Showing posts with label Rules. Show all posts
Showing posts with label Rules. Show all posts
19 May 2010
Building Asset Value
I thought I'd say a little something about how I decide to buy and sell companies, and what my rationale is behind each trade. There is some discretion involved, but not much, and this is certainly a fair summary of what I do. A simplified version of this is available on the Checklist page.
Let's say I start with £1000 in cash. I look for a company where I can pay £1000 for something worth at least £1,500. 'Worth' is a slippery term, but to me it means shareholder equity or book value, and I prefer tangible real assets to intangible assets. I realise that book value isn't always the actual net value of the company assets, what with 'cooking the books' and all. However, I don't have the time or interest in digging out all the details so I imagine that the good and bad net each other out. To be on the safe side I use a wide margin of safety.
So I head out into the market and find some companies where I can buy a pound fifty of book value for a pound. These companies are typically quite sick, often making losses, often unloved by almost everybody. Because they are often losing money they need to be able to weather their current problems. They need a bomb-proof balance sheet, or as near as can be. Typically this means they don't have a lot of debt and have at least fair liquidity.
Debt is often what gets a company killed. If the banks refuse to lend to a company which is dependent on debt it's game over and the companies I buy are not top of many banks lend-to lists. Debt can be measured in many ways, but I tend to use net gearing, which is gearing based on net debt, which is interest bearing debt minus cash and equivalents. What exactly is low debt is debatable and I don't have a hard rule, but certainly less than 100% of tangible equity.
Debt is often what gets a company killed. If the banks refuse to lend to a company which is dependent on debt it's game over and the companies I buy are not top of many banks lend-to lists. Debt can be measured in many ways, but I tend to use net gearing, which is gearing based on net debt, which is interest bearing debt minus cash and equivalents. What exactly is low debt is debatable and I don't have a hard rule, but certainly less than 100% of tangible equity.
And talking of getting out, if I can sell a company and turn its book value into cold hard cash then I will. Once the market price equals the book price I see no sense in hanging on. During my holding period the original £1,000 has turned into £1,500, perhaps with some small dividend paid out in the year or three I had to wait. Now I have £1,500 cash in my hands, so I go right back to the market looking for that pound fifty on sale for a pound, or in this case £2,250, at which point it all begins again.
As you can see, the focus is always very much on building up the total book value of my holdings. Of course, it isn't always a happy ending. Sometimes the managers manage to burn a big chunk of my book value up. Sometimes I wake up and the new annual report says my company is worth 30% less than it was yesterday and suddenly the market price is above book value. It might even be worth less than I paid for it. From here there are two courses of action. I can ignore the paper loss, turn a blind eye and say "I will only sell if I have a gain". But this is not logically consistent. It smacks of making up the rules as you go along and one of the keys to investing I think is to make up the rules and then stick to them! So what I should do - and have done so far on the one occasion it's happened - is to sell at a loss, try to work out where it all went wrong, swear at the management and start looking for the next unloved but robust company to back.
21 Mar 2010
Luminar, bond allocation and checklists
With the impending dividend payout from MJ Gleeson, I've been thinking about what to do with it. I mentioned at some point in the past that I wanted to hold more cash and bonds, using the CAPE10 based function I've posted about before. That function calculates my cash or bond holdings using the value of the FTSE 100 and is therefore suitable for portfolios where the stock holding is an index tracker following the FTSE 100. In fact that's exactly what I've used it for so far when annually re-balancing my wife's pension and currently the bond allocation is about 30%.
However, the value investing portfolio which is the focus of this blog is most definitely not a FTSE 100 tracker. The shares in my portfolio live in a dark little corner of the size and value grid where academia says out-performance is most easily had. On that basis I don't think I should hold cash or bonds based on the value of the FTSE 100. What I've decided to do instead is to be as fully invested as is sensible (i.e. if I have £100 cash there's no point investing it since the trade commission will be about £10).
Once I get my hands on the MJ Gleeson dividend and sell my bond holdings I'll have about £3,000 cash to invest; and Luminar is looking like a high risk high reward place to put it. This big nightclub operator is very cheap, both tangibly and intangibly. It doesn't have quite the low debt levels I typically like, but it doesn't seem to be drowning in debt. On the downside, they've just lost the founder and chief executive; and one of their major investments has just gone into administration probably wiping its ~£17 million value from the balance sheet. Further to the downside the company has lost over 50% of its tangible assets over the last 5 years which, although bad, pales next to the 90+% paper losses of shareholders.
This is as good an example of why value investors are a rare breed as you are likely to find. Only the maddest or hardiest of souls would give money to a company with such a poor record. Will I become one of them?
For those of you who are interested in this sort of thing, I've added a Checklist page to list the (semi) mechanical steps I take when investing. The whole area of checklists and why we need them is very interesting in itself and I'd recommend both The Checklist Manifesto
and Work the System
as an introduction.
and Work the System as an introduction.11 Jan 2010
Ennstone - post trade analysis
I'm going to record an analysis of each of the trades that I make so that I can learn from each trade. I'm sure that sometimes there may be nothing to learn, but that's not always going to be the case and it certainly wasn't with my first value stock back in 2008.
I had come to value investing from a more typical mindset where I was trying to predict the future in order to see where it was going to be most profitable to invest. I had been heavily invested in energy stocks through unit trusts back in 2005-2008 and they'd done incredibly well, almost doubling my money. But I had no idea how to value these unit trusts nor the stocks within them. When oil went to $146 I thought I was pretty smart. But we all know what happened next. I lost about 50% and that's a really big drawdown, one that made me almost physicall sick.
