Ten boring companies in deep trouble
Posted on February 25, 2008 by Richard Beddard
Filed Under Companies, Investing |
Yes boring can be ballistic too. But first, a reader’s stung me:
I wonder if you are seeing any fair value in the market. Your recent articles have focused on companies that you do not want to buy!
I take his point about focusing too much on companies I don’t want to buy (though others might want to buy them), but not necessarily about fair value. Some of the most attractive companies are unfairly valued*1. That is they are much cheaper than they should be.
Behavioural investing
Investors get over-excited about companies with a good story and ignore boring companies where the news is bad, pushing prices to unreasonable highs and lows. The more prices overshoot, the more unfair the price, and the bigger the opportunity for the investor who can exploit the behavioural foibles of other investors
These are the shares at the extremes, and, by definition, there aren’t many. At the low extreme, they’re so boring you’d sooner watch Chelsea play football than research them.
To work out the value of a company we must relate its price to what we are getting. Since profit (after employees, suppliers, the government, and lenders have taken their cut) is the shareholder’s reward, I relate the price to earnings per share, as many investors do. As one bad year could distort the ratio, the average of at least five years of earnings is a better benchmark of a company’s earning power than the more common historical and forecast price to earnings ratios.
Of course, one bad year can be the first of many, and a precursor to bankruptcy, especially if a company is highly indebted or its earlier profitability is suspect. By weeding out companies with high levels of debt and low levels of cash flow I hope to reduce the risk of bankruptcy and increase the probability a company will survive long enough to recover and reward investors.
Ten boring companies in trouble
Here are the ten companies with the lowest long-term PEs and good debt and cash flow histories. Their prices are so low in comparison to average earnings because nobody wants them:
- International Greetings (IGR) - Long-term PE: 2
IGR designs and manufactures giftwrap and cards. It floated at 50-odd pence in 1996 and almost made it to £5.00. Bbut it’s back at 45p following a series of profit warnings starting in August last year*2. In the latest, earlier this month, the company scrapped its dividend and revealed that it’s restructuring because it’s uncompetitive. - SCS Upholstery (SUY) - LTPE: 2
SCS sells sofas, and its price chart is frighteningly similar. It started issuing profit warnings in February last year and has fallen from over £5.00 to around 50p in about a year. Like IGS, it’s a victim of the consumer slowdown, although it’s easier to see why. Sofas are expensive and easy to put-off buying, if money’s short. SCS warned again in January, scrapping its dividend, its expansion plans, and its refurbishment programme. - London Scottish Bank (LSB) - LTPE: 3
LSB is a lender to the ‘non standard’ sector, and debt collector. Its price had been falling throughout 2007 and it fell of a cliff this January when it announced a shortfall in regulatory capital and reduced lending. It also scrapped its dividend. This is the latest news. - Metalrax (MRX) - LTPE: 4
Metalrax makes things out of steel; parts for buses, racking and flooring, and ‘bakeware’, or things you’d stick in the oven. Its profits and share price have been in slow decline for years, a decline that has accelerated since last summer, although the shares bounced when Metalrax concluded its strategic review last month and the financial director resigned “by mutual consent”. - British Polythene (BPI) - LTPE: 6
BPI makes plastic bags, film and sacks for farmers and industrialists, as well as shoppers. It also warned recently, although its woes look less severe than the four companies that top the list. Raw material costs are rising, sales are dipping, and so BPI is less profitable. - Dart (DTG) - LTPE: 6
Dart owns Jet2.com, a low cost airline for northerners, and Fowler Welch-Coolchain, a fruit and produce distributor. Its share price has been in free-fall for a year, apparently because it’s investing heavily despite heightened competition. The company admits it’s sacrificing profit margins for growth. - Titon (TON) - LTPE: 6
Titon makes ventilators for windows. It warned last August of rising raw material prices and production costs and lower exports due to the strength of the pound. Here’s the latest. - Bradford & Bingley (BB.) - LTPE: 7
Another bank, ’nuff said*3. - French Connection (FCCN) - LTPE: 7
I’ve already blogged FCUK, and scripted this iBall. - Dialight (DIA) - LTPE: 7
Dialight makes LEDs for lights and status indicators (on/off, for example). Its price has seesawed its way through the last decade and its sliding down one of the saw’s teeth now. In theory it’s a sexy, environmental, technological business but profits are down. Here’s the warning in April 2007. Since then, the price has almost halved.
