Report on Q1 2018

Report on Q1 2018

30 Mar 2018

In my report on Q4, I wrote that “for the third successive quarter, the markets were mysteriously calm.” The calm was disrupted in Q1 for sure: the main UK indexes fell by between 6% and 8%. The German DAX was -6.3%. Supported by a falling dollar, the US markets, though volatile, did better with the DJIA -2.5%. I hinted before that the stock markets might be vulnerable to rising interest rates or, more specifically, rising bond yields. In February it started to look as if this was happening; the US 10 year treasury yield had risen from 2.40% to 2.94%; but by the end of the quarter it was back to 2.74%. A similar pattern played out elsewhere. The 10 year gilt yield rose from 1.20% to 1.69% but ended the quarter back at 1.34%. It would seem that the wait for inflation goes on. Aside from the usual nonsensical white noise about “uncertainty” it is hard to escape the conclusion that the stock market is truly concerned about the ability of large corporations that feature in our lives daily to invest capital, service debt and pay dividends. Here is your day described in terms of dividend yields: you are woken by the ringing of the house phone (BT: 6.8%) and switch on the light (National Grid: 5.6%); you turn up the central heating (Centrica: 8.5%) and clean your teeth (Glaxo: 5.7%); you decide to go into town but your car has no petrol (BP: 6.0%, Royal Dutch Shell: 5.8%) and needs a new rear light (Halfords: 5.4%) so you decide to take the bus (Stagecoach: 9.0%, Go-Ahead: 5.8%); you do some shopping in Currys PC World (Dixons Carphone: 6.0%, Vodafone: 6.7%) and M&S (Marks & Spencer: 6.9%) before treating yourself to a pub lunch (Marstons: 7.4%, Greene King: 7.0%). Is it the end of the world as we know it? Yet, against this rather sinister background something quite different has been happening. Companies who want to buy each other seem to like these prices very much. On 22 December GVC announced its intention to buy Ladbrokes plc. On 17 January, Melrose bid for GKN; on 30 January UBM agreed to be taken over;...

Dogs and tricks – new light from accounting changes?

Dogs and tricks – new light from accounting changes?

13 Jan 2018

The following paragraph is not true. A neat way to value a company is to divide the share price by the earnings per share (EPS) which gives you something known as a P/E (price/earnings) ratio. A low P/E ratio (say <10x) implies that a share is cheap and a high P/E ratio (say >20) suggests expensive. Many people, some of them claiming to be investment professionals or financial journalists, still promote P/E ratios (which came to be the standard valuation method in the 1970s and the 1980s). Here are some reasons why they are wrong. MARKET CAPITALISATION IS NOT THE VALUE OF THE COMPANY The price of a share is a measure of one of a company’s liabilities (the equity owned by shareholders) but not the value of the company. The equity is what is left over after all other obligations have been met. The value of the equity is known as the market capitalisation of the company. EI Group (formerly Enterprise Inns) has 479.5 million shares trading at 143p giving it a market capitalisation of £685 million. Also with a market capitalisation of £685 million is Go-Ahead Group with 43.2 million shares at 1586p. Their earnings per share last year were 20.5p (EI Group) and 207.7p (Go-Ahead) giving them P/E ratios of 7.0x and 7.6x respectively. How cool is that? Are they both cheap and are they almost equally cheap? You will not be surprised to read that it’s not as simple as that. The balance sheet of EI Group reveals that it the business is carrying more than £2000 million of net debt whereas Go-Ahead has £200 million of net cash. Consequently, the enterprise value of EI Group is £2700 million (market capitalisation plus net debt) and Go-Ahead’S enterprise value is just £485 million (market capitalisation minus net cash). On that basis the pub leasing business is worth 5.6x as much as the bus and train operating business. This doesn’t tell us which share is more likely to go up but it gives us plenty of ideas about what might influence their prices. None of which involve reported EPS. EARNINGS PER SHARE Another reason why P/E ratios are nearly useless is that...

