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.
4 May 2010
April Update - Victoria gets a boost
Back to normal this month, with next to nothing going on this month other than volcanoes and general elections campaigns. If you're interested, please check out the Current Holdings, Trade History and Benchmark pages for the most recent updates.
Current Holdings
Electronic Data Processing made me happy by paying out a small dividend after I'd sold them, bringing the annualised returns for that company to 20% during my brief period of ownership.
The cash that I had left at the end of March went into Victoria, an existing holding. I increased this holding because I didn't really want to add another new holding - I like to hold around 10 companies - and it was the cheapest by price to book of those companies where I didn't already have more than 10% of the portfolio invested. On the downside I don't really rate Victoria's chances of being a big gainer as it hasn't traded much above its current price in the past - i.e. there is technical resistance - and it hasn't traded at book value for years and years, which doesn't bode well for my mean reversion theory. However, who am I to say what the future holds? Given that I think most analysts are as good at seeing the future as house bricks I ignored my own fears and upped the holding.
Benchmark
The benchmark figures this month are less ego boosting than last month, but at least they are not depressing. Once I get some 6 month and 1 year figures I think I'll drop the 1 and 3 month comparisons from the table as I think 1 and 3 month benchmarking is for the short term traders. Eventually I'll probably just do 1, 3 and 5 year comparisons to the FTSE 100, with 5 years being the important one.
FTSE 100 : 3.7% over my newly adjusted Fair Value
After my idiotic attempts to assign a 'fair value' to the FTSE 100 last month, the far more scrupulous blogger over at Retirement Investing Today pointed out that my assumption that the long run average CAPE is 16.4 (taken straight from Shiller's S&P data) is a bit too simplistic. It is a fact that the UK markets typically have a lower PE than the US. Since I have earnings data going back to 1993 I can only produce CAPE going back to 2002, which is only 8 years and a bit crummy. By looking at how far the S&P's CAPE was over the long term average during the 1993 to 2010 period and extrapolating that onto the FTSE 100, gives an expected long therm average FTSE 100 CAPE of 11.2. Once again the decimal point is probably going a bit too far.
IMO this is too low as I think the US markets were more over valued in the dot com bubble than in the UK, but of course that's my opinion and probably has no basis in fact. However, I think it's not unreasonable to move my expected average FTSE 100 CAPE to 13.8, the midpoint of those two values. On that basis I think the current fair value (i.e. the value that will give a future risk/return profile similar to the long term historic one) is 5,645. Given that it's 5,445 right now then I'd say it's only 3.7% overvalued, which in the big scheme of things is virtually nothing.
House Prices : Still a crazy 37% over fair value
Grantham thinks the UK housing market is one of only two financial bubbles yet to pop. Well, I think it popped two years ago, but the government has done an amazing job of patching up the hole. That doesn't change the fact that the air supply is fading and the rubbing is wearing thin. High oil prices may yet prove to be the needle once again.
Current Holdings
Electronic Data Processing made me happy by paying out a small dividend after I'd sold them, bringing the annualised returns for that company to 20% during my brief period of ownership.
The cash that I had left at the end of March went into Victoria, an existing holding. I increased this holding because I didn't really want to add another new holding - I like to hold around 10 companies - and it was the cheapest by price to book of those companies where I didn't already have more than 10% of the portfolio invested. On the downside I don't really rate Victoria's chances of being a big gainer as it hasn't traded much above its current price in the past - i.e. there is technical resistance - and it hasn't traded at book value for years and years, which doesn't bode well for my mean reversion theory. However, who am I to say what the future holds? Given that I think most analysts are as good at seeing the future as house bricks I ignored my own fears and upped the holding.
Benchmark
The benchmark figures this month are less ego boosting than last month, but at least they are not depressing. Once I get some 6 month and 1 year figures I think I'll drop the 1 and 3 month comparisons from the table as I think 1 and 3 month benchmarking is for the short term traders. Eventually I'll probably just do 1, 3 and 5 year comparisons to the FTSE 100, with 5 years being the important one.