I had come to value investing from a more typical mindset where I was trying to predict the future in order to see where it was going to be most profitable to invest. I had been heavily invested in energy stocks through unit trusts back in 2005-2008 and they'd done incredibly well, almost doubling my money. But I had no idea how to value these unit trusts nor the stocks within them. When oil went to $146 I thought I was pretty smart. But we all know what happened next. I lost about 50% and that's a really big drawdown, one that made me almost physicall sick.
28 Sept 2009
Buying Assets and Financial Strength
Over the past 6 months I've worked on my approach to finding good investments and I think I'm quite happy for now. I started out just looking at price to book, which often gave me companies with lots of debt, i.e. Ennstone, which then fall over at the first sign of trouble. Then I looked at liquidation value and cash flow, to protect against such a failure. However, I've now simplified it so that I pretty much just look at liquidity (current and quick ratios) and debt to equity ratios. Once the companies are filtered by those criteria I just buy whatever is cheapest to book, with half book being the most I'll pay. The ratios I use aren't set in stone, but they are ball parks to get me started and the amounts come from various texts as 'reasonable' amounts.
13 Feb 2009
Ennstone teaches me an important lesson
I think it can be difficult to learn anything without actually living it. So handily Ennstone, my first purchase of a value stock using not much more than price to book, has fallen over into the abyss. This is good for a number of reasons, although of course not so good for the staff.
The collapse of Ennstone has helped me re-think my approach to value investing and most importantly helped me to clarify to myself what it means to me to invest at all.
The collapse of Ennstone has helped me re-think my approach to value investing and most importantly helped me to clarify to myself what it means to me to invest at all.
10 Nov 2008
November update
Since I started the value investing approach I've been putting about 5% into each company. So far there are 6 companies, all of which have made sizeable losses which ties in with the saying that value investors "buy too early and sell too early". That's my excuse anyway.
As I continue to buy companies at a rate of about 1 a month I should be fully invested in just over a year, assuming that equities remain as cheap as they are now, which seems likely. Then of course the assumption is that as the markets recover to some extent these heavily oversold stocks rebound fast. Once they reach more sensible valuations (say, price/tangible book of 1) then I'll sell in favour of other companies that are still available cheaply.
As I continue to buy companies at a rate of about 1 a month I should be fully invested in just over a year, assuming that equities remain as cheap as they are now, which seems likely. Then of course the assumption is that as the markets recover to some extent these heavily oversold stocks rebound fast. Once they reach more sensible valuations (say, price/tangible book of 1) then I'll sell in favour of other companies that are still available cheaply.
13 Aug 2008
Value Share Selection
My share buying criteria are slowly taking shape, based on extensive back testing as reported in "What has worked in investing" by Tweedy, Browne Company LLC, plus some testing of my own using DigitalLook's Market Stars system and my reading of Ben Graham.
I'm a simple chap so I like simple rules. I start by sorting the FTSE all share plus the FTSE Fledgling indices by price/book. I select those in the bottom 10%. Then I sort those by market cap and select the smallest 10%. Then I exclude those with a dividend yield less than 1%. Finally I sort by price/book again. Basically this gives me small cheap shares that are still paying a dividend. Generally I don't like to buy shares with price/book over 0.5.
I'm a simple chap so I like simple rules. I start by sorting the FTSE all share plus the FTSE Fledgling indices by price/book. I select those in the bottom 10%. Then I sort those by market cap and select the smallest 10%. Then I exclude those with a dividend yield less than 1%. Finally I sort by price/book again. Basically this gives me small cheap shares that are still paying a dividend. Generally I don't like to buy shares with price/book over 0.5.
7 Aug 2008
Bought Pendragon at 8p and Ennstone at 16.47p
I started my toe dipping exercise into value investing this month. The plan is to start out light and only buy once a month or when I sell something. I want to hold up to 20 stocks and also use the sliding cash system I thought about last time where the cash % is twice the average PE of the market.
The general idea is to buy stocks from the FTSE All Share index which fall in the lowest 20% market cap of the bottom 10% price/book. So if there are 500 companies in the index then I pick the 50 with the lowest PB and then the smallest 10 of those by market cap.
Many previous studies have shown that these stocks can outperform the market over the next few years after purchase. The gist is that markets are not 100% efficient and that they over do the gloom on certain stocks or just don't value them fairly.
My sell signal will either be when the company reaches a price/book ratio of 1, or when I've held the stock for 5 years, whichever comes first.
This month I bought:
Pendragon at 8p, market cap 62M, PB 0.15. This is a car dealership network and it's been pretty beat up in this recession.
Ennstone at 16.47p, market cap 81M, PB 0.4. This is a construction and materials company and has not surprisingly lost a lot of value recently.
The general idea is to buy stocks from the FTSE All Share index which fall in the lowest 20% market cap of the bottom 10% price/book. So if there are 500 companies in the index then I pick the 50 with the lowest PB and then the smallest 10 of those by market cap.
Many previous studies have shown that these stocks can outperform the market over the next few years after purchase. The gist is that markets are not 100% efficient and that they over do the gloom on certain stocks or just don't value them fairly.
My sell signal will either be when the company reaches a price/book ratio of 1, or when I've held the stock for 5 years, whichever comes first.
This month I bought:
Pendragon at 8p, market cap 62M, PB 0.15. This is a car dealership network and it's been pretty beat up in this recession.
Ennstone at 16.47p, market cap 81M, PB 0.4. This is a construction and materials company and has not surprisingly lost a lot of value recently.
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