Unlike the FTSE 100, the FTSE 250 has put in a pretty decent performance over the last couple of decades.

Since it peaked in 2007 (at the end of the early 2000s credit bubble), the FTSE 250 has just about doubled and since its peak in 2000 (at the end of the dot-com bubble) the FTSE 250 has more than tripled.

Given that the FTSE 100 has produced zero capital gains since 1999, a 200+% price increase for the FTSE 250 isn’t too bad at all.

And if you take your starting point as the 2003 low which followed the dot-com bust, the FTSE 250 is up more than 500%.

But have these healthy gains come at the expense of sane valuations? In other words, is the FTSE 250 dangerously expensive?

You can find out what I think on my new website, UKDividendStocks.com:

The ongoing problems in the UK and global economies have driven many investors into the arms of safe, defensive companies that can generate consistent dividend growth.  It’s easy to see why this might be an attractive strategy, given the high levels of uncertainty and volatility in the stock market today.

However, the popularity of safe dividend growth shares has caused some people to ask whether this is the next bubble.

At first glance, it seems that there is.  Adam Parker of Morgan Stanley is quoted by Merryn Somerset Webb in MoneyWeek as saying “Defensive stocks are trading near a decade-high relative to their more economically sensitive peers”.

I’ve added some new free resources for investors who are serious about making the most of their money.  These include a new investment analysis worksheet, an updated guide to value investing and the latest articles and research by email.

The guide is now more practical than before, walking you through the process of value investing at the same time as going through some of the underlying ideas.

Find out more about these free resources >>

It’s been a while since I last mentioned the model portfolio that I run as part of the investment newsletter I launched last year.  The constituents of that portfolio match exactly those in my personal pension fund, so this is much more than simply a model that I’m ‘messing about’ with.

On January 6th I put 4% of the UKVI ‘aggressive’ fund into Armour Group at 7.46 pence.  The 4% came from existing cash from the sale of Victoria.  At the time Armour came top of the UKVI valuation table, with a ‘returns yield’ of about 40% and according to their web site “Armour Group is the UK’s leading consumer electronics group within the home and in-car communication and entertainment markets”.

The company trades on the AIM index, which I’m not so keen on as they have live outside of the tax haven of an ISA wrapper, so it’s not for those investors who only have money in an ISA, but I have a little bit outside the wrapper so that’s okay.

The key data are as follows:

ROE10 = 9.2%, ROE5 = 7.5%, ROE3 = 5%, P/B = 0.18, market cap = 5.3M

As is typical of many value investments, the trend in earnings is downward, but that’s fine as earnings mean reversion is one of the main causes of share mispricing.  Typically companies rebound faster and better than expected.

This leaves my cash position at about 14% which is spot on the current cash target.  The cash target for the ‘aggressive’ portfolio being half that used in the ‘defensive’ portfolio described in detail here.

As has become clear, my portfolio has undergone a major change from a collection of low price/tangible book, low earning companies to a growing collection of low price/book companies with far better earnings histories.

Using my new approach to valuation (which as ever is mostly stolen from the giants whose shoulders I am trying to stand upon), I found that most of what I owned was already ‘overvalued’.

The list of the departed and their annual gains is as follows, some of which I’ve mentioned before:

Company              profit/loss    Holding days
J Smart Contractors  5.2%           403
M J Gleeson          34.2%          541
French Connection    15.7%          639
600 Group            4.2%           682
Northamber           31.2%          757
Mallett              -8.9%          785
Titon                47.7%          812
Averages             18.5%          660

Even though I’ve ended up selling these companies outside of my original system (which was to sell when the price/book ratio reached one, or after five years) I am happy, or perhaps lucky, with the average returns.

Currently my valuation method is in a bit of a flux, and there may be some movement beyond what I mentioned before.  The basics remain the use of historic ROE and price/book, but the ROE factor it is likely to be some combination of ROE10, 5, 3 and 1, all handily provided by sharelockholmes.

The companies above were re-valued either with ROE10 alone or the averages of the above averages (making averages of averages seems to be a compulsion of mine).  Taking the average of the averages gives around a 40% weighting to the current ROE, with gradually less for the prior years.  It makes some sense to me and in combination with less strict price/book entry criteria (I will now buy companies above book value and with negative tangible book values (!)) it certainly throws up a different sort of company to those I’ve held before.  I’ll nail down the exact approach in the coming weeks or months.

