UK Value Investor

Following on from my thoughts in the last post I've added Luminar to the portfolio.  Luminar run popular venues where people can meet, eat, drink and dance.  This is the first new holding in almost five months and it feels good to have a change at last.  Instead of funding this purchase with the dividend from Waterman as originally intended, I sold my holdings of Electronic Data Processing (EDP) and used the proceeds plus some cash.  The affect on the portfolio is to add about £20k to its book value since Luminar is so much cheaper, although as I said before I'd be surprised if that didn't come down again.

Sale review of EDP 
Electronic Data Processing is the largest IT solution provider to the UK independent builders and timber merchants market place.  I bought shares in EDP on the 28th of August 2009.  At that time I thought the book value was about £14 million, which put the price/book ratio at under 0.5 and well within my target range.  The rest of the structure of the balance sheet was good, current and quick ratios were fine and the company had net cash.  However, I failed to spot that a recent share buy-back had been used to return some £6 million of excess cash back to shareholders.  So in fact the price/book ratio was about 0.8, far above what I'm after and only with a 25% expected upside.

The sale of EDP had been on my mind for a while and really I was just waiting for something better to come along.  Recently the share price had climbed back in to profit so that was enough to make me back Luminar instead.  In terms of results, I made 6.6% after fees for an annual rate of about 12%.

Purchase review of Luminar

Luminar is very different to EDP.  The price to book is worryingly less than 0.2, although the price to tangible book is still cheap but more reasonable 0.4.  These will change soon though as one of Luminar's holdings has gone bust which is expected to wipe about £17 million from the book value.  Even with that factored in the valuations are good.  Less good is the tangible gearing which is right around my limit of 100%, but given that the margin of safety is so wide I think I can accept somewhat more gearing than I'd like.

I've limited the amount invested in Luminar so that the target sale value isn't too large.  In other words, if I put 10% (~£6,000) into Luminar and the price went up to give a price/book of 1, then the holding would be valued at about £35,000, which would be about 40% of the total portfolio.  Far more than I'd like in a single company... especially one as highly geared as Luminar.

Mallett Final Results

Mallett, one of the largest and most exclusive antique dealers in the world and one of my holdings since 2008, have produced their final results for the year.  While they still made a loss the general mood is more upbeat as the cash position has improved, turnover is up and the loss is smaller than last year.  As the chairman says, "we are only part of the way through the task of re-engineering Mallett's business model and cost base in order to align them with the demands of a rapidly evolving marketplace", which is becoming a familiar phrase around here. 

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%.

With a report titled "Restructuring to return French Connection to Profitability", the team at French Connection have start the real work of turning their fortunes around.  I'm not really a details sort of person, so the main points are that they are selling the Nicole Farhi brand and loss making stores internationally.  I hate to speculate about the future, but generally I'd say this is a good thing and the markets seem to agree as it's been up by over 10% today.


More importantly for me, the report comes attached to the preliminary results for the year ended 31 Jan 2010.  The sole point of interest here is that the book value of the company has changed from £83.2 million at the interim report to £72.3 million now.  The market cap is currently £43 million so it's still cheap by my simple metrics.  All in all I've lost a little book value but gained some market value, neither of which should make me jump for joy nor cry into my tea.  I wonder if they'll give me a discount on a new shirt?

This month the market value of my holdings increased by over £2,000 while the book value changed hardly at all.  You can see the current holdings on the new current holdings page.  This will be updated each month so you can see how things have changed over time.  There was another dividend from trusty Titon which now makes three dividends since I've owned a slice of this little business.  This dividend totalled £178.83 and is currently sitting in my cash balance.  You can see the realised returns from Titon and my other holdings in the new trade history page. 

I've also added a benchmarking page so that you can quickly see the comparison between the returns of a traditional value portfolio against a FTSE 100 ETF.  This month I outperformed the ETF by 3.39%.  Although it's nice to have a positive month it's not really very important.  What is important is the multi-year returns since stock investing is for the long run.

