From the vault – The November 2013 issue of UK Value Investor

Recently I decided to make most of the back issues of my investment newsletter freely available. On top of that, at the start of each month, I’ll release the next back issue from two years ago.

This month it’s the turn of the November 2013 issue, which you can download from the back issue archive.

For those who don’t want to read the whole thing, here’s a summary of what was going on at the tail-end of 2013.

The value of long-term active investors

To start with I seemed to be having a bit of a backlash against passive investing. Quoting myself:

Passive investors are less likely to question company management about pay levels, internal investment decisions, environmental and sustainability issues, or anything else for that matter. The management of these companies will be under ever less pressure to deliver long-term value to shareholders, rather than whatever is in their own short-term interests. On the other hand, active investors (either you or the managers of any active funds that you own) have the potential to positively influence the companies they invest in as well as the wider economy.

I still largely agree with that.

However, the rise of passive funds may force active fund managers to sell themselves as much on their ability to add long-term value through corporate engagement as on their ability to generate market-beating returns.

Alternatively, the rise of passive investing may cause active fund managers to become even more short-termist than they already are.

This could lead to more demands for cash to be stripped out of businesses today (via dividends or share buybacks) rather than reinvested for the long-term, or that executives be rewarded primarily with share options, which can result in them desperately seeking profit growth today at the expense of the company’s (and shareholders’) long-term prosperity.

Market valuation, forecast and asset allocation

At the start of November 2013, the FTSE 100 was at 6,731, slightly above where it is today. It was “slightly cheap” on my CAPE-based valuation scale, which is pretty much where it’s been since the initial post-financial crisis rebound.

FTSE 100 valuation table - 2013 11

I briefly speculated that if the market breached 7,000 it might herald a new speculative bull market, but as we now know that didn’t happen (or hasn’t yet).

Model portfolio review

In the previous month, I’d sold Go-Ahead from my defensive value model portfolio, for an annualised return of 21% over an 18-month holding period.

That, of course, is good, but up to that point the model portfolio had failed to significantly beat its FTSE All-Share tracker benchmark, with both having gained – up to that point – slightly more than 30% since their inception in March 2011:

Model portfolio performance chart - 2013 11

Note: In the chart the “average” investor underperforms by 3% a year and the “bad” investor underperforms by 6%. These figures are taken from various bits of research which show that most private investors underperform the market by a long way.

As has always been the case, the portfolio was also spread fairly well across companies of different sizes, different industries and different geographies as you can see below:

Model portfolio diversification - 2013 11
Click to enlarge

Finally, I finished off the model portfolio review with a 1938 quote from John Maynard Keynes:

“Compared with their predecessors, modern investors concentrate too much on annual, quarterly, or even monthly valuation of what they hold, and on capital appreciation and depreciation generally; and too little either on immediate yield or on future prospects and intrinsic worth.”

One unusual aspect of my investment strategy is that I follow a policy of buying or selling one holding each month (out of 30 holdings), alternating back and forth between the two. Having sold Go-Ahead in October, November was therefore a “buy” month.

Buying: Admiral Group PLC (ADM)

As November was a “buy” month, the bulk of the issue was given over to my analysis and subsequent purchase of Admiral Group.

Admiral Group share price - 2013 11

“The Admiral Group is a highly profitable and fast-growing financial services intermediary. It now employs over 6,500 people at its offices in the UK, Canada, Spain, Italy, France, US and India. All its growth has been organic.”

My review of Admiral was generally very positive. It’s hard not to be positive when a company has such an impressive track record, which you can see in the chart below.

The company had a long history of steady growth and extremely high profitability and didn’t seem to warrant the low valuation and high dividend yield it had at the time.

If you include the special – but still regular – dividend, the yield in November 2013 was an astonishing 7.1%, although because half of that dividend is “special” the company’s yield was typically quoted on most websites as a much less exciting 3.6%.

The table below shows how Admiral scored against the key metrics that I look at before investing:

Admiral Group historic results - 2013 11

Fortunately, Admiral’s special dividend has continued to be paid (so far) and the total dividend return from this investment over the past two years has been 15.4%, for which I am truly grateful.

I closed my review of Admiral with a quote on the madness of short-termism, quoting William Nasgovitz from the book The Art of Value Investing, by Heinz and Tilson:

“The most important change in my 40 years of investing has probably been in investors’ time horizons. Today the majority of investors – Ben Graham would call them speculators – are focused so closely on this week, this month and this quarter. Stocks are bought and sold on penny deviations from short-term estimates, which is mind-boggling. Crazy as it is, we can’t complain – it just creates more opportunities for investors with longer time horizons.”

Defensive value stock screen

As always the last few pages of the newsletter were dedicated to the defensive value stock screen which I use to guide my buy and sell decisions.

Of course things have moved on over the last two years; share prices have gone up and down, as have the fortunes of individual companies. However, many of the companies in the top 50 in November 2013 still rank well on the screen today, although some notable examples do not.

The table below shows the top 50 stocks at the time:

Defensive value stock screen - 2013 11
Click to enlarge

Back to the future (or at least, back to today)

Although two years have passed, I would say that the UK market today is still pretty much where it was back then.

Valuations and corporate prospects are broadly similar and the FTSE 100 still seems unable to break through the 7,000 level with any sort of conviction.

As a more cultured person might say (in French, of course), “The more things change, the more they stay the same”.

You can download a copy of the November 2013 issue from the back issue archive.

Author: John Kingham

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