Companies with thin profit margins often make bad investments

This is the third in a short series of blog posts covering my stock screen and investment strategy updates for 2019 and beyond.

Here’s a list of the posts so far:

  1. Why I’ll be looking at reported earnings instead of adjusted earnings from now on
  2. Why I’m measuring capital employed growth instead of earnings growth
  3. This post
  4. Factoring in the risk of excessive corporate debt
  5. Investing in turnarounds, recovery stocks and corporate transformations
Continue reading “Companies with thin profit margins often make bad investments”

Why I’m measuring capital employed growth instead of earnings growth

This is the second in a short series of blog posts covering my stock screen and investment strategy updates for 2019 and beyond.

Here’s a list of all the posts in this series:

  1. Why I’ll be looking at reported earnings instead of adjusted earnings from now on
  2. This post
  3. Companies with thin profit margins often make bad investments
  4. Factoring in the risk of excessive corporate debt
  5. Investing in turnarounds, recovery stocks and corporate transformations
Continue reading “Why I’m measuring capital employed growth instead of earnings growth”

Why I’ll be looking at reported earnings instead of adjusted earnings from now on

Following a somewhat underwhelming 2018 I decided to make a few small changes to my stock screen’s metrics and my defensive value investment strategy.

My goal with these changes is to improve how I find:

  • Above average companies: those that can maintain or increase their dividends over the medium and longer-term
  • At below average prices: where the combination of dividend yield, dividend growth and capital appreciation are likely to give me an annualised return of 10% or more and a decent dividend yield as well.

This was originally going to be a single post, but it just went on and on, so I’ve split it into a series of short posts:

  1. This post
  2. Why I’m measuring capital employed growth instead of earnings growth
  3. Companies with thin profit margins often make bad investments
  4. Factoring in the risk of excessive corporate debt
  5. Investing in turnarounds, recovery stocks and corporate transformations
Continue reading “Why I’ll be looking at reported earnings instead of adjusted earnings from now on”

Why dividend investors should look at free cash flow

If you’re a dividend investor, I think you should pay more attention to a company’s free cash flow than its earnings.

In a nutshell, here’s why:

Dividends are paid out of cash, so we need to make sure a company is consistently generating more than enough free cash (i.e. spare cash) to pay the dividend.

And earnings (and therefore the standard dividend cover ratio) aren’t always a good indicator of free cash generation.

Continue reading “Why dividend investors should look at free cash flow”

How to measure a company’s growth rate

On the whole, it makes sense for long-term investors to invest in companies that are likely to grow over the long term.

And an obvious place to look for companies that are likely to generate long-term growth in the future is companies that have generated long-term growth in the past.

But how exactly should you measure a company’s historic growth rate?

There are a million ways you could do it, and that’s part of the problem. You have to narrow down the number of things you measure and deciding what to measure is not always easy.

Personally, I’ve usually measured growth as growth in revenues, earnings and dividends. However, I have recently moved away from earnings in search of something else which is a) more stable and b) more closely related to dividend sustainability.

That ‘something else’ has turned out to be a combination of tangible capital employed (which I’ll define shortly) and free cash flows (which I’ll define in an upcoming blog post).

Analysing companies with free cash flows and tangible capital employed is a lengthy topic and it will probably take a few blog posts to cover in full, so in this first blog post, I’ll just outline the three things I now use to measure a company’s growth rate.

Continue reading “How to measure a company’s growth rate”

The upside of market corrections

2018 has been a year of corrections for the UK stock market.

First, we had a market correction (a decline of more than 10%) in January and now we’ve had another in October.

This has unsettled a lot of active investors. I know this because many of them have emailed me asking whether this is a) a good time to get out of the market or b) a good time to avoid putting more money in.

These are entirely sensible questions.

Investors want to avoid losses and it’s easy to see how a 10% decline today could turn into a full-blown bear market tomorrow.

