Portfolio review – January 2011

At the end of January my fund was down over 1% taking the rolling one year figure to 13%, slightly lagging the FTSE 100. 13% is down a long way in relation to the December one year figure (22%) but that’s due to what happened last January rather than in this one (last year’s was much better). 

The goal as ever is to out-perform the FTSE 100 by an annualised 5% in any rolling 5 year period, but it’s more of a hope than a goal. Having a returns goal in stock market investing is a bit like having the goal of it being sunny tomorrow.

The current effort to increase the number of holdings to twenty stumbled slightly as two companies were sold and two were bought, as detailed below.

Sold – AGA
Somewhat surprisingly, AGA turned out to be the ‘least undervalued’ company on a quantitative basis and its sale returned 22% in only three months.

I bought AGA using version 0.1 of my evolving scoring system, which is a quantitative model to sort and screen stocks for further analysis. I’d say about 80% of any buy decision is based on this score with the remaining 20% going to soft qualitative research. The model looks for equity selling cheaply relative to its historic earnings and AGA certainly fitted that description.

My quantitative research is quite limited and if you like that sort of thing you will find many better exponents of it listed on the web site. When doing this soft research I typically ask just four things:

First, is the company that I’m buying now substantially the same company that produced the historic earnings? It can often be the case that valuable assets are sold off during restructuring and a special dividend pays out the proceeds to shareholders. In that case the company is not the company that earned the historic returns and so the numbers are misleading. As far as I could see the AGA I bought was more or less the AGA of the last 10 years, minus their foodservice company which they sold in 2007.

Second, why are the shares so cheap? For AGA the drop in share price started in late 2007 and seemed to be directly tied to the recession rather than anything specific to the company.

Third, is this fixable? Personally I couldn’t see any reason why after the recession AGA wouldn’t return to more or less the position it was in before, when the shares were in the 300-400p range rather than around 100p. Various commentators were worried about the pension fund, but this was outside my circle of competence, so I ignored it.

Finally, how are they fixing it? According to Frederick M. Zimmerman’s book The Turnaround Experience, successful turnarounds typically focus on core operational issues and incremental improvements rather than launching into new markets, products or businesses. In AGA’s case they seemed to be dropping non-core businesses even before the recession in order to focus on their consumer operations. Savings are being re-invested to improve and organically grow that core business.

In a nutshell that’s why I bought AGA. It scored well through a fundamental screen and ranking system and ticked each of my simple qualitative boxes.

AGA was sold because after only three months as the rise in share price made it the lowest scoring holding since the higher the price goes the less ‘value’ is left in the shares. In part this change from scoring high to scoring relatively low was due to a minor change in the scoring system. Hopefully such changes will become limited in time. It was also a sell target as it took up over 10% of the portfolio and I’m in the process of reducing the size of each holding to increase diversification.

Sold – Airea
Another leaver this month was Airea, the design led specialist flooring company. Airea was a victim of the move from version 0.1 to 0.2 of my quantitative model mentioned above. Version 0.2 places more emphasis on recent earnings compared to earnings over five years ago and in that respect Airea had done badly. This meant that the future outlook for the company appeared weaker than I first thought and according to version 0.2 it was already fairly priced which is an automatic sell signal.

The sale resulted in a loss of about 13% in a holding that was about 1% of the fund.

Bought – Enterprise Inns
Enterprise Inns owns a large collection of pubs (almost 7,000) which it leases out to landlords and provides them with additional support in return for various monetary returns. Going by historic earnings the current price is very cheap, debt is high but not high enough to stop the company coming near the top of my screen. The four qualitative questions give these answers:

Has the company changed dramatically in the last year or three? Not that I can see.

Why is it cheap? The recession is the obvious and rational reason. People are squeezed and don’t have the money to spend on quite so much booze. The company also has a lot of debt which seems to scare some investors, but that is already factored into my quantitative model and the potential rewards outweigh this risk. A detailed analysis of the debt is not my area of expertise.

Is it fixable? I don’t think that pubs are going the way of Blockbuster, so this looks like a cyclical downturn rather than a terminal decline to me.

What are they doing to fix it? They seem to have two main strategies. One is to sell non-core pubs and the other is a sale and leaseback scheme which sold 71 pubs in 2010 and it’s expected to be around the same figure next year. Both of these are focused on the core business rather than trying some new fangled idea.

On that basis around 4% of the fund went into Enterprise Inns with a current target price of 330p which I don’t think it will get anywhere near within the next year.

Bought – Hampson Industries
Hampson Industries is an international group serving the global aerospace industry. According to the web site, “Hampson is now the world’s largest supplier of highly engineered, close tolerance tooling systems for the fabrication and assembly of both metal and composite structures for commercial and military aircraft and space applications”. My model suggests a possible share price increase of around 150-200%, which of course is up to Mr Market and not me, unfortunately. And so to my four questions:

Is it still the same company? Yes, more or less. They have been buying companies over the last few years and selling some, but overall the basics of the business appear to be the same as they have been for the past few years.

Why so cheap? The recession is once again the answer; although in this case the global recession rather than the UK one.

Is it fixable? As with Enterprise Inns, this isn’t a problem with the company as such, it’s just a knock on effect of the global downturn.

How are they fixing it? The response seems to be operational improvements and major restructuring where required, which is what I like to see rather than a radical shakeup of the business.

Again about 4% of the total fund went into Hampson as I’m aiming for around 20 holdings.

