A Tale of Two Figures
Two weeks ago I wrote a post discussing book value and how investors could use the metric. The great discussion that ensued, both in the comments and in the realms of my fellow bloggers, highlighted quite nicely how even the basic building blocks of investment analysis can be interpreted in so many different ways. That's the reason that it's far from uncommon to read a shockingly bearish report, and agree entirely - but then to wander across to the territory of those who hold the stock, and find equally plausible reasons for the share price to double. Usually immediately. Shareholders are usually filled with the conviction that it should go up fast!
There is one point in that post, though, that I'd like to talk about a little further:
On the other hand, some of the companies my portfolio owns don't have particularly impressive book values - that is to say, I paid more for the company than I actually received in tangible assets. In this case, then, it may appear that I'm throwing money down the drain. What gives? Well, here I'll attempt to highlight two main ways I think about book values and how they help my analysis of a company.
This is clearly true. Not all the companies in my portfolio are trading at discounts to tangible book value - in fact, far from it. There's one company - Creston- that stands out in particular, though, as not only does it not trade at a discount to tangible book value, it trades at a negative tangible book value. The difference between these lies in the deduction of liabilities. A company with £100m of property and £50m of debt will have a positive book value - but the magnitude of that price to book value , from 0 to infinity, is decided by the market. But the market, no matter how highly it prices the company, cannot make a company trade at a negative PTBV - that requires total liabilities exceeding total tangible assets. Given my previous stance, then, it may sound like these companies are my worst nightmare; where is the 'margin of safety' I cherish? As always, there's more than one way of looking at it!Continue reading
Answering a few questions
Having recently gone over Howden again on the basis that it had been far too long since I covered it the first time, the next logical step would be looking againat the first investment I ever blogged about - Barratt Developments. That piece was somewhat different from my more recent style as I was finding my feet, but it's still a stockI like, and I think the case I made there is still relevant. As I was pondering how best to refresh my opinion, though, I rather fortunately received an e-mail from a reader. Perfect set up!
Saw that you were long Barratt, and wanted to see if you could share any insights on the UK market and home builders in general?
I'm pretty convinced that the UK market will remain flat going forward, held back primarily by lower LTV ratios and tightened lending standards, even though mortgages are affordable overall.
However, I'm curious why you chose Barratt out of the other major home builders? The majority of them appear cheap on a P/B ratio...What do you see driving improved performance over the next 12 months, for Barratt and the sector overall? And most importantly, how do you assign a value range to these type of companies? A traditional DCF valuation doesn't work well, since the high working capital requirements allow the firm to basically produce whatever cash it wants (albeit sacrificing future developments). Most analyst reports use price/book value ratio, but I'm hoping to find a second method as confirmation?
More on Book
Work and other reasons have conspired to see my notably off my investment 'game' this week, as I find myself now catching up on the latest twists and turns in all the big investment stories. In hindsight, I suppose, that's not really such a bad thing. I don't feel like I've really missed much, and doing markedly less portfolio watching than usual has probably insulated me from the usual gyrations of the markets. The EV Fund is trundling along as usual, with little in the way of huge moves or cataclysmic valuation changes recently, and so I go into the winter fairly content with all my positions.
There's always more to learn, though, and so I was rather pleased to see Richard Beddard post a sort-of reply to my post on book value and returns last week. As well as rather neatly delving further into the real grit of the issue, probably my favourite quote is the following:
What wrinkle in the market, in the way investors behave, gives us the opportunity to profit?
Investors tend to underestimate the prospects of struggling but strong businesses, and invincible companies, and the reason there are fewer Nifty companies than Thrifty companies in the The Thrifty 30 portfolio is I find it easier to identify the struggling but strong than the invincible.
Howden Joinery released an IMS today - hence why I deviated slightly from my usual Mon/Wed/Fri schedule this week. It's been a while since I covered them - their business being one of the first ones I ever covered on this site back in June and, since I felt like it was time for an update, I thought things timed up rather nicely! One thing to note - we've had a half yearly statement and an IMS since that first post, but the business is obviously materially the same. If you want a more general overview of the business - and if you don't know, take a look, as it's a great company - follow the link to the first post where I try and aim a bit more bottom up.
Nonetheless, since it's been a few months, I think the best thing to do is to take a look at the performance of the share price over that time period - shown in the graph above right and also compared to the FTSE All-Share, my chosen benchmark. There's some significant outperformance there, as their revenues have proven to be remarkably resilient in the face of continuing consumer malaise, as I suspected they would be from their previous history of performance. That said, the graph doesn't include today, and today we're seeing a rather significant reversal of that trend - with the market marginally up and HWDN down 5%. Outperforming still, but not quite so strong!
That 5% downtick is interesting from my point of view, as it's not immediately obvious what has caused it. The IMS to me looks strong; some key figures I've picked out include:Continue reading
October was largely a month of recovery for the market, bar the usual ups and downs on the way. The portfolio finishes the month up 10.3% - a strong finish, but still marginally below the All-Share, which came charging through at up 11.4%. This underperformance, once again, is mostly down to a lacklustre small cap index - something I took a little look at - but which gives me no cause for concern. For comparison, the smallcap rallied just 4.9% last month.
Before I start sounding too slippery, though, I should note that the explanation for the performance neither absolves me of the responsibility of trying to understand why my shares went down or gives me a get-out clause. In reality, a sizable chunk of my portfolio is invested in larger firms like Barratt and Howden Joinery - two of the best performers, as you can see above, which pull the portfolio up. Besides, in the long term, benchmarking to the FTSE All-Share is undoubtedly a benefit for me, as small caps tend to be the best performing shares over time, so for me to then complain when I pay the obvious price of short term volatility would be rather feeble.Continue reading
Is there a point where being a volatile week becomes the norm? Looking back over the last few months, it'd certainly be far more surprising to see a week where the FTSE stays level than one where it jumps up or down ~8% (sometimes more than once!) As ever, I'm trying to insulate myself from the wider market and think as a disinterested party, simply scouring my screens for good-looking bargains. It's not going particularly well, though, as I watch the gyrations of the FTSE - at least I can claim to not superficially be too influenced by it, as I still haven't done any buying or selling this month. I was rather pleased with the comment thread on Wednesday on my Book Value post - with 2 opposite, but both distinctly 'value', views rather eloquently set out. I'm not really sure where I stand between those two, and I suspect I hover between them depending on what company I'm looking at. Still, I'm not sure that's a bad thing, and I am trying to be more open minded recently. I reckon it opens up opportunities I may otherwise miss.
I was happy to read Valuhunteruk's piece on Lookers and Pendragon, both car retailers, and the former being a sizable chunk of my portfolio. As usual he's keeping his cards fairly close to his chest, saying that '... the valuation provides enough incentive to get involved but this may only be due to the fairly poor returns available in the rest of the market.' I'm decidedly more bullish on Lookers, as I think it ticks nearly all of the boxes I'm looking for. Debt is reasonable, it's trading cheaply relative to earnings, and it suffers from probably my biggest point of contention with the market - it's in an industry that's currently in the dumps. As ever, I think that the market tends to act with overbearing hindsight. The current situation - an incredibly low base - is, I think, actually a big positive for a business. Granted the scrappage scheme adds some noise to the data, but I think the main thrust remains the same. Buying in 2007 on a P/E of 17 got you an expensive business which was earning that on strong marketwide car sales. You can now buy the same company on a P/E of 9, which is earning that figure on low marketwide car sales. Which has more upside? My answer is probably obvious. I'm hoping my theory holds true!Continue reading