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.

Education Development International (EDD)

So far, so recession proof

Here’s a rarity, a company beating expectations that were positive anyway.

It’s Education Development International (EDD), the examinations company I berated last July and commended to Money Observer readers in August (pdf). iBall lampooned it in September.

Chief executive Nigel Snook has had the latest laugh. £1,000 invested in EDI last summer is worth over £1,500 today, a quicker return than I expected.

It’s very good news for smaller company investors, and one in particular, the friend who told me about EDI. Perhaps it’s a lesson not to disregard all tips received from mates in pubs.

You can read the AGM statement. EDI, which sells qualifications and the examinations, syllabuses and services like marking that go with them, is benefitting from the growth in vocational education generally, a depreciating pound which makes sales of its foreign qualifications more profitable, and a temporary windfall from the introduction of a new transport qualification.

Will it last? The directors think so. Chairman Richard Price bought over half a million shares at prices between 43p and 45p in January. Mr Snook also bought 50,000 shares and a non-executive director, Barrie Clarke, bought 100,000. Between them, they own 9.1% of the company, so they’re committed.

Valuing EDI against its long-term earnings is tricky though. It pays no tax because of huge losses developing and marketing Goal, a computer aided learning system. It’s likely to from 2010 though, which will reduce profit.

Those losses aren’t relevant now its main business is qualifications, and Goal is mostly a memory of the dot.com boom and bust. Erasing its losses from history gives a five-year price earnings ratio of about 17 at its newly inflated price, which puts EDI just out of my buy-zone.

But as confidence grows that Mr Snook’s right, and EDI is beginning to reap the rewards of years of investment in its protracted turn around, then growth investors will assume higher profits in future, than those in the past.

And, in the short-term, they’ll probably be attracted to a company that has yet to detect any impact at home, or abroad, from the recession.

Extremely distressing diligence

Arrghhh! Words can’t describe the frustration I feel at Education Development International (EDI). It starts with stockmarket ticker code, which is EDD – not EDI, and continues with every syllable of its annual report. Words are in fact, part of the problem.

It ought to be so simple. The company has a turnover of little more than £20m, it appears to be growing, it’s not in debt, it’s in a business – qualifications and assessment – that, I think, is genuinely beneficial (but not flash and prone to hype), and the share price values the company at less than eight times earnings, which is not very much at all. It should be an interesting small company. All that’s left is a bit of due diligence – checking that I understand how it makes money.

I’ve read the recent regulatory news, and the latest annual and interim reports. I’ve even flicked through earlier ones. It’s been tough. Fifteen years ago, I was a secondary school teacher, so I approached EDI with optimism. I didn’t expect to stumble through the chairman’s report in a daze, as though the document was a long-forgotten exposition of Finnegan’s Wake.

The words aren’t incomprehensible, just ambiguous. What is a support service, for example? Fortunately, I have a friend in the biz, and one evening last week I bought him a shandy and got some answers. Support services are syllabuses, past papers, marking schemes, training (for teachers), and schemes of work, lesson plans – we used to call them.

More seriously, for a little business EDI’s fiendishly complicated. It sells vocational qualifications but tests school children. It owns a bewildering array of even smaller companies – including its own Internet Service Provider. It’s an exam board, and it designs and administers bespoke qualifications too. It seems to be trying to make money from every corner of the examination industry and many corners of the world, which makes me wonder what it’s ‘core’ business is, and whether it’s any good.

The story (so far):

1. EDI was once Goal and its main product was an online assessment programme tied to the national curriculum for secondary schools. The idea is computerised testing and marking is more efficient than good plain old pencil and paper, but it caught on much more slowly than the company and its early dot.com investors thought. EDI still sells it to over 600 schools, which is less I think than in 2002 when 927 schools had access. You can try Goal  here.
2. Since then it’s bought exam boards, principally the LCCIEB (London Chamber of Commerce International Examination Board) and entered the qualification business in 2002: charging schools, training companies and businesses a fee for candidates they field in its exams and designing and accrediting qualifications for  organisations that want to run exams themselves.
3. Its qualifications are mostly vocational, under the EDI brand in the UK and the LCCI (London Chamber of Commerce International) brand abroad. Eighty-five per cent of its UK sales are vocational qualifications, so I think I’ve found the core business. Most of its international qualifications are vocational too.
4. EDI has just completed a multi-year ‘organisational development’ program in which it has physically moved from to Coventry and redeveloped its IT systems, and now its going to go out and sell. Alan Sugar would be proud.

Since vocational education, in particular a new diploma qualification to be introduced in September, is Governments answer to NEETs (young people Not in Education Employment or Training), who otherwise have poor prospects and generally muck up the employment statistics, and since British education has a strong reputation abroad, there are grounds for optimism. Doubly so, if EDI’s moving from a period of consolidation to a selling.

