When I added AstraZeneca to my portfolio in mid-2015 it was the second time I’d invested in this well-known pharmaceutical company. The reasons for both investments were more or less the same:
AstraZeneca appeared to be a fundamentally sound company with a good track record and a strong balance sheet.
The share price appeared to be attractive because of the uncertainty caused by its “patent cliff” (where major blockbuster medicines see their profit margins collapse as patents expire).
The investment basically came down to a few assumptions which were directly related to those two reasons:
AstraZeneca had a long history of profitable medicine development, so new medicines might be developed quickly enough to replace the old.
The company had a strong balance sheet, so it could use debt to fund research and development and/or the dividend during the lean years.
At some point, investors would probably become more optimistic about Astra’s future and the share price would go up.
And that’s more or less what happened, although the final results were satisfactory rather than spectacular.
Dunelm’s share price has fallen by more than 40% over the last two years.
Part of that decline is due to the market’s Brexit-related dislike of UK-focused cyclical stocks, as some fund managers have pointed out.
However, some of the decline is likely due to increased uncertainty about the company’s growth potential and its ability to compete in the new world of online and mobile shopping.
But before I get into that, let’s back up a bit and have a look at how Dunelm got to where it is today.
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.
For many dividend investors, the demise of Carillion was a disaster.
Not only did their portfolios lose an important source of income, they also saw a permanent loss of capital.
As usual, it’s easy to see what went wrong with hindsight, and in the August 2017 issue of Master Investor magazine, I wrote about some of the key lessons from Carillion’s collapse.
But in this case, hindsight was not necessary, and the problems with Carillion were easy to spot even several years before its eventual demise.
Of course, simply saying Carillion’s problems were easy to spot is of no use to anybody, so rather than do yet another Carillion post-mortem, I thought I would apply a little foresight and look for companies with similar “red flags” which investors might want to avoid or get out of.
One of your primary goals as an active investor should be to extract as much educational value from each investment so that the lessons learned can be used to create additional financial value in the future.
That’s why I always carry out a post-sale review as soon as I make the decision to sell an investment.
Galliford Try is currently the highest-yielding housebuilder with a dividend yield of 8%. That’s a very high yield, but is it enough to offset the risks of this notoriously cyclical industry?
2017 was another year of above-average investment returns in what is now a very old bull market.
As with previous year-end reviews, I’ll review my model portfolio’s performance against its various goals as well as the performance of the individual stocks I sold in 2017.
When I switched from deep value investing to defensive value investing in 2011, the first stock I purchased with the new approach was BP.
Six volatile years later, this has turned out to be a mildly disappointing investment. That’s partly because of bad luck, but it’s also because I paid too much in the first place. That’s a mistake I don’t plan on making again.
2017 is drawing to a close. I’ve already published my year-end FTSE 100 and FTSE 250 market reviews, so now it’s time to round up the most popular blog posts of the year.
As regular readers will know, I think many low-risk defensive “bond proxy” stocks are probably too expensive.
Although I usually only talk about UK stocks, I thought I would take a look at two high-profile examples of the bond proxy genre from across the pond: Coca-Cola and Microsoft.
Over the last 20 years, the performance gap between the FTSE 250 and FTSE 100 has been enormous.
While the FTSE 100 has spent most of the last 20 years failing to beat its dot-com peak, the FTSE 250 has raced ahead. In fact, it’s now almost three times higher than it was during the tech bubble.
So what does that say about the FTSE 250’s valuation today? Is the FTSE 250 in some kind of runaway bubble fuelled by quantitative easing and super-low interest rates?
2017 is drawing to a close, so once again it’s time for my semi-regular UK stock market review.
In this case, I’ll be looking at the FTSE 100’s current valuation and making a fact-based forecast for 2018. I’ll also use that same approach to make a forecast for the next decade.
In my opinion, the FTSE 100’s valuation is more important than any forecast, so let’s have a look at valuation first.
Reckitt Benckiser is a name which came up several times following my recent, mildly negative review of Unilever.
