (PVR) and T Clarke (CTO).

In theory:

Real contrarians are bullish now

Stateside, James Grant, says real contrarians are bullish now, because economists and investors are so pessimistic. Michael Panzner of Financial Armageddon disagrees.

An old obituary of Tony Dye reveals that the fund manager’s famous Cassandra-like warnings about the stockmarket in the late 1990’s were not the only time he was ahead of his time. He warned about the state of the global financial system too.

Economist Stuart Thomson predicts a WWW-shaped economic outlook over the next decade.

More evidence that booming economics do not breed booming stockmarkets, From the Empirical Finance Research Blog.

Markets are efficient much of the time, says Andrew Lo, but sometimes the ‘wisdom of crowds’ becomes the ‘madness of mobs’. Not so, say James Montier and Albert Edwards, mobs always rule.

Buying the S&P500 when its 10 year price earnings ratio is below average, and selling it when it’s above average, might beat buy and hold, says Steve LeCompte, but it’s probably not worth the effort.

Publishing is a dying industry says Paul Graham, the way to tell technological winners from  technological losers is to  determine whether they’re using technology to protect an existing source of revenue or giving people something new they couldn’t have before.

Value investing 101 from Columbia University’s Bruce Greenwald (video). Hat tip: Alex Garcia, Value Investing Pro

Hear, hear, Gregory Speicher spells out the importance of checklists.

Pity poor bankers, they’re not paid as much as sports stars.

Semiconductors and sustenance for value investors

In practice:

Wolfson ‘Interesting’ Microelectronics

‘Interesting’ can be a euphemism for beguiling, and Wolfson Microelectronics  (WLF) is certainly an interesting company.

Profits fell sharply in the year to December 28 2008 as demand for its audio chips collapsed. In its recent annual report, chairman Michael Ruettgers doesn’t know how bad things are going to get so he’s preparing for them to get worse before they get better by cutting costs, but not research and development.

On the other hand, Wolfson had $13m of cash and $92m of short-term deposits in December, far outweighing everything it owes. Total liabilities were $31m, none of them debt.

Although the shares look a little expensive, the price is 16 times average earnings over the last nine years, investors are getting a lot of assets for their money. One day Wolfson should turn them into profit, unless it needs them to fund its way through recession.

Since Wolfson’s a successful company in a hot but cyclical business, supplying integrated circuits for mobile phones, sat navs, TVs, games consoles, hi-fi equipment and other consumer electronics products, recovery seems like a reasonable speculation.

Despite the price of the shares, the company might merit a place in a Thrifty portfolio, if not now, then soon!

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No news is good news at Carluccio’s (CARL). Today’s trading update reported rising sales and new store openings as planned, which is a relief as I picked it for Money Observer’s March Share Sleuth column [PDF].

I’m following Steve Markus’ 140 character condensed company announcements on Twitter (@smarkus).

In theory:

Curse of the value investor is not so bad

When shares are falling, the value investor buys too early and when shares are rising she sells too early. It’s a curse. Because shares trend in the short-term, they’re likely to keep going in the direction they have been recently regardless of our benchmarks for value.

But it’s not such a bad curse, according to our man at Soc Gen, behavioural and value investing specialist James Montier.

He tested the returns of an imaginary investor who bought the US market whenever it fell to 10 times its average earnings in the preceding ten years, which he describes as ‘revulsion’ levels (i.e. very cheap and, incidentally, around the level of the UK market now).

On average, the investor bought four months before the bottom of the market losing him 20% but it only took a year to recover that loss. It’s a small price to pay, Montier says, for not being able to pick the bottom of the market.

To pick the worst-case scenario (so far), after October 1931 our investor bought eight months before the bottom, losing 53% and having to wait nearly two years to recover.

Buying like this also protected Montier‘s imaginary investor from loss:

Historically, investors haven’t ever lost money on a ten year horizon when they have purchased in the lowest quartile of valuations.

That is, when the market’s ten year PE is less than 13

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Mebane Faber, author of the Ivy Portfolio, tells me momentum “is not quite where we were going”, the three big ideas are:  diversification, timing and following the best investment managers.

Some of this week’s shares: Carluccio’s and DMGT

Two stocks in the buy-zone

Here’s part one*¹ of this week’s lightning review of companies that have:

1. recently published their annual reports,
2. long, profitable records, and…
3. relatively low share prices in relation to those profits

Carluccio’s (CARL)
To get a flavour of Carluccio’s watch iBall, last June it took a playful look at the restaurant-cum-deli chain last June. Unfortunately for shareholders, its share price has more than halved since then, and it had already fallen from its high a year earlier.

In 2006, it looked like a proper growth stock, but while it may still be growing in terms of stores, it was marginally less profitable in 2008, than it was in 2007. Still it has no debt, is funding new stores from cash flow, and it’s annual report looks so good I could eat it*².

The dramatic fall in the share price puts me in a quandary. By selling imported Italian groceries at its restaurants, it’s making money all day, and since most of its stores are in London there’s scope for expansion. Maybe this is just a temporary hiatus.

Its price to six-year earnings ratio is about 13 though, and although that’s a fair price to pay for a growth stock, I think that could come down if it spends more than a year in the doldrums. I like the idea of investing in Carluccio’s but think the price, if not the food, is still a bit rich.

Daily Mail and General Trust (DMGT)
DMGT falls into that category of companies I’d like if only it wasn’t so indebted. It has £1,000m in debt, which puts gearing well above 100%. Perhaps investors can reconcile themselves to such high levels of debt because DMGT is among the bluest of blue chip shares.

I remember calling DMGT’s financial director a couple of years ago to find out when it had last cut the dividend. The answer was somewhere between ‘never’ and the Second World War. It may even have raised the dividend every year since then. This time the dividend is up a modest 2% and it would surely be a huge statement, should the DMGT board ever cut it.

Perhaps that explains why the price has settled where it has, such that the dividend yields just under 6%. Investors cannot believe DMGT would cut.

Based on its dividend and earning power, DMGT’s right in the buy-zone. The share price is nine times average earnings over the last nine years, which is cheap for a company with its pedigree.  But there is a problem, apart from the debt. Its record of earnings (which fund the dividend) may not be that relevant.

The company built its reputation and profitability on its national and regional newspapers*³ but, in common with the rest of the industry, those titles are in a state of managed decline. DMGT is focusing investment on its other businesses, exhibitions and business information. The company boasts that its non-newspaper business has risen from 14% of operating profits to 62% in the last twelve years.

That’s good, but it also means DMGT is a different company to the blue chip of previous decades.

Footnotes:

1. Tomorrow: EasyJet, Intec and Ransom.
2. It sounds good too. Which would you eat first: The Rendiconto finanziario (cash flow statement) or the Conto Economico (Income statement)?
3. I loathe the Daily Mail, but its revamped website surprised me. It brilliantly juxtaposes fear-laden headlines with “Debbie looks better than Madonna, says Paul Daniels”. Much as I intend to click on “Brown told he’s lost markets’ confidence as bank shares sink again”, I find a trivia tractor beam drawing me to: “The Stig(s) unmasked:  Now Top Gear admits it employs FOUR drivers.”