Investment strategy – Page 4

Value traps – 18 Questions to help you avoid them

As value investors, we’re looking for “cheap” shares that are unpopular almost by definition. What we don’t want though are “value traps”, shares that are unpopular because the company is heading into permanent decline, or where a crisis is about to explode.

Instead what we want are cheap shares from companies that will continue to be as successful in the future as they have been in the past.

Having been caught out by a couple of value traps recently I decided to investigate this subject further with the goal of avoiding companies where there is a significant risk of a crisis situation occurring during my period of ownership (typically about 5 years).

In the book Corporate Turnaround (by Stuart Slatter and David Lovett), the authors outline a series of principal causes of corporate crisis and decline which tie in almost exactly with my own experience of value traps. So I’ve turned those principle causes into a list of questions that value investors can ask to help them avoid those dreaded value traps.

The questions are phrased so that a “yes” answer is good and a “no” answer is less good but not necessarily bad.

A “no” doesn’t mean the company is off limits as an investment, but a lot of noes might mean that you’ll only invest if the company has half the amount of debt you would normally accept, for example. In other situations declining to invest might be the right course of action.

My new investment spreadsheet

Recently I’ve made a few changes to my investment strategy and those changes are now reflected in this investment spreadsheet, which you can download and use if you so wish (and at your own risk).

Measuring leverage in banks, insurance companies and non-financial companies

Companies use leverage because it can boost earnings, and that’s a good thing.

But leverage is also bad because it increases the volatility of earnings and increases the risk of bad things happening such as rights issues, dividend cuts and bankruptcy.

The trick is to find companies with the “right” amount of leverage given your investment goals, and that requires the right tools for measuring leverage.

Taking account of return on capital employed

The return generated by the capital employed within a business can be a useful guide to its competitive strengths, and whether the company’s management is chiefly interested in enriching themselves or shareholders.

How property and stock market investors can apply the same investment principles

Property investing and stock market investing are more similar than most people realise.

Of course, there are many differences in the details, but long-term investors who are active in either asset class can benefit from the same sound and timeless investment principles.

Ben Graham laid out many of these principles almost 80 years ago, but more recently I found them within the pages of “The Five Fundamental Principles of Property Investment”, written by Nick Carlile of Platinum Portfolio Builder.

Fundamental dividend indexing – A smart beta approach for income investors

This guest post is written by Robert Davies of Maven Capital Partners:

Rather like cricket scores and the weather forecast, we get used to hearing about stock markets on a regular basis without paying a lot of attention. In fact, stock markets are big businesses in their own right.

The first demonstration of that was the 2012 acquisition by the London Stock Exchange of Pearson’s 50% stake in FTSE, the index provider, for £450m. Since then the LSE has gone on to acquire the Frank Russell Company, a US Index business, for £1.6 billion.

Clearly, keeping the scores for investors must be lucrative to attract so much capital to the seemingly mundane business of totting up share prices at the end of the day.

How I’m Increasing my focus on defensive sectors

Although I think of myself as a defensive value investor I’ve never really defined “defensiveness” in terms of the sector that a company operates in.

Usually, I just look for companies that have a history of profitable growth and dividend payments stretching back at least a decade. If a company has been consistently successful over such a long period of time then in most cases that’s defensive enough for me (assuming of course that it makes it through the rest of my investment checklist).

However, I’m always looking for ways to reduce risk without obviously reducing returns and I think paying more attention to defensive sectors is one way to do it.

Who is the best UK stockbroker?

This is a question I get asked quite a lot. Unfortunately, there’s no easy answer because it depends on how you define “best”.

Is the best UK stockbroker the cheapest one or the one with the simplest website? Is it the one where a nice broker will help you over the phone or where their execution-only platform has the tightest “spreads”?

Why you shouldn’t always trust your stock screen

Stock screens are perhaps the greatest gift that computers and the internet have given to investors. With just a few clicks, taps or keystrokes you can slice and dice the entire universe of public companies in hundreds of different ways.

If you want high-yield shares, that’s easy. High growth? That’s easy too. As is high ROE, low price to book, consistent free cash flow or almost anything else you could think of. It’s all there at your fingertips.

But while stock screens are a powerful tool in the search for sound investments, they can also be dangerous if used without care.

Passive and active investors want a level playing field

Passive investors and active investors have both been helped enormously by the number of websites that collate investment-related data and present it in a readily digestible form.

This low-volatility stock market will not last forever

This is a guest post by Robert Davies of Maven Capital Partners. Rob manages a passive “smart dividend” fund which tracks an index weighted on the size of a company’s dividend payments rather than its market cap.

How I value financial companies

Valuing financial companies (think insurance companies and banks) has always been a bit of a sore point for me because they don’t generate revenues. That may not sound so bad, but along with profits and dividends, revenues are a key part of how my stock screen decides which stocks are likely to be good value and which aren’t.

Stock market valuation mean reversion is a powerful force

Stock market valuation mean reversion, or less technically, the tendency of stock market valuation ratios to stay relatively close to their long-term average, which is one of the most important concepts in my investment framework.

The pros and cons of building an investment story

So you’ve crunched the numbers on a particular company, and they’re looking good. It has a long history of profitable dividend growth, and that growth has been faster and more consistent than average. It doesn’t have much debt, and the current yield is significantly better than the market average.

How do I start building a portfolio of shares?

Imagine you find yourself with a sizeable lump of cash. You’ve decided that you want to use that cash to build a portfolio of defensive shares for both capital gain and dividend income. How could you get started building such a portfolio?

Balancing risk vs. return, income vs. growth and quality vs. value

Investing is all about risk and return. In order to get higher returns, you usually need to take more risk, so there is a balance to be struck between what rate of return you would like and what level of risk you can live with.

Defensive shares – An unusual way to value them

In recent posts, I’ve looked at a variety of ways to track down and compare defensive shares. I’ve covered looking for consistent profits and dividends, consistent growth, high rates of growth and low debt. But finding defensive shares is only half the battle; the other half is having a reliable way to value them.

How to avoid companies with too much debt

For each company you might invest in, there is some prudent and optimal amount of debt that it can carry. Taking on some debt makes sense because many companies can generate more earnings from investing borrowed money (in a new factory, for example) than they’d have to pay in interest.

Fast dividend growers – How to find them

In recent posts, I’ve covered some simple steps that you can use to find companies with long histories of profitable dividend payments and consistent growth.

How to find reliable, profitable dividend growth

If you want to build a high-yield, low-risk portfolio, looking for companies with a record of reliable dividends and profits is a good start, but it’s not enough.