However, despite their seemingly sensible nature, these questions highlight an underlying fear of market corrections which is almost entirely irrational.

This fear of market corrections is irrational because corrections are almost never a bad thing for sensible investors.

In fact, most of the time corrections are either irrelevant or they’re exactly what an investor should wish for.

To see why this is true, let’s take a look at some common scenarios in which investors might find themselves.

Continue reading “The upside of market corrections”

A 5-step guide to dividend investing for beginners

I love writing about the basic principles of dividend investing, value investing and defensive investing.

So I thought I’d take a step back and write a meat-and-potatoes beginner’s guide to dividend investing containing just a handful of the most important points.

Continue reading “A 5-step guide to dividend investing for beginners”

How to manage a portfolio of shares

Unless you’re a buy-and-forget investor, managing a portfolio of shares is an ongoing activity.

In fact, for most people, it should be a lot like gardening. For example, you’ll probably want to:

  • Choose strong, healthy companies
  • “Plant” a diverse range of companies so the portfolio can thrive under a range of economic weathers
  • “Plant” a diverse range of companies so the portfolio isn’t overly affected by any one economic “disease”
  • Give them time to grow
  • Give them a regular health-check
  • Trim them back if they grow too big
  • Remove them if they’re no longer attractive or healthy

So just like a garden, a portfolio of shares is a dynamic entity which changes through the economic seasons. And just like a garden, a portfolio of shares needs regular care and attention if it is to reach its potential.

I’ve written about buying shares (on multiple occasions), selling shares and diversification before, so in this post, I want to focus on how these aspects of portfolio management come together in the real world on a regular basis.

Most gardeners check their plants on a regular basis to make sure they’re healthy and attractive. For the same reasons, investors should regularly check the companies they’re invested in.

For me this means reading each company’s latest annual, interim and quarterly results.

I also want to know about major acquisitions, mergers or other materially significant events that could impact a company’s long-term future.

Fortunately there’s an easy way to get this information.

Most public companies announce this sort of news via the Regulatory News Service (RNS) and there are various ways to access this info.

A good free way to access RNS info is

You can see the RNS announcements page for BT below, and I’ve drawn a handy red arrow pointing to the related RSS feed link (RSS is an easy way to have website updates pushed to you):

BT Group PLC FE InvestEgate

There are also many other RSS readers out there.

Personally, I use the RNS reader integrated into SharePad, which allows you to set up a virtual portfolio and then get all the news for those stocks.

One feature you’ll probably want in an RSS reader is a filter to block the large number of “junk” updates that RNS feeds contain, such as updates on “Total Voting Rights” or “Short Selling”. SharePad does that automatically but other readers will vary.

Every weekday I check the RNS feed for all of the holdings in my model portfolio. What I do next depends on what those updates are:

Annual results:

If a company announces new annual results then I’ll create a new Company Analysis Spreadsheet for that company by copying last year’s spreadsheet and updating it for the newly announced revenues, profits and so on.

I’ll then read through the annual results and jot down a few notes on how the company’s performing and where it’s heading.

Interim results:

For interim results I don’t update the company’s spreadsheet, but I do look at how revenues, earnings etc. are progressing.

Again, I read through the results and make a few notes on anything I think is relevant.

Trading updates / quarterly statements:

These are shorter updates and I usually just skim-read them as they rarely contain anything material to a company’s long-term future.

Other material news (acquisitions, mergers, regulatory changes, etc.):

How much attention I pay to these depends on how large their impact is on the long-term future of the company.

For example, if the announcement is for a small acquisition, I’ll just skim-read it. But if there’s a major regulatory change that could have profound impacts on the whole industry, I’ll read it in more detail.

This process usually takes a few minutes each morning. When there are annual or interim results to review then of course it takes a bit longer; perhaps half an hour or so for each annual results review.

Although I do this daily, I don’t think it would hurt to do it weekly and most weeks this RNS review should only take five or ten minutes, assuming you’ve set up filters to filter out most of the junk.

