EV – The First Month

July in Review

Well, it’s been a rollercoaster month, and here I am. Writing a review. After all I said about it being a long term project and being unable to discern a shred of truth from its performance in short time periods, I decided this month had enough interesting goings on that I should probably write a post summing it all up. I don’t expect most months to be this interesting, but with around half of my companies reporting results of some sort, I thought it may be worth a look. I’m undecided whether these reviews are a good idea for my mental state or not – whether segregating its performance, trying to distill meaning from the market movements and generally reflecting on my picks is wise investment practice or will just lead me to exactly the kind of short-sighted irrationality I’m striving to avoid. We’ll soon find out, I suppose – I suspect experience will lead me to lean one way or another on the issue – so if you never see me write a ‘month in review’ again, you’ll know which way I went!

In all, it’s been a positive month, though it’s obvious that we can’t tell anything about the long term trajectory of my picks. It was a very particular kind of month for the market – the kind which sees a general hammering of most stocks, with the FTSE All-Share down over 10% since I began the portfolio. Hence, several factors inflated my performance – notably my holding of 14% cash for the majority of the month.

Several of the companies experienced double digit percentage point growth in the space of a few days after reporting results, which was great, and a couple also notably bombed following announcements. Overall, though, the fund finished the month 4.5% down vs. a market fall of 10.6%. I’m pleased with this performance, and particularly considering it effectively ‘started’ the month 1.7% down – the effect of the high spread of the small caps in my portfolio, stamp duty and trading costs. Mostly, though, it leaves me curious to see how the shares fare when the market is in an upward direction – it may well just be that my picks are well insulated from the downturns, but equally participate little when things start rising again.

As I mentioned, though, there were several particularly interesting risers and fallers – as summarised in the boxes to the left. For the first, it’s not as if I can say I hadn’t been warned! Several of my fellow value investing bloggers told me housebuilders such as Barratt were a shaky proposition – summarised, I remember, as being ‘notoriously tricky to time’. Of course, that didn’t stop me from buying more on the way down and topping up my holding at a lower level. Two factors precipitated the fall; one of which, in hindsight, probably was my fault. The stock fell 5% on the day of its trading update which, to my mind, was perfectly in line with expectations. They expect a return to pre-exceptional profit, with the cost of a (long-term positive) debt refinancing putting them into post-exceptional loss.

Evidently I hadn’t read market sentiment correctly, as reading the results I would’ve expected a modest share price rise. This is a risk inherent in these shares – the big stocks with city coverage sometimes seem like a bit of a black box to me, with price moves that are completely contrary to my expectations. Maybe I’m still completely misreading the situation! The second reason is the high beta of the housebuilders. In essence, when the market moves, Barratt moves twice as much. There are a number of plausible explanations for this – their recovery is heavily dependent on mortgage lending, for instance, which at the moment is tied up to banks embroiled in the debt crisis. More broadly, demand for housing weakens sharply as real incomes fall, so bad economic data hits them harder than more resilient stocks. Whatever the reason for the fall, I’m determined to make every decision on the margin and not allow previous ones to cloud my thinking. As objectively as I can, I think Barratt are far farther from their intrinsic value now than they were when I first bought them, and so I added some more to my portfolio, despite the plummeting price.

Zetar are a happier story. I added them on an expectation of resilience and the belief that the 6ish P/E they were trading on undervalued the business. Hence, a slight improvement in net profit for the preliminary year-end results saw them shoot up over 20% in the following week as the markets revalued the stock. With sales for the first 11 weeks of the current trading year up 6% YoY, they also seem to be heading further in the right direction – and I still don’t think they’re finished yet. They’re now trading at a P/E of closer to 7 after they fell with the market, and so I’m convinced that I have a strengthening business at a very cheap price. Both the dividend and their performance mean I have, if anything, greater faith in the business than when I added them – and hence they’re staying put.