OIL…….Something Happened

OIL…….Something Happened

7 Jan 2015

The recent sharp fall in the price of crude oil is one of those rare financial events whose importance is appropriately reflected in press headlines.  Oil has a strong claim to be the world’s most important commodity and also the most political. OPEC was founded in 1960 by the charming quintet of Iraq, Iran, Saudi Arabia, Kuwait and Venezuela. According to its website: “OPEC’s objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” Were these companies rather than sovereign nations, this would be an illegal price rigging cartel subject to enough lawsuits to employ every lawyer until the end of time. As it is, it’s a legal price rigging cartel that everyone else has to live with if they wish to continue consuming oil. In 1973, OPEC became explicitly political when the US supported Israel in the Arab-Israeli war. It banned exports to the US and the barrel price of crude quadrupled from $3 to $12. It was a shocking inflationary impact that the world did not need. The Iranian revolution in 1979 saw a further leap from $14 to $40. The next great move came in the 21st century as global economic growth was propelled by developing countries such as China and India that became huge importers of oil. The price touched $140 until the financial crisis torpedoed the world economy in 2008 and the price fell right back to the 1979 price of $40. It is worth making a couple of points here. One is that the oil price has shown itself to be very volatile with changes in marginal demand having a huge impact. The other is that, partly thanks to OPEC, the market’s opinion of whether oil is cheap or expensive has largely relied on referencing its own history – the most unsophisticated way of valuing anything. That having been said, it is obvious that oil over $100 makes costly oil supply viable, notably from Canadian oil sands but also from fracking. The world...

Report on Q3 2014

Report on Q3 2014

4 Oct 2014

The stock market remained nervous, reportedly seeing below-average turnover in Q3. The trend that began in Q2, of the shares of smaller companies performing worse, continued. The FTSE 100 fell by 1.7% and the FTSE 250 by 2.9%. For the third quarter in a row, yields on European government bonds fell to previously unimaginable lows. German 10 year Bund yields have fallen below 1% (now 0.93%). To put this in some context, 10 year Japanese bond yields were around 1.9% before the financial crisis bit in 2008. Japan is considered to be the reference case of a country suffering from long-term deflation. Its 10 year yield is now 0.53%. Since June 2008, Japanese yields have declined by 72% and German by 80%. As I have noted before, the bond markets are shrieking the news that global growth has made a long-term shift to lower levels. Many will argue that this is bound eventually to be reflected in lower corporate profits. It is hard to argue with that but wrong to assume that share prices are consequently too high. When yields on all financial assets are falling, investors are paying higher prices for them. A dollar of corporate profit literally becomes more valuable than it used to be. Many stock market commentators, seemingly obsessed with short-term news and the aphrodisiac of growth, appear to be incapable of understanding this. Given that the cloud of deflation continues to hang over the world (see above), the traditionally nervous month of October will probably produce plenty of gloomy headlines. In my post about the supermarkets, I pointed out that, when operating leases are included as liabilities, Morrison was much cheaper that Tesco and Sainsbury. Well, the gap has reduced but not necessarily as anticipated. Morrison’s price has fallen but the others have fallen further. Tesco’s accounting practices have caught up with it and I must say that, as yet, there is no price at which I would buy it. At last I have noticed the beginning of a backlash in the press against Lidl and Aldi – our nostalgia for the 1970s must surely be limited. Sainsbury has promised a strategic review, a development that appears to have...