Let’s return to that gardening analogy. Gardeners check the individual plants in their garden, but it’s also a good idea to check the health of the overall garden. And by health, I mean that the garden is not only healthy today but that it is likely to be healthy long into the future, regardless of what nature throws at it. For an investment portfolio, this means building in a layer of protection against these major risks:

Company risk: The risk that a company you’re invested in goes bust, or suffers a significant and long-lasting decline in its ability to generate revenues, profits and dividends

Valuation risk: The risk that a company you’re invested in suffers a significant and possibly long-lasting share price decline

Sector risk: The risk that a sector you’re invested in suffers a significant and long-lasting decline

Geographic risk: The risk that a country you’re invested in suffers a significant and long-lasting decline.

I’ve written about investment diversification before, so here I’ll focus on how I try to control these risks on a monthly basis.

The first thing I do is update the Portfolio Analysis Spreadsheet to reflect changes in the value of each holding. The spreadsheet can then work its magic and tell me how exposed the portfolio is to any one company, sector or country (the UK in my case).

For example, here are some charts showing the model portfolio’s current exposure to each of those three risks.

Value investing portfolio holdings 2018 08

Value Investing portfolio - sectors 2018 08

Value Investing portfolio - geography 2018 08

Of those risks, the only one that makes me (very) slightly uncomfortable is the portfolio’s UK weighting of slightly more than 50%.

That’s because I have an investment rule relating to UK exposure:

If that’s my rule, why is my model portfolio slightly over-exposed to the UK at the moment?

The answer is that over the last year or two UK cyclical stocks have, for fairly obvious reasons, become attractively valued relative to other companies.

And because I’m a value investor I go where the value is, and to an extent that’s in UK cyclicals, at least for now.

However, if things go badly and the UK has a lost decade or two, then investing heavily in UK cyclicals could be a bad idea. And that’s precisely why I have a soft limit on how directly exposed the portfolio can be to one country’s economy.

You can get data on the geographic source of company revenues and/or profits from SharePad, or you can often find it in the latest annual report.

Going back to the gardening analogy (again), gardens need to be trimmed and weeded to keep them healthy and a portfolio of shares is no different.

To give you an idea of why you might want to sell an investment, here are a few recent sales from the model portfolio along with the main reason why I sold each of them:

BHP Billiton: Sold because the company was no longer attractive (its growth rate had collapsed in recent years).

Beazley: Sold because the share price had grown too fast (up 100% in two years) and the share price was no longer attractive.

AstraZeneca: Sold because the company was no longer attractive (its growth rate had declined and its debts increased substantially).

Victrex: Sold half of this investment because it had grown by 80% in five months, by which time it made up more than 6% of the portfolio (I don’t like individual holdings to exceed 6%). As those examples show, there are three main reasons for selling:

Weeding (selling an unhealthy company): A company becomes unattractive because it’s growth, profitability, debts or something else has become significantly worse than when you invested in it.

Removing (selling a healthy company where the share price has grown too fast): A company has performed well, but that success has made the shares popular and expensive.

Pruning (selling half a holding to reduce its size): If a company has performed well the share price may have increased to the point where the holding is too big. In my case, I tend to cut positions in half once they grow to more than 6% of the portfolio.

In addition to the reasons listed above, my sell decisions are influenced by the portfolio’s current diversity.

So if, as is currently the case, the portfolio is overweight UK cyclicals, I would rather sell a UK cyclical holding than an international defensive holding.

And if I do sell a holding one month, I’ll buy something to replace it the following month. But here again, the portfolio’s diversity can affect my buying decisions.

Out of thirty holdings, my model portfolio currently has three companies in from the Support Services sector, so even if my stock screen‘s top-rated stock was a Support Services company, I would be somewhat reluctant to buy it.

Doing so would potentially leave the portfolio overexposed to risks that are specific to that sector.