I think these stocks have the potential to recover. But that’s not to say they’ll definitely recover.
Bottom fishing
Before investing in them, or writing about them I’d double check the numbers in the company’s annual reports (profits, debt, cash flow), and assess the certainty of recovery. If all a company must do is trade better, it’s interesting. If it must radically change its business (like HMV and French Connection, perhaps) it’s too speculative…
The bad news is these stocks have negative momentum. Even if they recover, they could fall more before they do - just because investors are giving up on them. You have to have a really contrarian mindset to hold them and not fret.
The good news is there’s no hurry; usually companies take years to recover, which gives you time to do you own research.
It might seem like wish fulfilment. That you can package a PE ratio with debt and cash flow ratios and some nous to produce a list of shares that will beat the stock market, but the academic research suggests it’s possible*4.
Footnotes:
- I think that’s actually what my correspondent means!
- I’ve linked to RNS news releases on the Interactive Investor mothership. You can subscribe to the news feeds using RSS, as you may have subscribed to this blog.
- I avoid banks because I find their accounts so difficult to understand. They can’t even value their own assets!
- The long-term PE is a major factor in Dr Keith Anderson’s Naked PE ratio, which markedly improves the predictive power of the PE. James Montier tested the long-term PE and found that it outperformed the market by 13% per annum between 1980 and 2005. His excellent book, by the way, is available in our shiny new book store. Finally, the Z-score is a useful method of predicting bankruptcy. It’s a combination of many ratios, like mine.
Comments
11 Responses to “Ten boring companies in deep trouble”
Leave a Reply
Greetings Richard,
Interesting article. Many thanks.
Do you have the PEG ratios for those shares?
I have been following Metalrax for some time now but I suppose it is only the coward in me that stops me buying the shares.
Have you bought any of the shares you mentioned in your article?
We hope you and your Family are well.
Best wishes from John and Mary-Anne
Hi John - great to hear from you.
I don’t think any of them will qualify for a PEG. As you’ll know peg relates the price earnings ratio to earnings growth rates (often a mixture of the recent past and forecasts). All of these companies are experiencing negative growth (i.e. earnings are shrinking). The trick I’m trying to pull off is to find companies that are sound enough to get through a few years of poor profitability and then recover.
I do plan to produce a list of cheap growth stocks, though - so keep watching!
Re: Metalrax. It looks as though your caution has served you well so far. Timing these kind of deep value situations is, I think, probably impossible.
Hi Richard,
Your comment about behavioural investing makes me think about a poker game. There are some big players out there who manipulate the market by playing on human nature.
Take, for example, the current rally. This rally is in the face of a huge amount of bad news still coming in, and it is almost like no one cares any more. People want to play their hand and mistakes will be made.
It is often said that EMT does not apply to the short term markets but does apply to the long term markets. In other words, in the long term, the companies share price will revert to its long term average value so you should try to buy it cheaply. I do wonder how true this will be because, long term, underlying market values change so dramatically it is like trying to hit a moving target.
While I agree with crunching numbers to guide you (and using long term data such as the 10 year PE), I guess that the only true way to invest is to find a ‘good company’ and buy it
Thanks Richard,
I will keep ‘watching this space’
JH
Hi Robin,
Phew. Where do I start!!! Well, I suppose the main point is that I think (following James Montier’s lead) that it’s often big boys that succumb to human nature - they’re forced into short-termism when a plucky private investor, stout of heart, and with only himself to answer to can afford to take the longer view.
