UK Value Investor

I first bought Waterman on October 22nd 2009.  I had recently sold Harvard International for a profit of £4,102.82 and needed somewhere to put the proceeds and some additional cash.  Waterman marked a slight change in my rules.  Whereas before I would only invest when a company was trading below 2/3 of tangible book, I decided to allow intangibles into my valuations. 

I've long been fiddling around with various mechanical methods of adjusting an almost passive index investing stragety to improve the risk/reward ratio.  This is sometimes known as Tactical Asset Allocation (TAA).  I thought I'd put up some charts of my efforts.

The lines in the charts are for four portfolios:  Cash, with the returns calculated using the average instant access interest rates borrowed from the rather excellent Swanlopark;  The FTSE 100 with dividends reinvested;  A 60/40 FTSE 100/cash split rebalanced each year; Another FTSE 100/cash split which is rebalanced annually using my asset allocation function which is fed with the FTSE 100 real earnings over the period in question.

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'm a big fan of CAPE (cyclically adjusted price earnings) and Tobin's Q as tools for understanding expected future risk and returns from a stock market.  After reading Wall Street Revalued: Imperfect Markets and Inept Central Bankers, I'm an even bigger fan. 

The logic is simple.  Market valuations must be tied in some way to earnings (the discounted cash flow that I hear so much about from earnings based investors).  Earnings for an entire market, over the long term, are somewhat predictable using past earnings.  These earnings are generated by assets and so market values are tied in some way to assets.  CAPE seeks to value markets using earnings and Tobin's Q does it with asssets (or net assets to be more precise).

Electronic Data Processing is a company I bought recently. I've since found out that they bought back half the shares for 6 million pounds just after the most recent financial report. The web sites that I use to filter stocks have the new number of shares (12.5 million, down from about 25 million) but have the cash balance as at the last statement, £8 million, rather than the actual amount post-buyback of around £2 million. So the NTAV isn't 13.5 million, it's 7.5 million, so the market cap of 5.8 million isn't below half NTAV, it's about 80%... there's a lesson in there. READ the last few reports rather than just the latest one!

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.

The owner of Barratts shoes I think. I had a quick look at their valuation as at Feb 08. They had negative liquidation values (using net net or 80/50). Their cash flows had been about -8p per share over the last few years. Not sure how that gave a share price of about 60p in the good times.

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.