However, I am willing to hold more than 10% in a given sector if the companies have little meaningful overlap (e.g. they operate in different countries or sell into very different markets despite operating in the same sector).

Having kept up to date with company news on a daily or weekly basis, and measured and tweaked the diversify of the portfolio on a monthly basis, the final portfolio management task is to measure performance.

Personally, I’m not interested in daily, weekly, monthly or even yearly performance.

That’s because in the short-term (i.e. anything less than about five years), the market’s random walk will overpower the underlying performance of the companies you’re invested in.

So although your portfolio’s total revenues, earnings and dividends might go up by 20% over three years, that can easily be wiped out by a short-term, temporary market “correction”.

But over five or ten years, such corrections are likely to be overpowered by the long-term, sustainable growth of the companies you own (assuming your investment strategy is sound).

I won’t belabour this point as it’s not overly complicated. You can just use a spreadsheet’s Internal Rate of Return function to calculate returns, including cash in and out. Or you can unitise your portfolio, just like a unit trust.

Here’s a quarterly performance review I made earlier which goes into some more detail on why tracking short-term performance is such a bad idea for most investors.

When it comes to portfolio management, a little goes a long way

So in summary, portfolio management is a lot like gardening.

Share portfolios require a small amount of work on a regular basis to keep them healthy, attractive, growing and robust.

None of this takes very long, apart from analysing new investments which you would probably be doing anyway.

And for me, the time spent keeping up to date with each holding, as well as the portfolio’s overall diversity and performance, is just another form of sensible investing.

4 Rules for selling shares

Most active investors I speak to have no real strategy for selling shares.

And if they do it’s usually a simple one, such as selling on dividend cuts or selling if a company’s share price falls by 20%.

I think this is a huge mistake.

Choosing what shares to sell and when to sell them is incredibly important. In fact, your selling strategy should be just as well-thought-through as your share-buying strategy, and just as rigorously applied.

For me, selling is all about improving the portfolio by weeding out weak and/or overpriced companies. As with the rest of my investment strategy, I follow a number of rules when selling.

Continue reading “4 Rules for selling shares”

Stock market investors: How to think like a property investor

In my family, I’m the odd one out. My parents see property investments as their pensions. My brother sees property investments as his pension. My cousins see property investments as their pensions.

I’m the only one, as far as I know, who favours stock market investments over property investments. And this is despite the fact that most of my personal retirement funds came from some lucky timing in the property market between 1995 and 2005.

Although I don’t think one is necessarily better than the other, I do think stock market investors can learn a lot from their property investing counterparts.

Specifically, there are four things stock market investors should do to make themselves more like property investors.

Continue reading “Stock market investors: How to think like a property investor”

How to build a high-yield low-risk portfolio of shares (a 12-step guide)

“The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.”

– Ben Graham

Here’s a comprehensive but accessible guide to building a high-yield low-risk portfolio of shares.

It’s the strategy behind the UK Value Investor model portfolio, it’s the strategy I use to manage my own investments and it’s based on the work of Benjamin Graham, one of the great stock market investors of the 20th century.

Before we get into the 12 steps, here’s a basic outline of this approach to building a high-yield low-risk portfolio:

  • Buy high-quality, dividend-paying companies
  • Buy when prices are low and yields are high
  • Build a diverse portfolio of these companies
  • Regularly weed out losers and trim back winners

Okay, that’s obviously very simplistic, so let’s break down those four key points into 12 steps.

Continue reading “How to build a high-yield low-risk portfolio of shares (a 12-step guide)”

Should you let winners run and cut losers quick?

Holding winners for longer and selling losers faster is a well-established rule of thumb for investors and traders alike.

The idea is to offset the natural response of most people, which is to quickly sell winners (in order to lock in profits) while hanging onto losers for all eternity (in order to avoid locking in losses).

However, I’m not a fan of riding winners and cutting losers, at least as it’s commonly practised. Here’s why.

Continue reading “Should you let winners run and cut losers quick?”

