Valuing housebuilders

I have a warm affection for housebuilders. This is unusual among value investors, who (if the blogs I read and the people I talk to are anything to go by) typically tend to see them as horribly cyclical, commoditised land banks run by executives with an uncanny knack for leveraging into recessions and mis-timing the market. There is certainly some truth in this.

I’d probably hate them too, if it wasn’t for the good they’ve done me. My first ever investment was in Barratt Developments in the depths of the recession when, armed with only a notebook of valuation metrics and the sort of blind confidence only a true rookie could muster, I stuck the vast majority of my (admittedly meagre!) savings on the beleaguered builder. Sure enough, it was a blow-out bet, and probably has a small part in me being here today. Had the coinflip come up tails, I’d probably have quit and become a dentist. I’m thankful for my early fortune - ‘Expecting Dentures’ doesn’t have quite the same ring to it.

But let me lay out the discussion in this post. This is that, in my eyes, housebuilding is one of the few sectors the market understands well. It values housebuilders in a way fairly consistent with what I’ve highlighted in the first paragraph above. How is this? Typically, it is on a book value basis. A book value basis makes sense in a commoditised industry where your biggest input is capital; because the capital you employ in your operations will be the best guide to how much profit you make. It is difficult to see how any one player could earn a supernormal return on capital – the biggest chunk of your cost base (land) is subject to intense competition from other builders, and the margins on your finished project are inherently constrained by the availability of other houses nearby… which is doubtless the basis on which the acquired land was priced. Consider that Bovis called the biggest challenge in 2014 ‘the availability and cost of subcontract labour’. This bears all the hallmarks of a commoditised sector, where the economic profits flow through to the inputs.

Homebuilders

Next PLC – An early indicator of quality

I was browsing Stockopedia the other day and came across an article on Next. I like Next – it’s a clear success story and an excellent company. Aside from the interesting article itself, there was also a fascinating comment about the quality of the team and processes at Next, with evidence taken from their Annual Report.

I’ve never actually taken the time to read one of their annual reports – which is a failing of mine, as I think you get a lot from reading the annual reports of demonstrably successful companies. It’s subject to a lot of hindsight bias, of course, but given how many annual reports of pretty poor companies a value investor will usually end up reading, there might be something of a benefit in a ‘compare-and-contrast’!

There’s lots of good stuff there – click through and read it – but I’ll just focus on one. I’ve reproduced the figure from the annual report here:

The explanation itself is pretty elementary – it’s just a simple observation that you have alternative uses for your cash, and optimising shareholder returns is always about using your cash in the best way. There’s lots that can be added to the above analysis, and criticisms you can level at it, too – notably that Next is a company with such great returns on tangible capital that, in reality, share buybacks are significantly worse than organic growth. On that front, actions speak louder than words – buybacks have been fairly restrained, and investment in organic growth has been substantial, accretive, and careful enough that (unlike so many) growth has been executed consistently and without the usual bloating of central costs, diminishing returns on marginal capital and general organisational ‘fatigue’ that you see so much elsewhere.

But aside from that - even aside from the fact that Next have successfully executed their buyback plan to the great enrichment of long-term shareholders – there’s an even more fundamental point that comes to mind.

I think you significantly beat the market over a 5-10 year period if, with absolutely no other criteria, you just invest in companies which actually talk about the benefits and reasoning behind good capital allocation. It’s deeply worrying how few companies either acknowledge or consider the possibility of share buybacks, or actually spend any time talking about logical investment planning in acquisitions, with respect to return on investment and what else they could do with the money. One piece of logic; (which seems scarily prevalent in US companies) that any acquisition which is earnings accretive must automatically be a good thing, is so ridiculous it doesn’t even bear considering. Some of these discrepancies doubtless come about from the principal-agent problem; the fact that CEOs have a much more vested interest in enriching their personal domain and building their legacy than conservatively maximising long-term returns.

My little suspicion – that management teams which talk about capital allocation deliver better returns – is interesting from the perspective that it might not even need good capital management to be true. I suspect that simply the fact that management acknowledge its importance is well correlated with management being switched on and alert in other respects.

The argument is more or less unprovable, I guess, and again I note that it is subject to a great deal of survivorship and hindsight bias. It’s easy to pick up an annual report of Next, a great company, and then essentially ‘data mine’ for variables which you then suppose are positively correlated with that success.

Still, it’s my hunch. Good capital allocation is much, much rarer than I would hope, and I think that makes it a particularly valuable asset.