Regarding hitting a moving target. Well I agree, but I think that’s where using five to ten year’s earnings comes in. That period is supposed to span a cycle and therefore be a more realistic measure of a company’s earning power than any single year’s earnings figure.
The danger of just buying a good company (apart from it turning out not to be as good as you think it is) is that you might be confusing ‘good’ with ‘top of the cycle’ (i.e. because it’s doing well now you think it’s good.) which is why, I think, it’s important to buy good companies when they’re cheap.
Of course you can pay a fair price for a really great company and do very well too. I think that’s much more difficult, and subjective, although I’m not averse to trying!
What do you think about Woolworths? I think they are trading around 10p at the moment. Are they undervalued. They have plenty of shops and loyal shoppers maybe ideal for a takeover?
Hi Duncan,
Interesting company. According to my spreadsheet (and I haven’t checked these figures) it’s long term pe is 3 so it would be high up the list of value stocks.
I’m not sure about its financial strength, its headline profit figures are quite different from statutory ones and I think it’s more indebted than it once was so I’d need reassurance about that.
My main worry would be the heightened competition in retail from the Internet. I wrote about this in the blog on HMV. In some categories like music and film its threatening to make shops obsolete!
I don’t have any firm views because I haven’t researched it. But quality of earnings, debt and competition would be the first things I’d look at.
Good luck
Hello Richard I too like to bottom fish for boring little companies that have fallen out of bed with Mr Market.
I have recently bought into Cagney PLC, which I now feel look like being reasonably good value. I would welcome you thoughts please, negative, positive or neutral.
Many thanks Sincerely David
Hello Richard,
Half of my portfolio consists of “recovery”plays
I have done well in the past with Amstrad, Quarto, Universal Salvage and have been watching International Greetings, but their level of debt is overwhelming hence the recent price fall (40% since your article) The City is “nervous”.
My latest speculation is with “Molins” Unloved at 135p. Future p/e 5, dividend yield 5%, EPS 42p, debt £7.6M, net assets 260p. Meets your criterion!
Hi David,
Thanks for your reply. Crikey, Cagney’s tiny! It doesn’t meet my criteria because it’s only reported two years of results - hence it doesn’t have a long-term PE. I can’t really comment on the business as I had not heard of it until you posted your comment but if you think the current weakness in the price is down to general uncertainty about the economy (which will of course affect an advertising agency) but that the company’s basically sound - it could be interesting. One thing I like is the lack of forecasts - always a good sign a company might be unjustifiably ignored. Good luck with it. I’ll keep an eye on it, now I know a reader is a holder
Hi John, good to hear from you. Slighty miffed to hear that Quarto and Universal Salvage did well for you as I’d looked at them briefly but not taken it any further (not really! Always happy to hear of another investor’s success :-)).
Molins is interesting. It has a nine year pe of about five by my calculation - which is pretty good for a company with a variable but pretty profitable past.
As an investor, if I were to look into it further, I’d want to satisfy myself on the disparity between its normalised earnings and statutory earnings. Just as a quick check I take the last five years of each and divide normalised into statutury. Molins gives me a ratio of 0.2 which makes me wonder about the quality of its earnings. That said its cashflows cover normalised earnings so it may not be anything to worry about.
I’d be concerned that over a third of its revenues come from tobacco machinery. There’s an investing angle to that and a personal one. The investing one is simply that I’m not sure the industry has a future. The personal one is that cigarette manufacturers are the only businesses I won’t invest in on principle, and I suppose making the machines that make the cigs is only one step away. That doesn’t mean I disapprove of people who do invest in tobacco!
I’ll be keeping an eye on Molins as a potential value play for readers of this blog. And I’m really pleased that you John and Duncan shared these contrarian ideas.
Richard.
PS I agree that debt is a concern with International Greetings, which is why I looked into SCS first. That said, it might have quicker turnaround potential given that greetings cards ought to be less cyclical than sofas.