Report on Q2 2014

Report on Q2 2014

3 Jul 2014

I have noted before that it is generally the case that smaller companies’ share prices are relative beneficiaries of improving confidence. Large blue chips do better when investors are seeking protection. In Q2, the FTSE 100 rose by 2.2% but the FTSE 250 (companies 101-350) fell by 3.4%. There has been widespread profit taking from the shares where much of last year’s good stock market performance was concentrated. This is evidence that nervousness is about. As was evident in Q1, the prices of assets regarded as safe continue to rise and the definition of “safe” to become less demanding. I mentioned the marked fall in European government bond yields in my Q1 report and returned to the theme in June. Irish 10 year bond yields fell from 3.43% to 2.83% in Q1 and have since declined to 2.37%; Portuguese from 5.9% to 3.73% and now to 3.66; French from 2.46% to 1.99% to 1.61%; and so, it seems, it goes on. Nervousness among equity investors is generally a good thing. Complacency is dangerous but very hard to spot. (An interesting philosophical question is: can one simultaneously be complacent and recognise one’s complacency?) It is only when nervousness turns to panic and rout that it becomes destructive. There is a stock market saying to the effect that a bull market climbs the wall of worry. I find this quite wise. There is another well-known traditional piece of advice – “Sell in May and go away” with its less famous follow up – “Come back on St Leger’s day”. The St Leger is a horse race which falls this year on 13 September. I have always felt that this is suspiciously convenient for City types who want to go to Wimbledon, Lords, Henley and the south of France. Certainly share volumes fall in the summer and market moves can be exaggerated. It’s a nasty thought that your portfolio might misbehave if you are not there to look after it. So, by all means, make up a little rhyme to justify some profit taking. I have certainly questioned the level of my shares that have done well and have taken profits in some. But I have failed...

Report on Q4 2013

Report on Q4 2013

7 Jan 2014

The FTSE 100 rose by 4.4% in the quarter for a full year gain of 13.9%. The FTSE 250 (that’s companies from 101 to 350) performed twice as well in 2013, rising by 28.8%. There are never truly hard factual reasons why share prices move but it generally remains the case that smaller companies’ share prices are relative beneficiaries of improving confidence. Large blue chips do better when investors are seeking protection. It is also probably the case that smaller companies are less well known and consequently deliver more surprises. Note that in bad times they typically deliver more bad surprises which point takes us back to why large stocks do better when investors are nervous. It is reasonable to conclude that confidence improved in 2013. The mood implied by the yields offered by government bonds rose from clinically depressed to merely grumpy – in the case of the UK this was from 2.0% in January 2013 to 3.0% now. In the US the rise was slightly sharper, from 1.8% to 3.0%, but it was much the same story. The bond markets are suggesting that we are looking at a fairly gentle, low inflation recovery. Analysts sometimes name this “Goldilocks” (not too hot, not too cold) and it feels like a very comfortable investment environment. Comfort eventually causes complacency and this is exactly why it is wrong to commit one’s investment strategy to an opinion about the future, no matter how tempting. Investment is always about how probability is priced. Consensus rarely offers compelling value. I am pleased though not surprised to say that my satellite index of companies with female executives quite dramatically extended its outperformance against the FTSE 250. After the first nine months of 2013, the FTSE 250 was +25% but the 27 companies with female executives had risen by 35%. After the full twelve months, those numbers were +29% and +46% respectively. As for the shares that I recommended this year, in Q3 I wrote that I was surprised that Enterprise Inns rose by 40% in Q3. In Q4 it was much quieter, rising by 6.5%. I am not attracted by the value of the company now and I don’t...

Bring on the girls

Bring on the girls

5 Nov 2013

A few weeks ago, I listened to Carolyn McCall, CEO of Easyjet, choosing her Desert Island Discs on Radio 4. After her first 18 months in the job, the shares have taken off, soared and flown since the start of last year (+187% as I write). I found myself thinking that she had timed that career move perfectly – there has been a tremendous cyclical recovery in many airline stocks. Then I wondered if I was being a little harsh. We will never know, obviously, but would things have gone so well if Mr Buggins in a suit and tie had been appointed instead? Then a week ago a friend e-mailed me to ask what I think of Mitie shares and I replied: “I’m ok with Mitie. It’s run by women”. He thought I was being humorous and in a way he was right. It was a true but unserious answer. Yet it had emerged from my sub-conscious and caused me to wonder whether I might prefer companies with female executives. (Mitie is a stand-out as both the CEO and CFO are women). I have as many unsubstantiated and uninteresting views on the different qualities of the sexes as anyone but I do not make investments on the basis of generalisations like that. I want to see some statistics. So I went looking for some. First, some background about where we are, in the UK, on this topic. Girls are now outperforming boys academically and I read a comment piece the other day saying effectively that we should now be more worried about the fate of our young men. Be that as it may, it is widely recognised that the scarcity of women at board level is egregious. Many people would say that it is unfair and proof of discrimination. I would say that it is prima facie evidence of a damaging waste of talent that, as an investor, might well be costing me money. In February 2011, the government published a document entitled “Women on Boards”. Britain is the only country that could commission a report on “diversity” from a white chap known as Lord Davies of Abersoch CBE but this quote from...

