As I said in the last post, the fact that earnings can impact company valuations has finally entered my brain and caused a cascade of activity in my once quite and peaceful fund. The turmoil began with the the 600 Group.
I first bought 600 Group back in December 2008 when it was trading at a sizeable discount to tangible assets. Gearing was low and liquidity was good and that was enough for me.
However, things move on and now I look at returns on equity as well as book value, gearing, liquidity, etc. Over the longer term the ROE for this company are frankly appalling and the economic value of the company’s assets is much less than their book value. For example, ROE10 is -0.5%, ROE5 is -2.4% and the current ROE is -14.5%, none of which screams of success.
I realise of course that this is massively oversimplifying things, but unless you have a brain the size of a planet then pretty much any analysis you do is a massive simplification of reality.
So 600 Group departed with a total gain of 4.2% in almost 2 years, to be replaced with Barratt Developments.
Barratts is a very different company to what I’ve invested in before. Yes it is trading below book and tangible book, it has reasonable debt and liquidity, but what makes it different is its size. The market cap is £723 million and the net asset value is over £2 billion. That puts it well outside of my usual small cap zone. But in terms of what I’m buying I am much happier. Price to book and tangible book are lower than with 600, but also ROE10 and ROE5 are better at 14.3% and 7.3% respectively, including the negative values of the last two years.
It is cheap for various reasons: the housing market, the economy, the recent rights issue, the level of debt they took on at the peak of the market, etc etc. But as of now I think it has a good chance of outperforming over the next year or three.
And because everybody else seems to, I’m going to include a target price. As of now my target price for Barratt Developments is 208p which, although it sounds a lot compared to the current price of 75p, is way below the previous zone of 250-800p in which it traded for much of the last decade.
Of course none of my feeble analysis means I will be better off with Barratts than I was with 600, but in terms of the kind of companies they represent (high earners versus low earners), I think I will be.
Hi UKVIAll I can say is you are a braver man than me 🙂 Of course I'm an index tracking kind of guy and don't gamble on the stock market but given the austerity we are about to enter combined with the huge housing market over valuation that I'm seeing then Barratt seems a brave move.Now I'm just wondering who's the contrarian… In all likelihood it's you and you'll do well out of it. That's why I follow a mechanical investing strategy as I have proven that I can't stock pick.CheersRIT
Hello RITGamble? How very dare you! It's all science don't you know? Regarding Barratt, It's a numbers game. It just fills part of a portfolio of stocks with high-ish historic returns on equity and low book value. Over time a group like that 'should' outperform. I can see what you mean about the housing market and I totally agree being a bear myself, but I try not to let such macro assumptions affect my stock picks as I don't believe in prognostication.Regarding your post on the S&P CAPE valuation, it does look like the US is still overvalued, unless the yanks have forever given up on reasonable dividend yields and are happy to focus on capital gains only. At least things are 'better' over here in that regard.
Hi UKVIAt some point though they are going to realise that the capital gains aren't there either and then they'll be left with no choice but to start looking for yield again. As I show in the 1st chart in real (inflation adjusted) terms the S&P 500 price today is the same as in 1997. So no gains for 13 years.CheersRIT
Hi UK Value Investor,I must say I am happy to find YET another one of the very rare breed classic investors in the U.K. Follow my articles, blog, website at http://www.yellowcapital.co.uk regards from a fellow value manhaydn ellwood
RetirementinvestingHave you read Ben Graham? There is very interesting material regarding the power of a safety margin combined with diversification. I think you can assume UK Value Investor is working along these lines. Good luck to all value investors!
Hi William C, I have read the Intelligent Invetstor twice and have Security Analysis on my bedside table. Value investors only invest with a margin of safety. That can be in two or more ways, eith a 2/3rds discount to intrinsic value, net tangible asset value or a net net asset value. regarding diversification, true value investors run highly focussed portfolios. between 12 & 20 issues should be sufficient and they tend to weight half the portfolio to the top 4 or 5 holdings. do some research on Seth Klarman, Value Investor. I like UKVI's top down overlay using the CAPE measure, but I think he reivented the wheel there (which is good because it shows he is capable). Prof J Hussman has already devised a similar Peak to PE ratio that shows the preferred equity/bond ratio. although, Ben Graham did this in intelligent investor when he said a cautious investor should always work between 25% equity, 75% bond and an enterprising investor the other way round.The man was a genius.