In many ways, Reckitt Benckiser is in the same boat as Unilever. They’re both companies which are highly valued because of their historically low-risk, steady growth characteristics.
That’s why they’re sometimes referred to as “expensive defensives”.
But in recent years, Reckitt Benckiser has generated little in the way of steady growth.
To fix that, management has decided to spend more than £14 billion acquiring Mead Johnson Nutrition, a global leader in infant nutrition.
This could be a smart move, but from where I’m standing the acquisition may have turned Reckitt Benckiser into a high-debt, low-growth timebomb.
Reckitt Benckiser’s growth is going, going gone?
Let’s start with the reasons behind this acquisition; primarily, Reckitt Benckiser’s relatively weak growth over the last few years.
I say “relatively weak growth” because context is important here.
In the good old days of 2012, you would have seen a company riding the crest of a wave. Reckitt’s growth had averaged 17% per year over the previous decade and very steady growth it was too.
This made the company very popular with investors and their enthusiastic buying pushed the share price up from £40 to more than £80 over the last five years.
More recently though, the company has repeatedly failed to live up to the market’s expectations and the shares have fallen back below £65:
Growth has virtually flatlined in recent years
Today, Reckitt Benckiser’s ten-year growth rate is a modest 5%. Even more worrying is that growth over the last five years has virtually ground to a halt.
Yes, the 2016 results saw a decent uptick, but that was largely to do with Brexit and the subsequent devaluation of the pound.
How so? Because more than 90% of Reckitt Benckiser’s revenues are generated outside the UK, so when the pound goes down, Reckitt Benckiser’s revenues (reported in GBP) go up.
So if we ignore Brexit then the company’s recent growth has barely kept up with inflation.
This is not good and there are myriad reasons behind these results. They range from one-off mistakes to potentially wide-ranging changes in how consumers view global premium brands (i.e. not as favourably as they once did).
I’m sure many of the institutional investors who jumped on the Reckitt Benckiser bandwagon are not especially pleased with the way things have gone these last few years.
I think it’s likely that huge amounts of pressure have been put upon management, by investors, to pull their fingers out and start generating some growth, pronto.
In response, management decided that if they couldn’t generate growth organically, they’d simply go out and acquire it.
Growth by acquisition can be a dangerous game
And by “acquire” I mean big acquisitions, starting with the acquisition of Mead Johnson for a little over £14 billion.
That’s a huge acquisition, even for a £45 billion company like Reckitt Benckiser.
It is, in fact, more than seven times Reckitt’s recent post-tax profits. And for context, I define any acquisition which exceeds a company’s recent average profits as “large”, so this acquisition is seven times bigger than my definition of large.
There are pros and cons to an acquisition of this size, of course.
On the positive side, Reckitt Benckiser’s revenues, earnings and dividends will jump up in its next annual results.
That’s because Mead Johnson brings with it revenues of around £3 billion and post-tax profits of around £0.4 billion. These will provide a healthy boost to Reckitt Benckiser’s existing revenues and profits of almost £10 billion and £2 billion respectively.
So revenues, earnings and dividends will all increase and Reckitt Benckiser will own the world’s leading infant nutrition franchise. What’s not to like?
In a word, debt.
To afford this £14 billion acquisition, Reckitt Benckiser has increased its debts from an attractively prudent £2.4 billion in 2016 to an eye-watering £17.2 billion today.
In terms of the important debt-to-profit ratio, that increase takes Reckitt from 1.4 in 2016 (comfortably below my preferred maximum ratio for defensive companies of five) to a palpitation-inducing 9.7 today.
This is, in my humble opinion, insanely high and fortunately, it seems that management agrees.
To reduce debt and re-focus the business around its health and hygiene core, the food business (which includes famous brands such as French’s Mustard) has been sold.
This should raise around £3.2 billion, which will be used to reduce the company’s enormous debt pile to about £14 billion.
And let’s not forget, the acquisition will boost profits by about 25% which will also reduce the debt-to-profit ratio.
