Investment case study: UK Mail Group generates an annualised return of 33.7%

This investment case study will dig into many of the specific steps I take to buy, hold and sell great businesses for income and growth.  But before I begin, I want to point out one thing. 

Annualised returns of 33.7% are NOT a realistic expectation for any investment in the stock market.  The returns for this investment were extremely high because the UKVI portfolio only held the shares for 12 months, which means that the random movements of the stock market created abnormally high returns.  If you go into the stock market expecting 20% or 30% per annum, you are very likely to be disappointed.

Overview

If you’ve been following my writings for any length of time, you probably already know that I invest in ‘world-class’ businesses for income and growth using a relatively defensive value investing strategy.

The goal is to manage a portfolio of outstanding businesses, where the portfolio always has a higher yield than the FTSE 100 and, at the same time, is able to grow that income faster than the index.  That growing income stream, in turn, becomes the driver of future market-beating capital growth (although, of course, there are no guarantees).

I bought UK Mail in October 2011 for 210p and sold it in October 2012 for 262.5p.  During that time, it also paid out dividends of 18.2p for a total gain of 70.7p, which is 32%, or 33.7% annualised.

How did I work out what to buy, when to buy and when to sell?

I have an investment process which I work through every month, either selling the most overvalued holding or adding a new undervalued investment from the market.  This helps to constantly improve the portfolio, always pushing it towards more income, more quality and more growth.

It also means that I don’t have to guess what I’m supposed to do next.  October 2011 was ‘buy’ month, so that allowed me to focus completely on the task of buying the most attractive investment that I could find.

Buying: Why pick UK Mail Group?

UK Mail Group fits my criteria as a market-leading company with a long history of profits, cash generation and dividend payments to shareholders.  The 2012 annual report puts it like this:

UK Mail is the leading independent parcel, mail and logistics services company within the UK and a major alternative to Royal Mail for business mail requirements.

If you’ve downloaded my free investment worksheets, then you’ll know that I like to value companies based on their long-term financial results, so let’s start there.

The results above are how things looked when I added the shares to the UKVI portfolio in October 2011.

The average earnings per share in the period above was 21p, and the average dividend was 17.7p.  When I first looked at the company, the shares were trading at 210p, which means the shares were trading at ten times the average earnings in the last decade, which is low, even for a company that isn’t growing.

The dividend yield at the time was 8.6%, which of course, is huge and is often a sign that the dividend is about to be cut.

The next step for me is to check for debts and other obligations to make sure that they won’t be a reason for the company to fail or cut its dividend.

In this case, UK Mail had very little debt, with net interest charges of only £100k and pre-tax profits of around £15m, so the interest was covered by a huge amount.

Looking back over the last decade’s annual reports as well as its current situation, I couldn’t see any obvious reason why that dividend was going to be cut.   Looking ahead to the future, I couldn’t see any particular reason why the parcel and courier delivery business wasn’t going to keep on ticking, just as it had in the past, for many years to come.

On that basis, my investment thesis was one in which the dividend would be maintained, and the 8.6% yield would be enough to entice other buyers into the shares.  This would eventually push the price up.  Until that time, I could sit back and collect the 8.6% income each year.

Holding:  The hardest thing to do is nothing

One of the hallmarks of a good investor is that they don’t pay much attention to the stock market.  What they tend to do is buy the shares of good companies at low prices and then get on with the business of owning those shares.

What exactly does owning shares entail?  Well, not very much.  Generally, it means reading the quarterly updates from management, and watching the dividends accumulate in your cash account.

Very occasionally, you might check the share price just to see if the market wants to buy your shares back at an excessively high price.

What it doesn’t entail is constantly watching the share price as it bounces around every day.  What it also doesn’t entail is listening to every single piece of news that comes out about the company and trying to factor that into whether or not you should sell your investment.

Of course, this has all been said before by people much smarter than me:

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years” – Warren Buffett

“There are times when doing nothing is a sign of investing brilliance” – Warren Buffett

“I think there’s something to be said for developing the disposition to own stocks without fretting” – Charlie Munger

“The long-range view requires patience”  – Sir John Templeton

“The real money in investing will have to be made not out of buying and selling, but out of owning and holding securities, receiving interest and dividends, and benefiting from their long-term increase in value” – Ben Graham

So with UK Mail, I sat and held and received dividends, but eventually, I chose to sell.

Selling: Why sell if the shares are going up?

A major part of my portfolio maintenance policy is to buy and sell on a regular, controlled basis.  October 2012 was a ‘sell’ month, giving me the opportunity to free up some cash from my least undervalued investment.  This cash will then be reinvested into what I think is the market’s most attractive opportunity the following month.

What changed UK Mail from being attractive to unattractive?  First and foremost, it was down to the share price increase, which had the knock-on effect of reducing the yield.  If the share price goes up, the dividend yield goes down, and at some point, there may be better places to invest.

With the shares at 262.5p the yield was just under 7%; still well above average, but far less attractive than 8.6%.  Add to that the minimal prospects for future dividend increases and, relative to the UKVI portfolio’s other holdings, UK Mail was less attractive than all the others.

How do I decide which is more or less attractive?  The process is the same as the one I use for buying.  I compare the company’s long-term growth record, the quality and consistency of that growth, the current yield and the prospects for future dividend increases.  It is the combination of current yield and future growth that defines how attractive an investment is.  With growth of 0% and a yield of less than 7%, I now think there are better alternatives out there.

This decision to sell has netted the portfolio a 33.7% annualised return from its short investment in UK Mail, which is far more than I would expect on average; however, results like this are always welcome.

In summary…

• I bought a market-leading company with a long history of consistent profitability, financial strength and reliable dividend payments
• I bought the shares when the dividend yield was very high, which made up to some extent for the lack of dividend growth prospects
• I held the shares for a year, largely doing nothing, which is, of course, the hardest thing to do
• I sold the shares when the combination of income and its potential growth looked to be weaker than my other holdings and weaker than many other potential investments in the market
• I bought and sold the shares in a calm and methodical way, mostly looking at long-term economic fundamentals rather than buying and selling in an ad-hoc fashion driven by short-term news.