RSM Tenon are, I suppose, a similar (if slightly more extreme) tale. They lost over 60% of their value at the start of this year as the market seemed to demote them from strong growth potential to perennial disappointers – and they sat at a P/E (pre-exceptional) of something like 5. The difference between ‘exceptional’ costs and otherwise, I imagine, was a particular source of concern among the market participants. Still, I ran the numbers repeatedly and couldn’t justify their precipitous fall, a situation which left me rather uneasy. Not having a neat explanation was troubling, but the numbers spoke for themselves and I bought the management line. They, too, were around 10% higher but fell with the market towards the end of the month. As with Zetar, I still think they’re undervalued, but the situation is slightly more complicated in Tenon’s case. The pre-close trading update they released was rather light on the numbers, but the bulk of the revaluation probably came from the line saying they expected profit ‘in line with market expectations’. With market expectations putting them on a forward P/E of 5, this is clearly good news – especially combined with them reporting revenues up around 30%. The numbers aren’t solid yet, though, and there could be any number of other nasties lurking in there – further heavy exceptionals, for instance. This probably explains some of the investor caution. As shown by my holding, though, I think these fears are overplayed – and have not even considered selling. Let’s hope the annual report doesn’t show me to be a fool!

Finally, Cranswick were hit by that most obvious of factors – the rise in food prices. Being squeezed between the supermarkets and farmers who are getting hit with the rising price of feed meant they essentially had to absorb the rising cost of production, with the result that they reported that operating profit would be lower for H1 this year than last. The shares promptly sold off and have traded down with the market since. While I looked at food prices in my introduction to Cranswick, I probably should’ve expressed my confidence in my ignorance more clearly. Short term food prices fluctuate, but I bought the business for a number of reasons, none of which are hugely affected by the peak and troughs (hoho!) of the pig market. They’re financially sound and reliably profitable, so they’ll ride it out and come out of the other side with no problems.

So, there’s a wrap-up of my contentment and caution. At the moment I’m struggling to resist the urge to market watch as my portfolio plummets – small caps are getting battered today. Still, every cloud has a silver lining, and it’s exactly these sort of drops that give us, as value investors, the possibility to pick up good shares at cheap prices.  On a website note, hopefully I’ll soon have a ‘portfolio’ tab at the top of the website where I’ll keep a list of my holdings for those who are interested – watch this space.

Back to the supermarkets next post as I continue my investigation with the UK growth pick, Morrisons.

3 Replies to “EV – The First Month”

  1. Mark Carter

    Thanks for the write-up. You’re doing well, beating the market.

    I’m in two minds about housebuilders, as house prices to income still looks historically high. Housebuilders do seem to be improving piece by piece, though, and they are on historically low multiples. I see BDEV is an PTBV of 0.4. Over the last decade it has been at 1.1, suggesting to me it’s cheap. It is also on a PER of 46, which for cyclicals is likely to be a good sign.

    It’s interesting to look at the levels of inventory to sales. In 2003, they were 80%. In 2005, they were 96%. In the latest finals, they were 164%. Inventory levels have clearly risen, which is not a good sign. Clearly, we are in a bad time for housing – which of course might mean it is a good time to buy given the cheapness of the shares. Looking at the latest few financials, it is difficult to determine any change in trend which the market might not have spotted.

    • Lewis

      Barratt is still giving me a headache!

      I’m still convinced Barratt is undervalued, but that has almost become the problem. With smaller cap shares, I review their (usually simple) operations, look at their balance sheet and other factors, and am done. With little institutional coverage, pricing inefficiencies wouldn’t hugely surprise me – indeed, this is why I hold so many small caps. We’ll see if I’m right on that front in a few years. But with Barratt, every argument I present has an equally strong rebuttal. Their improving margins on the feed through of land, the resilience of house prices in the face of rock bottom mortgage lending etc. – I’m sure there’s an anti-me out there saying exactly the opposite and arguing for downward price pressure.

      I’m also acutely aware of my own fallibility. It’s fairly well documented that when you have a vested interest in something, you tend to block out negative arguments and surround yourself with the positive. Still, I’m holding. I’m not here to play mind games with myself, and the big share price dip is probably exactly what’s bringing on my self-doubt. I simply review my spreadsheet, look at why I bought them, see if the logic is still there and the fundamentals are still strong – and act accordingly.

      I just have to live with not knowing where I’m right or horribly wrong for a year or three!

  2. Richard Beddard

    What a month to start an investment portfolio! I won’t comment on performance because I think its completely meaningless but judging by the level of the analysis you’ve made a good start.

    Regarding your sanity and monthly reviews. I too do monthly reviews, and I have no doubt I’d be much happier not doing them. I regarded it as the cost of doing a public blog (the benefits of which, if you don’t get paid, the scrutiny your ideas get and the rigour of documenting your decisions) because people expect some sort of running commentary on performance. The trick is perhaps to note the performance dispassionately but then not dwell on it, and comment on how your investment process is going.

    Any way, here’s to many monthly reviews in future.

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