FTSE 100 : 3.7% over my newly adjusted Fair Value
After my idiotic attempts to assign a 'fair value' to the FTSE 100 last month, the far more scrupulous blogger over at Retirement Investing Today pointed out that my assumption that the long run average CAPE is 16.4 (taken straight from Shiller's S&P data) is a bit too simplistic. It is a fact that the UK markets typically have a lower PE than the US. Since I have earnings data going back to 1993 I can only produce CAPE going back to 2002, which is only 8 years and a bit crummy. By looking at how far the S&P's CAPE was over the long term average during the 1993 to 2010 period and extrapolating that onto the FTSE 100, gives an expected long therm average FTSE 100 CAPE of 11.2. Once again the decimal point is probably going a bit too far.
IMO this is too low as I think the US markets were more over valued in the dot com bubble than in the UK, but of course that's my opinion and probably has no basis in fact. However, I think it's not unreasonable to move my expected average FTSE 100 CAPE to 13.8, the midpoint of those two values. On that basis I think the current fair value (i.e. the value that will give a future risk/return profile similar to the long term historic one) is 5,645. Given that it's 5,445 right now then I'd say it's only 3.7% overvalued, which in the big scheme of things is virtually nothing.
House Prices : Still a crazy 37% over fair value
Grantham thinks the UK housing market is one of only two financial bubbles yet to pop. Well, I think it popped two years ago, but the government has done an amazing job of patching up the hole. That doesn't change the fact that the air supply is fading and the rubbing is wearing thin. High oil prices may yet prove to be the needle once again.
2 Apr 2010
Dividends by the bucket load
March has been the busiest month at the UK Value Investor head offices (the spare bedroom) for a long time. There's been reports from Mallett and J Smart, a report and strategic review from French Connection (I love their new website) and dividends from Waterman, Gleeson, Northamber and Titon. Then there's the somewhat infamous purchase of Luminar, a company so scary it seems that almost no one will touch it.
Results
I've updated the Benchmark, Holdings and Trades pages so you can see how things have evolved since last month. The total book value is up by over 14% and the market value is up by just over 7%. This compares quite well with the benchmark FTSE 100 ETF, with over 13% out-performance over 3 months. However, I won't get too excited as that could vanish in no time. I'm looking forward to getting some 6 and 12 month comparisons which will be a bit more meaningful, and one thing to remember is that these 3 month figures are helped out somewhat as the portfolio was coming out of a bit of a lull a few months ago.
Annual and Interim Reports
French connection's latest report provided some information on their strategic review of how the management are going to turn things around. I don't really look into these sorts of things too deeply, preferring instead to leave the running of the company to the professionals. Book value was down slightly.
J Smart, the property investment and development company, said (via the Chairman) "There seems to be little prospect of an increase in turnover here over the next twelve months". Book value was effectively unchanged.
As mentioned in the last post, Mallett's situation is improving somewhat and book value was down only a small amount.
Dividends
First up is the very large dividend from M J Gleeson (over £1,000). Since they have basically shut the business down into hibernation mode to sleep out the recession, they've built up excess cash which they gave away in this dividend. For now this is going to stay as cash although I expect to invest it somewhere more exciting during the month.
I thought I'd have a go at market prognostication. Sweeping many of the details under the carpet, I try to value the UK market via the FTSE 100 and it's current price relative to the last 10 years real earnings (PE10 or CAPE) and how that compares to the the long run average of CAPE. There's not much data for the UK but there is plenty for our friends in the USA. Over there the average value of CAPE is about 16.5 and I can only assume that ours is in the same ball park. That's not a hideous assumption since from 1993 it has averaged 18.7 during the biggest bull market in history.
From what data I can salvage for the FTSE 100, our current CAPE is 14, which is good since a lower CAPE results in higher expected future returns (a subject I will bang on about in future posts since I think it is important and doesn't seem to get mentioned enough). I might even stick my neck out and say the 30 year annualised real returns are likely to be between 1.75% and 5.75% based on some scatter plots and other fiddlings I've hacked together.