Report on Q3 2013

Report on Q3 2013

2 Oct 2013

The FTSE rose by 3.9% in the quarter (Q1 +8.7%, Q2 -3.0%) meaning that year-to-date it is +9.2%. I didn’t recommend a single new share in the quarter. This is partly because I was away in France, but is also because no compelling new ideas turned up. City analysts are expected to come up with recommendations (usually ‘Buy’s) regularly but real people don’t have to. To some extent, this reflects my current view of the stock market. The most likeable companies are generally priced accordingly. As I mention repeatedly, value is always relative and shares must always be compared to other asset classes. On that basis, there is not so much to worry about. UK house prices are creeping higher from unaffordable levels, encouraged by the government’s reckless Help to Buy scheme. (I heard the PM complain that the average income is unable to buy the average house. You might think that the solution is to raise the average income or lower the average house price or preferably both, but the answer from our government is to play “let’s pretend” and to forward the problem into the future, as usual). With growing numbers of people hooked up to the life support of the 0.5% Bank Rate, the chance of regular savings accounts bidding for your money are also about 0.5%. The only practical rival to equities in Q3 was, surprisingly, government bonds. On 10 September I recommended one. UNITED KINGDOM 1 3/4% TREASURY GILT 22 was trading at 92 then. This is an investment to tuck away for the long term but in the short term it has risen to 93.78, which, for a gilt, is pretty exciting. Shortly before the end of Q2 (12 June), I suggested a yield portfolio of twelve shares. From that date, they have returned 6.1% (including dividends) against 2.3% for the FTSE. So my implied caution has worked out quite well. The only stinker was Ladbrokes, thanks to a profit warning derived from its concerning failure to manage its online business. That having been said, its cash flow remains good and it has pledged to maintain the dividend. Today (167p) it yields more than 5% so I am,...

Report on Q2 2013

Report on Q2 2013

5 Jul 2013

The FTSE fell by 3% in the quarter meaning, obviously, that the easy wins of Q1 (+8.7%) were unavailable. My Q1 recommendations of Enterprise Inns and Go-Ahead trod water. Home Retail Group fell after its last trading update, apparently on the basis that the rain kept people away from Homebase. Such absurdities provide buying opportunities for investors and would-be barbecue chefs. At 138p it has a historic FCF yield of 29% (admittedly 2012 was an exceptionally good year for its free cash flow.) In May, I updated on ICAP which was still at 327p. The volatility of this share can be unnerving but right now it is 15% higher at 378p and it has maintained and paid its large dividend. In May I wrote that I would not be buying FirstGroup at its ex-rights price of 111p. At today’s price of 97p I am still not buying but I’m still watching. I also offered a list of twelve yield stocks. So far, so good. Ten are essentially unchanged or higher compared to a slight (0.8%) fall in the FTSE. Only UBM and Royal Dutch are down (I don’t know why). For anyone fretting about my worst ever investment (in Taylor Wimpey), it just released a positive trading statement and is trading at just over 100p – and yes, I have sold some. In April I wrote dismissing gold as an investment after it fell below $1400 an ounce. It is now $1242 and as unappealing as ever, in my opinion. My view on QE, available here and there, is that it probably does nothing to stimulate economic growth but that it will continue to be favoured by the Treasury which influences the Bank of England decisively. Yesterday the MPC under its new Governor Carney stated that: “..the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.” In other words, the Bank Rate is going nowhere from its 0.5% base and QE is safe in their hands. The stock market duly rose 3% in...