I realise this move (from buying assets on the cheap with little or no thought for anything else, to paying much more attention to the earning power of the assets) represents a sizeable amount of style creep, which can be a very bad thing; but as long as you’re creeping in the right direction I think it’s justifiable.  I can only point my finger in Buffett’s direction and say that if he did it, so can I.

The UKVI fund was down 6.48% this month compared to our iShares FTSE 100 benchmark. This was due to a large 7.04% gain in the benchmark which completely trounced my holdings over this short period.  What upside we had was mostly thanks to French Connection and their sale of Nicole Farhi, which prompted a raft of activity from institutional owners perhaps helping the share to its 23% gain from last month. On the downside, Luminar continued to slide another 16% but now it is such a small part of the fund that any further losses will be barely noticeable overall.

The six monthly figures are not much better (down 3.4% relative to benchmark), but six months is too short a time to make any meaningful judgments on performance. The goal for the fund is to outperform the benchmark in any given five year period so I am not sweating the small stuff just yet.

Other events of note

M J Gleeson sold off their property maintenance and emergency respose unit, Powerminster. I have no idea how this sale to Morgan Sindall for £6.6M cash will affect things other than to give Gleeson a boost to their already huge £20M cash balance.

In addition to French Connection’s share price increase, the fund received its first FCUK dividend which puts their total realised returns at 1.1% which is 0.8% annualised. Not exactly Earth shattering but at least it is a start.

Victoria’s latest interim management statement said of their three geographic regions that Australia was good, the UK was bad and Ireland was ugly. In summary they said that;

Overall, the trading environment will continue to be challenging. However, the Group remains confident that it has a financially strong position, a solid and geographically diverse business model which is well positioned to support future growth when the markets in which it operates start to strengthen.

Notice the all important word, “when”. The “when” may be sooner than with some other holdings as Victoria has a lot of exposure to Australia which may well return to boom long before the UK can even dream of such things.

Titon Holdings also produced an interim management statement but a much happier one than Victoria’s with revenues are up by 19%.  However, uncertainty and caution continue to loom large on the horizon and so the champagne remains on ice.

600 Group have just released their preliminary results for the year but I’ll leave any comment on that for next month, except to say that they are still making a loss overall, book value is down slightly but they at least made an operating profit in the second half.

How goes it for the market?

Currently the FTSE 100 has a real PE10 of about 12.7 which is slightly below my long term average estimate of 13.8. This is pretty close to a sensible value and if I were rebalancing an index tracker account between stocks and bonds today I’d put 72% into stocks.

And housing?

Some signs of weakness have started to appear, but as ever with the market that acts like a super tanker it may take a long time to find out which direction we’re headed. Currently the PE is still about 5.5 according to Nationwide, which is over 30% above my estimated sensible ceiling of 4.

Back to normal this month, with next to nothing going on other than volcanoes and general elections campaigns.  If you’re interested, please check out the Current Holdings, Trade History and Benchmark pages for the most recent updates.

Current Holdings

Electronic Data Processing made me happy by paying out a small dividend after I’d sold them, bringing the annualised returns for that company to 20% during my brief period of ownership.

The cash that I had left at the end of March went into Victoria, an existing holding.  I increased this holding because I didn’t really want to add another new holding – I like to hold around 10 companies – and it was the cheapest by price to book of those companies where I didn’t already have more than 10% of the portfolio invested.  On the downside I don’t really rate Victoria’s chances of being a big gainer as it hasn’t traded much above its current price in the past – i.e. there is technical resistance – and it hasn’t traded at book value for years and years, which doesn’t bode well for my mean reversion theory.  However, who am I to say what the future holds?  Given that I think most analysts are as good at seeing the future as house bricks I ignored my own fears and upped the holding.

Benchmark

The benchmark figures this month are less ego boosting than last month, but at least they are not depressing.  Once I get some 6 month and 1 year figures I think I’ll drop the 1 and 3 month comparisons from the table as I think 1 and 3 month benchmarking is for the short term traders.  Eventually I’ll probably just do 1, 3 and 5 year comparisons to the FTSE 100, with 5 years being the important one.