One of my holdings, M J Gleeson, announced a 15p special dividend.  Since I hold over 6000 shares that's over £1,000.  Unsuprisingly the share price has jumped up, although it will probably jump back down again after the ex dividend date.  How this affects my ownership of M J Gleeson depends on how high the price spikes.

Finally, both Richard Beddard and Monevator have mentioned my little blog recently, so I tip my hat in their general direction.  Thanks chaps and good luck.

This is just a minor update to my previous post about allocating assets to stocks depending on the current value of CAPE compared to its long term average.  In the graph using Shiller data I plotted a straight line at 16.35, the current long term average of CAPE.  However, it would perhaps have been better to show the CAPE average as it would have looked at the time, therefore removing the benefit of hindsight and showing what information investors would have had at the time.  And here it is, with the long term CAPE average shown in black:

I've mentioned my tactical asset allocation efforts in a couple of previous posts.  Both of those have been somewhat vague about how I actually decide on the stock/bond split, although not deliberately so.  If Ben Graham can shout out the Net Net method to the world over 50 years ago and not have its effectiveness affected, then surely my tiny wispers on the web can do my approach no harm.  In fact it may to some miniscule degree make the markets more efficient.  Like the proverbial fly stopping an oncoming supertanker.  Perhaps I may even win a Nobel Prize, but I doubt it.

Both Shiller and Smithers and others have shown that it is possible to value markets and that market valuations are bound by an invisible elastic thread to both earnings and assets.  More importantly, these valuations allow you to say something about the expected future returns.  Higher valuations mean lower expected returns and lower valuations mean higher expected returns.  Also, average valuations mean average expected returns.
Shiller's CAPE (Cycically Adjusted Price Earnings) is my starting point when looking at earnings related valuations.  This is the ratio of current market price to the market's average real earnings over the past decade.  For the S&P500 the long term average CAPE is currently 16.35 and is shown below as the horizontal line.  The data for this can be found here.

As mentioned previously, my wife's pension is invested using a 'tactical asset allocation' function dreamed up by my good self.  It basically uses the long term average of the FTSE's real CAPE (real as in adjusted by RPIX).  More specifically it uses the long term average of what I call CAPE10, which is the average of the last 10 years CAPE values.  I'm not sure if this is any better than just using a longer earnings average for CAPE (i.e. CAPE is also known as PE10, the current price of the market divided by the average of the last 10 years real earnings, so you could use PE20 or PE30 as has been done in some studies to good effect).  However I haven't seen anyone else use it so it's nice to be in virgin territory, even if the difference is likely miniscule and possibly negative.
Anyway... the current CAPE10 value is 15.8.  I have estimated the long term average CAPE10 to be 17.59.  That's pretty approximate as it's derived via various adjustments from the long term average CAPE of the S&P 500, i.e. the US market.

So my market prognostication is that:

• The FTSE 100 is current 'undervalued' by 16%
• The current 'fair value' is about 6,170

Therefore I think that future returns are likely to be slightly above average.

I've chosen the iShares FTSE 100 as my benchmark as it's about as near as you're going to get to holding the FTSE 100 directly.  It's also easy to calculate total returns (returns assuming dividends are reinvested automatically) as they have a nice table of 1, 3 and 6 month returns, and 1, 3 and 5 year returns.

I don't like the idea of setting target returns since I cannot control those returns.  I only like to target things I can actually have an influence on, like winning races at a kart track, or swimming 20 lengths of a pool. 

However, given that I am investing my money through stock picking I must think I can outperform (on a risk adjusted basis) the FTSE 100, otherwise I'd just hold that iShares ETF.  So, on that basis I am forced to have some kind of goal, which I have subtly outlined below:

My investing goal is to beat the iShares FTSE 100's total return over any given 5 year period

I'll post a table, updated monthly, comparing my 1, 3 and 6 month and 1, 3 and 5 year returns against my benchmark.  May the best theory win.