The Franc blow-up & the dangers of ‘crowdsourcing’

Earlier today I saw a picture of a trader on Zulutrade, a crowdsourced trading platform. It’s a bit like eToro, which I’m more familiar with, mostly because it spams me with adverts on Twitter. Here’s the blurb of Zulutrade:

There was a time when trading was a headache. Not anymore! You don’t have to study or monitor the market, because hundreds of signal providers from all over the world are doing it for you. All you have to do is pick the Signal Providers you like, and ZuluTrade will quickly convert their advice into live trades in your trading account directly with the broker. And the best of all, it’s completely FREE!

and of eToro:

Social Trading is about opening the markets to everyone. At eToro we encourage people to connect with one another to discuss, trade, invest, learn and share knowledge across the network. From now on, you can copy the traders you like with a “click” of a button

Basically, you copy other people’s trades. Presumably you think they’re doing something smart, and something you can’t be bothered or are unable to do yourself. Anyway, here’s that picture of the Zulutrade trader I promised earlier:

Quarto – cheap, leveraged & the sole survivor

When I ‘cleaned up’ my portfolio at the start of the year – after 8 months of it being basically inactive – I liquidated everything except Quarto. Quarto stays on, partly for nostalgia’s sake, and partly because it’s the only one of the portfolio I still hold personally. The rest were long gone.

I still think Quarto represents good value at the current price. Some background on the company, courtesy of my first post on Quarto three years ago:

Quarto are in publishing, but with a few key differences from firms that may immediately spring to mind. The most important one is probably the type of books they are producing. Instead of focusing on fiction, a rather hit & miss affair that hopes to churn out a few bestsellers every year to compensate for some of the flops, Quarto have a varied portfolio of books with very narrow remits and niche audiences. Perhaps I could best illustrate this with their best selling book in 2010: ‘Complete Guide to Wiring’. By focusing on books for such small groups of people and keeping such a wide portfolio, Quarto remain fairly insulated from the more brutal swings in consumer spending.

It’s coffee table books and other niche stuff, basically. Lots of ‘gifting’ sort of books, too; ones you wouldn’t necessarily buy for yourself. They do a good trade at Christmas. Here’s what the past looked like:

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January 15: Portfolio Performance

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The portfolio on this website has been more or less defunct for the whole of this year. Since I got a job, I thought it best if I didn’t trade with it until I better thought about how to run an online portfolio and be employed by an offline one – there are obvious conflicts of interest, after all. Still, yesterday I realized it was coming up to what would have been the third ‘New-Year’ review… and I thought it’d be interesting to run it anyway. Call me sentimental – carry on the portfolio in absence of any changes, just as I left it.

You can see the results above. Since starting this blog three and a half years ago, the portfolio returned 140%, or an annualised rate of 28.4%. The FTSE AllShare, over that timeframe, has been broadly flat. We’re also more or less flat on a year ago today, which ruins the annualised growth rate a bit, and makes the graph a lot less sexy!

Reading back through my articles, you’d be forgiven for thinking that the vast majority of this rather credible performance is due to luck. I wouldn’t disagree – though I would note that it was luck tempered with the fortune of stumbling onto an investment strategy that consistently outperforms the market anyway. If you only pick stocks from a quantitatively cheap end of the market, as I did over the last few years, you’re likely to outperform even if your qualitative analysis adds little value. I suspect that’s very much the case with me, reading back.


The future

I’ve figuratively liquidated the portfolio and put the cash into my hypothetical bank account, save for one company - Quarto – which I should say I continue to hold in my offline portfolio, too. I hope I’ll be able to add to this rather undiversified collection of assets (cash & one stock!) with some additions over the next few months, though I’m not in a rush. The additions are likely to be of a larger-cap – and more global – nature than before.

Thanks for reading what is now the fourth year of my experiment. I genuinely hope that I look back in two years with the same perplexitude (you were buying WHAT?!) as I have just done compiling these figures!

 

Tivoli A/S: Punchy price, pleasant perks

Tivoli is a lovely place; unusually for one as poorly travelled as me, I’ve been there. It’s a little amusement park – though the phrase doesn’t really do it justice and they call it ‘Tivoli Gardens’ – in the middle of Copenhagen. If you ever get a chance, definitely pay it a visit – the entry price is a steal, the atmosphere is lovely, and there’s a big swing carousel which you can ride on that gives you a great view of the city.

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