So good news, today EDI revealed its new corporate image to:

…bring together into a common ‘house style’ the disparate corporate and product presentations which are the result of acquisitions made by the Company over the past three years.

It’s mailing 5,000 customers, and it’s updated the website, which was utterly shambolic, alternating the new brand EDI, with the old one, Goal (that’s a page from the old site, which still appears to be available).

But it’s been a good decade for exam boards. The government’s obsessed with assessment and league tables so one concern is why, for most of the decade, EDI has struggled? And why’s it sticking with Goal? I’ll be asking the directors when I call to check the story I’ve concocted because the positive thing about a company that doesn’t present itself well is it turns off investors¹, which may in part explain the share price. They’ll wait until the profits speak for themselves, which may give the hard-working investor an edge.

Dairy Crest on iBall

Talking of examinations, Dairy Crest has graduated from blog to iBall. Watch it, if only for the Benny Hill intro.

Footnotes:

1. Though the new website is a big improvement, so perhaps that edge is about to vanish.

A company and a book to cheer you up

If you thought my last post on Dairy Crest was a reluctant vote of confidence, you’re right.

Posting links to news stories like the ones in the right sidebar of this blog it’s hard not to let gloom seep into my stockpicking brain. Sadly hysteria is an occupational hazard, which explains why journalists don’t make good investors*¹.

Headlines like RBS issues global stock and credit crash alert are driving me to listen to techno music as I write, just to ward off all the negativity.

Editing articles like Peter Temple’s latest Growth Portfolio update doesn’t help. Over the long-term his portfolios have done very well, but the growth portfolio is in retreat. He’s sticking by Claimar Care (CCGP), a company profiting from our aging population. You might think it’s the mother of all growth markets but the shares are down 60% since he bought it, and he’s not usually one for overpaying. He’s cutting Zirax (ZRX)  just because it’s a smaller company.

They say “elephant’s don’t gallop” but when the prices of smaller companies are galloping in the wrong direction and just about every company looks like a burnt-out cyclical, an ex-growth stock, or a fantastically overpriced hole in the ground, you know the psychological bunker‘s caving in and the Jerries are coming to get you.

Education Development International

But surrender is not an option and panic definitely isn’t, so I keep looking for opportunities. The good news is I’ve discovered a promising share, Education Development International (EDD). It markets qualifications, tests, and examinations and the textbooks and crib sheets that go with them. It’s quadrupled in price over a year or so, it’s on a price earnings ratio of less than ten and there are as many letters in ‘education development’ as there are millions of pounds in its market capitalisation. Too good to be true? We’ll see. I’ve much research to do, but I got the idea from the best possible kind of tip. Not the:

Psssst! This one’s gonna make us rich

…kind. I learned about EDI from an admirer of the company, who works for a rival.

That’s the first glimmer of hope, that there are still stocks worth buying. The second comes in the form of therapy, a book to help us see through the fog.

Turtle Trading

I asked our bookshop to send me a review copy of The Complete Turtle Trader by Michael Covel because:

1. Fellow blogger, Todd Sullivan liked it.
2. It’s going to teach me about the dark side, momentum investing.

It’s also a good reminder of the importance of shutting out noise, and sticking to your system. Richard Dennis, the Chicago trader at the centre of the tale, was a reader of ‘Psychology Today’, not the Wall Street journal.

The book documents a unique episode in investing history when, to settle a dispute in the early ’80s, Richard Dennis and his partner trained a diverse band of recruits in a simple momentum trading system. They wanted to prove whether great traders are born great, or whether trading is a skill that you can learn. Their results give us hope. According to the jacket blurb, Mr Dennis made £100m from his Turtles.

Momentum traders buy assets that are going up in price, and sell assets going down in price, regardless of the fundamentals (i.e. what those assets might actually be worth or how much they might earn). It’s the antithesis of value investing. I should hate it, but I’m about 60 pages in, and I love it so far.

But I think momentum traders have more in common with value investors than either side cares to admit. Both seek to exploit behavioural anomalies. That’s to say markets tend to extremes or exuberance and disgust. Momentum investors seek to ride the exuberance. Value investors seek to plunder cheap shares, when other investors won’t even consider them.

Just as the existence of anti-gravity might validate the physics of gravity, an analogy I’ll not push any further because I don’t actually know it’s true, if momentum investing works then value investing should too.

At its most extreme, the efficient market hypothesis, which I’m guilty of bashing at every possible opportunity, says that knowledge and experience cannot help an investor beat the market. The lesson of the Turtles is, apparently, it can. Interesting, I think, even if you don’t subscribe to Dennis’ system. And comforting too, if you’re on the wrong end of a lesson in humility from the stock market.

More books to mend the soul next week.

Footnotes:

1. Just a supposition. It’s why I tell the ed-in-chief I’m an investor first and a journalist second. You really can’t let all the bullshit get in the way.