The full spectrum of value
Next up… CPL
Looking at my screens this month it felt like I’d developed tunnel vision. All I could see were companies I’d included in the Thrifty 30 portfolio, or companies I’d rejected. There must be more, surely…
So I configured Sharelockholmes to produce a list of companies that had been profitable over 1, 3, 5
and 10 years, that were not in negative equity, and had market capitalisations over £5m.
There are 400 companies in that list, which meet my minimum quality requirement.
I dumped the list into a spreadsheet to calculate each company’s earnings yield, dividing average return on equity over the last ten years by price to book value, and filtered out any company with a yield of less than 10%.
Then I filtered out various undesirables, miners, housebuilders and financial services companies, mainly.
There remain 142 companies in the list and no matter how I sort it, sprinkled throughout are interesting companies. Companies I’ve fancied in the past, like Dechra Pharmaceuticals, that I thought too expensive. Old favourites that have fallen on hard times, like RM. Massive companies, like AstraZeneca, and lots of Thrifty 30 companies of course.
Top of the list is reject Bloomsbury but next in line CPL an Irish recruitment company that also features in my bargain screen. I hadn’t intended to look at CPL, unemployment has tripled in Ireland in the last five years and it may stay that way for a long time, but looking at CPL’s earning power in this screen makes me think the company could be a bargain regardless. Despite Ireland’s economic woes, in its latest year CPL earned 11% return on equity according to Sharelockholmes.
I shot a 140 character query into Twitter asking if any investors had come across it. Blogger Philip O’Sullivan replied:
Come across it? I used to cover it when I was an analyst! Great company & mgmt. Will blog about it later today.
So there you go, next up for consideration is CPL. Here’s Philip’s post.
And hopefully there are many more in my screen, which, I think, almost captures the full spectrum of value. It’s far too big to put in a web page, but here’s the spreadsheet.
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Hi richard, In terms of extending your search for new ideas – is there a reason that you would not extend you tried and trusted Nifty and thrifty screens to stocks that are quoted outside of London market. If your approacg to value has merit, then it is likely to be just as applicable in Nth America, Europe Australia etc. (I have seen much evidence to suggest that valuation has not really ever worked in Japan as a strategy).
Hi John, thanks for your comment! Well, I have been tempted, so much so that when my reply turned into a completely new blog post: http://blog.iii.co.uk/the-future-of-the-thrifty-30/
On Japan, James Montier reported in 2009 value beat the market and generated positive returns since 1990 (i.e. the peak of the bubble):
“The Japanese experience suggests value investors need not concern themselves with
any form of market timing. Despite the pronounced cyclicality of the Japanese market, value
strategies have plodded along nicely (a return of 3% p.a. vs a market return of -4% p.a.). An
even more impressive performance is available to those who short. A long value/short
glamour strategy has generated 12% p.a. in the post-bubble world!”
I can email you the note if you haven’t got it.
Please do. The reason that I mention it is that his old colleague Andrew Lapthorne has done extensive work on the performance of value screens. If I am not mistaken they perform best in the UK and US, and dont really perform at all in Japan.
Done. Interestingly the 3% return figure was from low p:bv shares. He references a study by Andrew Lapthorne, but I haven’t looked at it.
Aye, this value thing can be difficult to pin down. You can slice and dice the data a million different ways and sometimes a company will look cheap by one measure and expensive by another. A lesson I learned last year was that coming up with a whizzy spreadsheet is fine, but don’t leap into it to agressively without thinking it through!
And don’t be afraid of cash unless you have a hard policy of being fully invested. Or, if you’re value criteria are proving very hard to meet, perhaps concentrate your portfolio to the thrifty 20?
Hi John, thanks for the comments. On the whizzy spreadsheet front I need to be wary about my latest. It values companies relative to profits over the last decade. I think there will be a lot of value traps in there – companies whose profits won’t match up in the next, say, five years.
I’m looking at Armour at the moment, my biggest ‘mistake’ so far, and let’s just say I think I allowed myself to believe its past profits meant something even though I recognised big risks because, in the early stages of building the portfolio, I had a lot of cash and was scared of getting left behind by the market.
So I agree with your second point too.
I’ll save the humiliating confession to following the herd for the post-mortem, hopefully before I take a break over Christmas!
Hi Richard
I see JD Sports is listed on your spreadsheet and is silly cheap at the moment. I’d be interested in your observations were you to run your ruler over that one
Hi Trident,
I have looked at JD. See: http://blog.iii.co.uk/tag/jd/
The price has taken a hammering since then, which may make it more attractive.