FTSE 100 : 3.7% over my newly adjusted Fair Value

After my attempts to assign a ‘fair value’ to the FTSE 100 last month, the blogger over at Retirement Investing Today pointed out that my assumption that the long run average CAPE is 16.4 (taken straight from Shiller’s S&P data) is a bit too simplistic.  It is a fact that the UK markets typically have a lower PE than the US.  Since I have earnings data going back to 1993 I can only produce CAPE going back to 2002, which is only 8 years and a bit crummy.  By looking at how far the S&P’s CAPE was over the long term average during the 1993 to 2010 period and extrapolating that onto the FTSE 100, gives an expected long therm average FTSE 100 CAPE of 11.2.  Once again the decimal point is probably going a bit too far.

In my opinion this is too low as I think the US markets were more over valued in the dot com bubble than in the UK, but of course that’s my opinion and probably has no basis in fact.  However, I think it’s not unreasonable to move my expected average FTSE 100 CAPE to 13.8, the midpoint of those two values.  On that basis I think the current fair value (i.e. the value that will give a future risk/return profile similar to the long term historic one) is 5,645. Given that it’s 5,445 right now then I’d say it’s only 3.7% overvalued, which in the big scheme of things is virtually nothing.

House Prices : Still a crazy 37% over fair value

Jeremy Grantham thinks the UK housing market is one of only two financial bubbles yet to pop.  Well, I think it popped two years ago, but the government has done an amazing job of patching up the hole.  That doesn’t change the fact that the air supply is fading and the rubbing is wearing thin.  High oil prices may yet prove to be the needle once again.

March has been the busiest month at the UK Value Investor head office (spare bedroom) for a long time. I’ve had reports from Mallett and J Smart, a report and strategic review from French Connection (I love their new website) and dividends from Waterman, Gleeson, Northamber and Titon. Then there’s the somewhat infamous purchase of Luminar, a company so scary it seems that almost no one will touch it.

With the impending dividend payout from MJ Gleeson, I’ve been thinking about what to do with it. I mentioned at some point in the past that I wanted to hold more cash and bonds, using the CAPE10 based function I’ve posted about before. That function calculates my cash or bond holdings using the value of the FTSE 100 and is therefore suitable for portfolios where the stock holding is an index tracker following the FTSE 100. In fact that’s exactly what I’ve used it for so far when annually re-balancing my wife’s pension and currently the bond allocation is about 30%.

However, the value investing portfolio which is the focus of this blog is most definitely not a FTSE 100 tracker. The shares in my portfolio live in a dark little corner of the size and value grid where academia says out-performance is most easily had. On that basis I don’t think I should hold cash or bonds based on the value of the FTSE 100. What I’ve decided to do instead is to be as fully invested as is sensible (i.e. if I have £100 cash there’s no point investing it since the trade commission will be about £10).

Once I get my hands on the MJ Gleeson dividend and sell my bond holdings I’ll have about £3,000 cash to invest; and Luminar is looking like a high risk high reward place to put it. This big nightclub operator is very cheap, both tangibly and intangibly. It doesn’t have quite the low debt levels I typically like, but it doesn’t seem to be drowning in debt. On the downside, they’ve just lost the founder and chief executive; and one of their major investments has just gone into administration probably wiping its ~£17 million value from the balance sheet. Further to the downside the company has lost over 50% of its tangible assets over the last 5 years which, although bad, pales next to the 90+% paper losses of shareholders.

This is as good an example of why value investors are a rare breed as you are likely to find. Only the maddest or hardiest of souls would give money to a company with such a poor record. Will I become one of them?

For those of you who are interested in this sort of thing, I’ve added a Checklist page to list the (semi) mechanical steps I take when investing. The whole area of checklists and why we need them is very interesting in itself and I’d recommend both The Checklist Manifesto and Work the System as an introduction.

With a report titled “Restructuring to return French Connection to Profitability”, the team at French Connection have start the real work of turning their fortunes around.  I’m not really a details sort of person, so the main points are that they are selling the Nicole Farhi brand and loss making stores internationally.  I hate to speculate about the future, but generally I’d say this is a good thing and the markets seem to agree as it’s been up by over 10% today.


More importantly for me, the report comes attached to the preliminary results for the year ended 31 Jan 2010.  The sole point of interest here is that the book value of the company has changed from £83.2 million at the interim report to £72.3 million now.  The market cap is currently £43 million so it’s still cheap by my simple metrics.  All in all I’ve lost a little book value but gained some market value, neither of which should make me jump for joy nor cry into my tea.  I wonder if they’ll give me a discount on a new shirt?