New Stockopedia fund
Since there is a good chance that I am making up these results I have started a mirror fund on the Stockopedia web site. They are entirely independent of me and so I cannot fix the results (of course if my results are rubbish they are unlikely to be fixed). The trades will be the same as for my personal account, just a day or so later. Don’t be too critical of its performance though as the fund only began a few weeks ago; please give it a year or three before passing judgement. 

Unfortunately their ‘fantasy fund’ system seems to be down as I write this so I’ll add a link to my static pages once it’s up and running again.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

13 thoughts on “Portfolio review – January 2011”

  1. Re Enteprise Inns, I see they closed at 102p yesterday, the same prices as Marston's which I hold. Well, I'll race you.I guess Enterprise will do well if they escape restructuring because of NAV, but I get a good divi from Marston's. However, debt of 6x Market Cap is scary in an industry that is going to meet a lot of headwinds.Did you consider Punch Taverns, or was that too racy?

  2. Embarassing admission time: I bought PUB at about 87p on a recovery play. I bailed out at 70p, considering them far too risky. They currently at 69p. In hindsight, I think it was ill-considered of me to have bought in the first place. Let's hope I learned a valuable lesson.If you punch (no pun intended) one of the pub companies into Google Finance, you'll see a list of companies in the same sector. I noticed MARS, PUB, YNGA, MAB, HVT, LMR, JDW, ETI, CPUB, AVA, LEP – although I think some of them are not real pubs. My point is this: there are a lot of pub chains, and it seems like a very crowded sector.These companies almost uniformly seem to be in a mess, with low returns on equity, and, where they earn profits, they are low in relation to the amount of debt. It seems that they were all copying each others' strategies. I don't know if that's necessarily true, but they all seem in a uniform mess.I think Salis' comment is right on the money: debt of 6X mkt cap is scary in an industry that is going to meet a lot of headwinds.If I did have an idea on how to invest in this sector, it would be to find a company with minimal debt and were perhaps doing a little better margin-wise than the competition. My game-plan might be be wait for the weaker companies to fail one by one, thereby setting up my favourite for a strong recovery.The problem is, I don't see such a contender. They all seem to have way too much debt, so it's anyone's guess who the survivor is going to be. Whilst most of the pubs seem to be trading on book values less than one, I feel that most of the book values will turn out to be illusory.The sector is very scary, and I think very speculative. I urge you to re-consider your holding.

  3. Hi SalisMarston is a bit expensive by my measures. I'm typically looking for things that will have a lot of upside if things turn out to be not quite as bad as everyone thinks, so ETI fits that bill more so. In terms of racing you, my ETI target is about 300p, so if you're racing to the same target then I accept your challenge, but I may bail out long before that if something nicer comes along.As for Punch, it scores just about the same as ETI on my system. ETI just edged it out, although from my point of view they're effectively the same thing.

  4. Hi MarkIf I was putting a big part of my fund into ETI then I don't think I would have put anything into it as it's pretty high risk. However, 4% as part of a diversified portfolio is acceptable to me. But you're right, that level of debt does start to skew the debt levels of the whole portfolio which is typically what I keep an eye on, rather than individual holdings. Having recently added Yellow Pages (you can take the blame for that one) and Johnston Press (more details next month), I think I've hit my limit on highly geared companies for now. The next few additions will be more conservative.

  5. JohnGood luck with the Stockopedia fund – I've just set one up too. I'll keep a close on yours for interesting ideas…

  6. Hi John, it sounds like you're iterating your way to your own magic formula, but I thought gearing was part of it, so how come the highly geared companies?

  7. Hi Richard. Version 0.1 looked at 'normal' earnings, worked out the margin of safety given by the current price and then factored in the F-score. Version 0.2 added gearing where more gearing = bad, but only slightly so. These companies were picked with 0.2. 0.25 changes the gearing factor from linear to exponential, so 200% gearing for example weakens the score by a factor of 4 rather than 3 (I can't remember the transformation function offhand). With this system ETI scores less well and is quite near the bottom of my current holdings, although still near the top of the whole universe of 500 or so stocks that have 5 year ROE data. But I'll hold it for a year or so anyway otherwise I'm just churning as I hone my approach.The as yet unused version 0.3 additionally factors in ROE as an absolute number rather than just in relation to the book value and current price, so higher ROE companies score higher than they did before.So currently the top 20 using version 0.3 have an average 'normal' ROE of 20%, P/B of 0.7, upside to 'normal' price of 380% and gearing of 20%. That sounds like a reasonable group to me.However, Mervyn King said "The chances of our central projection coming true are close to zero", and that's a sentiment I completely agree with!I'll explain all this futile mad scientist stuff at some point and at the same time coin a catchy name for the system like v-score, or Most Excellent Formula or something.And as I said to Mark regarding high debt holdings, I'm a portfolio investor so I don't look at the individual holdings as much as the averages across the portfolio. So I'm looking for high ROE, low-ish gearing, low P/B etc on average.Apologies for hogging my own comment section.

  8. Richard – I have just skim read the book, but the points I make cover 80% of the gist i.e. don't throw the baby out with the bath water, just make the company lean and mean… unless you're YELL in which case you have no choice but to change quite radically as the core (paper) business is on the way out.Yorkiem – If you read this put up a link to the fund and I'll keep a beady eye on it.

  9. Exactly! Peer review is a difficult but highly effective way of testing your methods. When you have an audience it makes you work harder to understand exactly what it is you're doing and why, at least that's what it does for me.

  10. Oh, I'd have been tempted to hang on to AGA. There aren't many companies with that brand strength in the UK market. (Even a book genre – Aga Saga!)Hampson Industries does look cheap, but watch out for military spending cuts in the US. Anyway, I may well be buying a few myself.

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