How to Pick Quality Shares: A book review

Phil Oakley’s new book, How to Pick Quality Shares, details a three-step process for selecting profitable stocks.

It’s the kind of investment book I like because it’s mostly focused on numbers and ratios, and it approaches the topic of investing in a down-to-earth and step-by-step manner.

I found the book particularly interesting because its general goals are very similar to my own (buy quality companies at attractive valuations) but the details of how to achieve those goals are almost entirely different.

Continue reading “How to Pick Quality Shares: A book review”

The journey to a million-pound portfolio

One million pounds is a lot of money. It’s more than enough for most people to retire, and becoming a millionaire remains a long-term dream for many.

That’s why I’ve chosen one million pounds as the new long-term goal for the UK Value Investor model portfolio.

Of course, any idiot can set a goal. What matters is whether or not you can achieve it.

Continue reading “The journey to a million-pound portfolio”

Some more questions to help you avoid yield traps

Last month I outlined six questions designed to help investors avoid potential yield traps. This month I’ll cover four more.

These four questions, plus the six from last month, look for a variety of warning signs including:

  • bad management
  • high costs
  • dangerously large or risky projects
  • excessive acquisitions
  • highly cyclical markets and
  • markets that are likely to decline over the next decade or more

Although it can be difficult to define exactly what bad management is, for example, investigating these issues and drawing conclusions is still a very worthwhile activity.

That’s because it can help you build up a nicely rounded picture of a company, far beyond what you’ll get from just looking at financial statements.

Continue reading “Some more questions to help you avoid yield traps”

How many defensive shares should you hold?

If you’re a relatively defensive investor like me, you probably like to have a decent number of defensive shares in your portfolio.

But what number should that be? Or more correctly, what proportion of your portfolio should be invested in defensive shares?

One entirely reasonable answer would be to invest 100% of your portfolio in defensive shares. If you valued defensiveness and low risk above all else then that might be a good strategy.

But that could also be a bit restrictive as there are currently only 81 defensive companies in the FTSE All-Share out of a total of 626.

My approach to being defensive is a little more balanced. Yes, I want my portfolio to be less risky than the market, but I also want a market-beating dividend yield and market-beating capital gains as well.

In order to simultaneously achieve those three goals of low risk, high yield and high growth, I am willing to invest in cyclical companies because they can add a bit of rocket fuel to an otherwise dull portfolio. However, rocket fuel is dangerous stuff, so I wouldn’t want to overload on cyclical shares because they might explode during the next inevitable recession.

So what is the right balance between defensive and cyclical shares for an investor who wants to combine low risks with high yields and high growth?

Continue reading “How many defensive shares should you hold?”

6 Questions to help you avoid yield traps

As a dividend-focused investor, I’m always on the lookout for high-yield shares, whether that yield is high relative to the market average or high relative to the company’s peers.

However, as most yield-seeking investors soon discover, high-yield stocks do not always deliver the yield you were hoping for. That’s because dividends can be cut or even completely suspended, and the higher the historic or forecast yield the more likely that is to happen.

This is the dreaded yield trap, where investors are lured in by an attractive yield and then stung with a capital loss when the dividend is cut.

In order to avoid this fate where possible, I’ve built up a series of questions which every potential investment must answer before I’ll invest so much as a penny. These questions are designed to help me avoid companies that are exposed to significant risks, where those risks arise from factors such as large acquisitions, excessive expansion or changing patterns of market demand.

Of course, these questions are not foolproof, but I’ve found them extremely useful in recent years and in the latest issue of Master Investor magazine I’ve covered the first six yield trap questions in some detail.

Continue reading “6 Questions to help you avoid yield traps”

How I find long-term dividend growth stocks

Although I think of myself as investing in defensive value stocks, I could just as easily call them dividend growth stocks.

That’s because finding companies with a good combination of dividend yield and dividend growth is absolutely central to everything I do.

Continue reading “How I find long-term dividend growth stocks”