Yields are usually for a reason

Yields are usually for a reason

12 Jun 2013

Investment is betting on probabilities, not on outcomes. How can we judge if the probability of an event is over-priced or under-priced? Do not try to guess the probability of an outcome with a view to pricing it. Do ask when the price is telling you about the probability – then ask yourself if this is reasonable. For obvious reasons, investors are now very interested in dividend yield but they also have reasons to be worried about the stock market. Commentators seem to be evenly split between those who are looking down and suffering vertigo and those who say that equities continue to offer attractive value compared to what else is on offer. According to my own investment rules, you will find me in the second camp for as long as that proposition continues to be true. Dividend yields are as reliable a measure as any for judging what the market thinks of a company. Then, as the quotation from my fourth investment rule (Probability) says, we can ask ourselves whether this is reasonable. Below is a table of current dividend yields from shares that I follow. There is a wide range which, if the market is efficient, should tell us that we can choose between relatively safe companies with relatively low yields and relatively risky with commensurately high returns. Before I discuss any individual stocks, I will characterise what these various yields imply.     Price Yield BG 1165 1.4% Fuller Smith & Turner 925 1.5% Domino’s Pizza 670 1.5% Travis Perkins 1520 1.6% Experian 1175 1.9% Regus 165.00 1.9% Home Retail Group 152 2.0% Diageo 19.15 2.2% Interconti Hotels 1835 2.2% Smith & Nephew 755 2.3% Rentokil 88 2.4% Millennium 549 2.5% Cranswick 1120 2.7% Stage Coach 287 2.7% Kingfisher 344 2.8% Hays 90 2.8% BT 312 2.8% Synthomer 194 2.8% Sage 348 3.0% Rexam 505 3.0% Micro Focus 659 3.1% Unilever (€) 31.4 3.1% Reed 736.0 3.1% Tate & Lyle 811 3.2% Greencore 130.00 3.3% St Ives 160 3.3% Greene King 750 3.4% Debenhams 92 3.6% Morgan Crucible 277 3.6% M&S 448 3.8% Pearson 1173.0 3.8% UBM 690.00 3.9% Mitie 253 4.1% Costain 254 4.2% Tesco 343 4.3% Marstons 142 4.4%...

FirstGroup – watching with the wolves

FirstGroup – watching with the wolves

21 May 2013

Back on 14 February, when I wrote recommending Go-Ahead Group, I included summaries of my views on the other transport stocks, including this on FirstGroup: At 189p, FirstGroup has a market capitalisation of £911m but an enterprise value of £3357m due to £2446m of net debt (including pension liabilities). Its historic dividend yield of 12.5% tells us that the market expects the company to cut or skip its dividend (decision due in May). This would be a speculative investment and is too dangerous for my taste. With revenues of £6500m, this business is not going to disappear but the risk is that it will end up being mostly owned by creditors rather than current owners of the equity. And so, it came to pass, more or less. Yesterday equity owners were asked to put up a fresh £615m to defend the equity’s role in the company’s balance sheet against the creditor wolf pack: or as the rights issue press release coyly puts it – to “support the Group’s objective to remain investment grade”….Let’s hear it for investment grade! Yay! The poor shares swooned yesterday – down by 30% to 156p. It’s strange how bad news seems harder to predict than good, no matter, apparently, how explicit the evidence of publicly available facts. It may be that the terms of the rights’ issue – 3 new shares for every 2 existing shares at 85p each – were pitched at such a low level that the odour of desperation was repellent. In passing, fees of £30m (nearly 5% of gross proceeds) for an issue that surely does not need to be underwritten demonstrate that there are still bankers out there whose skills surpass mortal understanding. Never mind. It is not immoral to make a mistake, nor to be stupid, nor to wonder whether new investors might at some point take advantage of the pain of others. At today’s cum-rights price of 156p, FirstGroup has a market cap of £750m and net debt (including pension liabilities) of £2280m for an enterprise value of £3030m, or 0.44x revenues. These ratios will change after 11 June, when the shares trade ex-dividend but, on the face of it, the value...