JD’s record is phenomenal but I was put off, as I have been by almost every retail company, by leases, and competition (It’s raining footwear this Christmas in our household for some reason and it’s all come online, some of it direct from Nike/Ugg etc. and some of it from Sports Direct. Hate their shops, but you don’t have to go into them any more do you, and you get a gigantic free mug with every order!).
With revenues and costs (upward only rent reviews) under pressure it’s a scary, changeable environment, and I want to be fishing in calmer waters!
Hah, I just wrote on another of your posts that perhaps you should try a new angle into the sort of companies you might like, and et voila! You’re *fast*.
I wouldn’t be so quick to dismiss housebuilders if I were you, personally. Obviously scary given the current climate, but potentially real value in their assets of the sort you like there. At the least it might be useful to see which ones have what it takes at a time you feel the outlook is more rosy for them.
I think you’re right Monevator, I should at least have considered them. I almost did a week or so ago and then I read a post on Valuhunteruk in which he talked about some of the rather complex financial arrangements on their balance sheets, see: http://www.valuhunteruk.com/stock-ideas/housebuilders-part-2-how-to-value-them/ and I’m afraid I thought “gawd, I can’t face it!”.
However, I’ve been thinking I should put some of them through Ben Graham’s liquidation value worksheet and see if they look cheap. That would focus on current assets (which includes property in the case of housebuilders, but only at 50% of book value) and would value potential horrors like “avalable for sale financial assets” at zero.
http://blog.iii.co.uk/net-net/
I appreciate this goes to the heart of the pros and cons of value, but in literal terms ‘liquidation’ asset values could be a bit misleading, in that in any scenario where housebuilders have to sell assets (land) in a fire sale, they’re definitely not going to get much of a price.
As I’ve written recently, I think the structural shortage of UK houses (barker et al) is a potential floor for prices/land values. Perhaps an alternative analysis would be to run its figures for a very flat 10 year scenario of no boom or bust, just limping on like today for 10 years?
The only complicated thing about BDEV is that they have started paying for land through accounts payable. I think it may be cheaper than debt but I really have no idea how the accounting works. Apart from that, it is just working out at what kind of price they can liquidate inventory for and you can just project out various scenairos given the relatively simple business model. If you valued at 50% BDEV would be worth (off the top of my head) at least double what it is worth now.
My general view is that if things carry at roughly this level of activity BDEV should be fine but, given the debt, if activity slows down much more then equity won’t be worth anything. I reckon demand is actually quite strong (largely due to simple demographics) but banks are massive problem (if the ringfence happens soon, this could change the mortgage ‘game’ significantly). I am still thinking over my view (I am probablly more bullish) but if you think households/banks are going to have improved their financial position in three years then BDEV is one of the biggest no-brainers of all time.
Hi Calum. This is where my lack of knowledge about property shows itself. Are you saying that BDEV is effectively extracting more generous terms from whoever sells it land?
Maybe the way to look at payables is the way my liquidation sheet would. Value the payables (i.e. for land) and all other liabilities at 100% of their balance sheet values but the land itself (part of current assets I imagine) on the balance sheet at a more conservative rate, say 50%. Deducting all liabilities from current assets valued at fractional multiples of their balance sheet value would give a liquidation value we could compare to the share price.
Yes, my vague understanding is that the people who are selling the land are getting a bad deal (or, to put it a more relevant way, BDEV is getting a good deal relative to the cost of debt it was facing in FY09). The model I used did value the liability at 100% and then I put the land through the model (as brownfield goes straight to inventory) where it all just got liquidated over time.
I think the valuation is quite tricky as the company has a lot of financial leverage, is heavily linked to economic recovery, and it has a slow ATO meaning it buys an asset, holds for two/three years, and sells it which means it can go seriously wrong in the mean time. As a result, the outcome for the equity will be quite asymmetric. Either it will make a lot of money or it will go bust (in my view). So I think the best way to value BDEV is to examine what different scenarios mean and then think about how likely they are. The disclosure in for BDEV’s inventory valuation model is good (although I don’t get how they get to £3b odd) and, due to the relatively simple model, it is pretty easy to work out what will in various scenairos. I think it is just a bit problematic to say inventory is worth 50% and leave it there. At the least, I think a 50% value implies some kind of recovery (if we continue at the current level inventory is worth around £1.1b against a 50% value of £1.6b).