Results
I've updated the Benchmark, Holdings and Trades pages so you can see how things have evolved since last month. The total book value is up by over 14% and the market value is up by just over 7%. This compares quite well with the benchmark FTSE 100 ETF, with over 13% out-performance over 3 months. However, I won't get too excited as that could vanish in no time. I'm looking forward to getting some 6 and 12 month comparisons which will be a bit more meaningful, and one thing to remember is that these 3 month figures are helped out somewhat as the portfolio was coming out of a bit of a lull a few months ago.
Annual and Interim Reports
French connection's latest report provided some information on their strategic review of how the management are going to turn things around. I don't really look into these sorts of things too deeply, preferring instead to leave the running of the company to the professionals. Book value was down slightly.
J Smart, the property investment and development company, said (via the Chairman) "There seems to be little prospect of an increase in turnover here over the next twelve months". Book value was effectively unchanged.
As mentioned in the last post, Mallett's situation is improving somewhat and book value was down only a small amount.
Dividends
First up is the very large dividend from M J Gleeson (over £1,000). Since they have basically shut the business down into hibernation mode to sleep out the recession, they've built up excess cash which they gave away in this dividend. For now this is going to stay as cash although I expect to invest it somewhere more exciting during the month.
After that dazzling payout there's been a good showing of dividends from some of the other holdings. Waterman have paid out another small amount, bringing the return so far from that company to 3.8%. Northamber continue to keep me happy with another dividend bring their realised returns to 5.3%, although that's only 3% annualised. Finally the eternal Titon (soon to reach its second anniversary as a holding) has paid out again, bringing returns to 8.5% or 5% annualised.
It's interesting that despite me paying no attention to dividends whatsoever, they still make up about 35% of the realised gains so far.
Transactions
As I said in my last post, EDP is no more and Luminar is now the newest and (by book value) biggest holding in the portfolio. Because of the extremely low valuation I have decided to limit the amount put into Luminar; and according to others that's a good thing as most people seem to think the company is either doomed or about to raise capital thereby diluting existing shareholders, i.e. me. As ever, I try to keep any prognostications to a minimum and simply look at the company structure and valuation today.
FTSE 100 : 15% under fair value
I thought I'd have a go at market prognostication. Sweeping many of the details under the carpet, I try to value the UK market via the FTSE 100 and it's current price relative to the last 10 years real earnings (PE10 or CAPE) and how that compares to the the long run average of CAPE. There's not much data for the UK but there is plenty for our friends in the USA. Over there the average value of CAPE is about 16.5 and I can only assume that ours is in the same ball park. That's not a hideous assumption since from 1993 it has averaged 18.7 during the biggest bull market in history.
From what data I can salvage for the FTSE 100, our current CAPE is 14, which is good since a lower CAPE results in higher expected future returns (a subject I will bang on about in future posts since I think it is important and doesn't seem to get mentioned enough). I might even stick my neck out and say the 30 year annualised real returns are likely to be between 1.75% and 5.75% based on some scatter plots and other fiddlings I've hacked together.
House Prices : 37% over fair value
Another area that I think can be valued using PE ratios is housing. In this case you don't need to average earnings over 10 years when looking at housing, as house buyer earnings are pretty stable, vastly more so that corporate earnings. The long run average PE (from 1980) is about 4 and in my mind 3 means the market is very cheap and 5 is very expensive. Of course there are regional variations etc etc, but I try not to worry about the details. Also I think my 37% number is ludicrously precise but at least I didn't add a decimal place.
Happy Easter.
Happy Easter.
28 Mar 2010
Goodbye EDP, hello Luminar
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.
Sale review of EDP
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.
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.15 Mar 2010
French Connection's strategic review
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?
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?
28 Feb 2010
February Update
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.
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.
21 Feb 2010
A value based asset allocation strategy - A minor update
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:
Although the average plot now wiggles to some extent, it doesn't take long for it to settle in close to 15, from where it never really deviates very far. In fact, continuing my obsession with averages, the average of the long term averages of CAPE is 15.4. Putting this into the allocation function gives the results below, which is little different from the previous version since the function is fairly insensitive:
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