Report on Q1 2013

Report on Q1 2013

26 Mar 2013

I will review the success of my own advice every quarter because it looks like a good discipline and it feels like the chance to brag or whine, both of which could be satisfying. First, the share tips. My first ever post in November suggested that Enterprise Inns was probably worth more than 67p and suggested 120p as a possibility. Today’s price of 109p (+63%) is a nice slice of beginner’s luck. Then I suggested that Marks & Spencer could not justify a share price of 400p unless it was a takeover play. The takeover talk faded and the shares fell. Then the takeover talk restarted and it popped up to 400p again. My opinion is that it is too messy to be a plausible target but never say “never”.  In January I recommended ICAP at 327p. It had a decent jump on news of slightly better trading but then fell back when it was linked with the Libor “scandal”. So it is basically unchanged and still appears to yield 7%, albeit now with a “known unknown” risk. Then I tipped Home Retail Group, which jumped while I was writing about it. I’m chuffed to say that it has jumped again. It was 122p when I started writing about it, 140p when I published and is above 155p now. So far, so good: I expect it to go further.  Then in February I recommended Go-Ahead at 1367p. That has also lived up to its name and has risen by 8% including its half-year dividend. Obviously these triumphs are not unconnected to the fact that the FTSE rose by c.8% in the quarter. Now, the other posts. The student sub-prime loans are designed to blow up in 20 years, which is when my “model” student will start to reduce his outstanding debt. The guilty should be out of sight by then. Interestingly, RPI (now 3.2%), which is the driver for the increase in interest on the loans that students took for the first time this year (RPI +3%), will no longer be designated as a national statistic” according to the United Kingdom Statistics Authority. When I say “interestingly”, what I really mean is that I...

Transport shares – Go-Ahead can make my day

Transport shares – Go-Ahead can make my day

14 Feb 2013

One of the earliest stock market bubbles was in railway companies in the 1830s and 1840s. At the time, rail was the new technology replacing canals and it is not difficult to understand why people with capital to invest were excited. As with all predictable technology-driven changes, it took much longer than its early supporters expected. (I will briefly digress on why this might be. My theory is that obvious technological change attracts opposition from “old-technology” incumbents. Stuff than comes from nowhere (YouTube, Facebook) happens with shocking speed. In the case of the English railways, canal operators lobbied aggressively against them. When roads in turn began to compete with railways in the 20th century, no doubt the rail companies behaved in the same way). Many of the issues that mattered to the railways in the 1840s are still making news. New railways had to be approved by Acts of Parliament and landowners complained about plans to lay tracks over their property. Over the years, governments have veered between light touch regulation of transport infrastructure and complete nationalisation. British Rail was a state monopoly between 1948 and 1994 (from what I remember, these were not golden years of commuting) and was then clumsily privatised. Since then we seem to have been in a state of hybrid private ownership including the foolish listing and insalubrious de-listing of Railtrack. Operating franchises have proved hard to price correctly (to say the least) but we have more or less arrived at the point where trains and buses are mostly operated in the UK by five companies. Arriva was acquired by Deutsche Bahn in 2010. The other four are all still listed; FirstGroup, National Express, Stagecoach (which owns 49% of Virgin Rail) and Go-Ahead. I am not particularly interested in the operational details of running bus and train services but simple analysis of the four companies indicates that running buses is more profitable than running trains. Operating margins from bus services are typically +/- 10% whereas trains seem to struggle to hit 5%. One of the most basic ways to compare companies within the same sector is to look at the ratio of each company’s enterprise value to its revenues....