This month the market value of my holdings increased by over £2,000 while the book value changed hardly at all.  You can see the current holdings on the new current holdings page.  This will be updated each month so you can see how things have changed over time.  There was another dividend from trusty Titon which now makes three dividends since I’ve owned a slice of this little business.  This dividend totalled £178.83 and is currently sitting in my cash balance.  You can see the realised returns from Titon and my other holdings in the new trade history page.

I’ve also added a benchmarking page so that you can quickly see the comparison between the returns of a traditional value portfolio against a FTSE 100 ETF.  This month I outperformed the ETF by 3.39%.  Although it’s nice to have a positive month it’s not really very important.  What is important is the multi-year returns since stock investing is for the long run.

One of my holdings, M J Gleeson, announced a 15p special dividend.  Since I hold over 6000 shares that’s over £1,000.  Unsuprisingly the share price has jumped up, although it will probably jump back down again after the ex dividend date.  How this affects my ownership of M J Gleeson depends on how high the price spikes.

Finally, both Richard Beddard and Monevator have mentioned this blog recently, so I tip my hat in their general direction.  Thanks chaps and good luck.

I’ve chosen the iShares FTSE 100 as my benchmark as it’s about as near as you’re going to get to holding the FTSE 100 directly.  It’s also easy to calculate total returns (returns assuming dividends are reinvested automatically) as they have a nice table of 1, 3 and 6 month returns, and 1, 3 and 5 year returns.

I don’t like the idea of setting target returns since I cannot control those returns.  I only like to target things I can actually have an influence on, like winning races at a kart track, or swimming 20 lengths of a pool. 

However, given that I am investing my money through stock picking I must think I can outperform (on a risk adjusted basis) the FTSE 100, otherwise I’d just hold that iShares ETF.  So, on that basis I am forced to have some kind of goal, which I have subtly outlined below:

My investing goal is to beat the iShares FTSE 100’s total return over any given 5 year period

I’ll post a table, updated monthly, comparing my 1, 3 and 6 month and 1, 3 and 5 year returns against my benchmark.  May the best theory win.

On January 12th Waterman Group paid out a dividend of £125.92.  As with Northamber, this will probably just sit in cash for now as it’s not worth investing just a few hundred pounds in one go.  Or I may change my mind and move it onto my Bonds ETF as I want to get the bond allocation up towards 20-odd percent as part of my stock/bond split described here.

On January 12th Northamber paid out a dividend of £177.45.  This will likely just sit in cash until I have enough to make a purchase worthwhile (due to commission costs etc).

I first bought Waterman on October 22nd 2009.  I had recently sold Harvard International for a profit of £4,102.82 and needed somewhere to put the proceeds and some additional cash.  Waterman marked a slight change in my rules.  Whereas before I would only invest when a company was trading below 2/3 of tangible book, I decided to allow intangibles into my valuations.

The idea is that on average intangible assets do produce economic benifits (i.e. earnings) to justify themselves.  I have no evidence to support this other than that the majority of companies I have looked at have traded above book value, including intangibles, at some point in the last five years.  Allowing intangibles into my valuations also expands on the sorts of companies I can invest in, such as Waterman.  Waterman an engineering and environmental consultancy group where goodwill has been paid for mergers or aquisitions in the past.

A much more extensive and interesting report on Waterman has been recently written up by Richard Beddard whose Thrifty 30 is broadly similar to what I’m trying to do, but is very different in that it’s earnings rather than asset driven.

This purchase has already been updated onto my Trade History.

Electronic Data Processing is a company I bought recently. I’ve since found out that they bought back half the shares for 6 million pounds just after the most recent financial report. The web sites that I use to filter stocks have the new number of shares (12.5 million, down from about 25 million) but have the cash balance as at the last statement, £8 million, rather than the actual amount post-buyback of around £2 million. So the NTAV isn’t 13.5 million, it’s 7.5 million, so the market cap of 5.8 million isn’t below half NTAV, it’s about 80%… there’s a lesson in there. READ the last few reports rather than just the latest one!

The same kind of thing happened recently with Abbeycrest, where they issued 40 million shares at 5p each for £2 million. But the shares have a market price of 9.5p so that blows the price to tangible book ratio up to over 1 since 40 million shares are now priced at twice the equity they raised! I’m not sure what to do about this. My theory is that I’d sell since I can get more selling the shares than I could by selling the company assets. But I might wait until the next financial report to see how this all shakes out. I may do something similar with EDP mentioned above.