What a paragraph! Sums up the situation really well. I offered a few less incisive views a couple of weeks ago:
http://monevator.com/2011/11/25/buy-shares-in-house-builders-not-a-new-build-house/
Trouble is, if Calum’s right, housebuilders are for gamblers. The case depends on the market having stabilised but how can we be confident of that? Their prosperity is not in their own hands.
I think it depends on time horizon. There are house builders who I think are a safer bet over shorter time horizons, in case of the worst (e.g. Berkeley Group, which I hold).
At least a few don’t have much debt, either. (From memory PSN and BWY, and possibly RDW though I think it’s said it’s going to gear up).
BDEV and TW are the deep value multibaggers if the market rebounds even modestly to underwrite the value of their land banks, but if you don’t want to take that risk then I think these others might be worth a look.
Obviously just my thoughts, I’ve no special insights into the sector except as a keen private investor making my way in the world.
Wow! According to Sharelockholmes PTBV at Berkeley is 1.66. What’s the justification?
Barratt is lowest of major householders on 0.42, rest range up to Persimmon on 0.89.
Just off the cuff views, but if there are doubts the likes of Barratt can survive then it’s not really an option. Meanwhile there doesn’t look like there’s much to gain from Persimmon if you don’t have a view on where the property market is going.
Hah, well I bought them 35% lower and am holding on, they are on my ‘quality’ list of UK companies where (look away now!) it’s worth paying more.
There’s only five or six on there (Diageo is another, for instance).
Good brownfield regeneration sites, top quality output, and a plan to return a lot of capital to shareholders that’s already running ahead of schedule.
They’re no value share though.
Thanks Monevator, just trying to get a feel for the lie of the land.
The *lie” of the land?
There is the Freudian slip of a value investor!
I participated in the Alpha Challenge stock pitch competition this year, and the industry was homebuilders, so I did quite a bit of research on them in November.
Berkeley is far and away the best run homebuilder, with a singular focus on the London market (which continues to grow) and a well-defined plan for returning cash to shareholders over the next several years. If you compare operating metrics, it isn’t even close – yet, the stock trades at a deservedly high premium. Persimmon is very well-run as well, and I believe the only other one besides Berkeley that didn’t have to raise capital in the downturn.
Ended up recommending a long for Taylor Wimpey. The company almost went bankrupt after an ill-timed merger (right near the top of the market in 2007), but the market seems to continue pricing it like its going out of business despite one of the largest strategic land banks and a renewed focus on margin improvement over volume.
Outside of Berkeley, they all seem cheap. My general impression was that banks refusal to lend (especially at the high loan-to-value rates of the past) will continue holding back the housing market in the short to medium term, but the long-term aspects are very favorable (affordability vs. renting, age of homes especially in London market, supply of housing required to keep up with population growth, etc).
-Adam
My post on TW – http://www.valueuncovered.com/alpha-challenge-a-long-short-idea-in-home-builder
Thanks Adam, very interesting summary of the housebuilders.
On the long-term fundamentals, you’d have thought demographics etc. are favourable but (and I really haven’t thought about this much!) In the back of my mind I’m worrying that despite lots of demographic trends that suggest a demand for new properties the housing market seems dysfunctional – I don’t understand how a situation can exist where prices are so high they discourage demand and then don’t adjust down to meet it, but it seems to me that’s the situation we’re in. Maybe it’s linked to credit, which allowed people to pay more for houses pre-crunch, but not now. The result has been the freezing of the housing market. but if economies like the UK economy go through a prolonged deleveraging then the pressure on prices could get worse, not ease. Wages aren’t rising much. This is what puts me off housebuilders really – it’s not just a matter of them tightening their belts, finding efficiencies, looking for new markets. All of that could be rendered insignificant by prolonged house price deflation.
It depends on the risk:reward. If the upside is large enough then it may not matter if there is a chance it may go bust…although it depends how likely the downside is. My view is that the upside from even a slight recovery is probably big but the risk could be bigger.
I haven’t had a look at all the other companies but I noticed Persimmon as well. Lower unit sales than BDEV, lower average sales price, and lower inventory…worth £600m more than BDEV though. I am going to put a spreadsheet together on it in Jan but I have feeling it is to do with the debt. The premium for the safety is way too large though.
Hi Calum. Thanks, your replies have been very helpful. The problem I don’t like the risk:reward mindset. I just think I’m very bad at weighing the two. I prefer to think in terms of minimising risk and letting the reward look after itself. If you look at them that way companies that are at risk of going bust are untouchable. And rock solid ones like Berkeley (apparently) are speculative because of the high price of the shares. Maybe there’s some value in the middle. I’ll be very interested to see your thoughts on Persimmon.