However, even accounting for these factors, Reckitt Benckiser will still have a debt-to-profit ratio of more than six, which is comfortably above my preferred maximum for defensive companies.
A one-off unsustainable growth spurt
Another problem with debt-fuelled acquisition strategies is that they are usually unsustainable.
In this case, Reckitt Benckiser has boosted revenues, earnings and dividends by 25% or so by borrowing money to buy another company.
However, that’s a one-off event and post-acquisition growth for the combined business is expected to be low single-digit.
If management wants another easy acquisition-driven growth spurt, they’ll have to take on even more debt, which will make the company even more risky than it is today.
Hopefully they won’t do this, but you never know.
Expensive defensive or high debt, low growth timebomb?
Okay, perhaps “timebomb” is an overstatement.
Reckitt Benckiser is still a defensive company selling market-leading, premium-branded health and hygiene consumer goods.
But it is a statement of fact that the company has produced very little real growth in recent years and that it is more indebted than almost any other defensive company in the FTSE All-Share.
So although Reckitt Benckiser is still defensive (i.e. not particularly affected by recessions), I don’t think it’s a low-risk company. Its debts are simply too high for that description to be appropriate.
And because I don’t think it’s a low-risk company, I don’t think it deserves a premium price, and yet a premium price is what it has today.
With the shares at £65.50, the dividend yield is just 2.4%. Even if we assume that next year’s dividend is 25% higher than this year’s, the yield only goes up to 3%.
That’s still below the FTSE 100’s dividend yield of 3.9%, or perhaps 3.5% or so if you buy an index tracker.
Or if you don’t trust the dividend yield as a valuation metric, you might want to look at price relative to earnings over the past decade.
And here again, Reckitt Benckiser does not exactly look cheap. PE10 (which is what I call this ratio) is about 18 for the FTSE 100 and about 28 for Reckitt (or 26 if we factor in 25% higher profits in 2017).
That’s a big difference and it underlines my feeling that Reckitt Benckiser is not only a high debt, low growth defensive stock, it’s also an expensive defensive stock.
I would buy Reckitt Benckiser if…
I still think Reckitt Benckiser is a reasonably good company and I would invest again (having done so not once but twice before), but only under these conditions:
Debts are reduced – Those debts would have to fall below £11 billion at least, and preferably below £10 billion (and preferably much lower than that), and
The price is reduced – The share price would have to fall below £55. At that point, the forecast yield could be as high as 3.5% and, more importantly, the company would enter the top 50 stocks on my stock screen.
However, my guess is that the debt-reduction process will take many years, so don’t expect to see Reckitt Benckiser in my portfolio anytime soon.
In this blog post, I review my decision to buy Rio Tinto shares in 2012, and my decision to sell them last week.
Here’s the executive summary:
Rio Tinto was a volatile investment with some extreme ups and downs, but when I eventually sold its shares the returns were okay.
The investment also rammed home the importance of buying highly cyclical companies at extremely low valuations, which is something I recently learned from my investment in Braemar Shipping.
Unilever PLC is one of those defensive income stocks that investors love to love.
In fact, investors love Unilever shares so much they’ve pushed the price up from £25 in 2015 to a recent high of £45.
Does this mean it’s too late to buy Unilever shares? Or if you already hold them, should you keep holding or does the price increase make this a good time to sell?
Here’s a quick update on my high-yield, low-risk portfolio, which has now doubled in value over the last six years.
Hopefully, this review will give you some ideas about how you can perform your own portfolio review, which is a critical part of being a good investor.
The first thing is to review your investment goals.
The stock market doesn’t offer shares with high yields without good reason.
Sometimes the companies are out of favour with investors because they’re having a bad PR day, but nothing more.
In other cases, the company might be in serious trouble with a dividend that is about to be cut.
Most high-yield shares sit somewhere in between. The risks are clear if you look in the right places, but how they’ll affect the company is far from obvious.
In this blog post, I’m going to look at two companies sitting in that middle “danger zone”.
