London Value Investor Conference, May 2014 - Part 2 - Charles Heenan

29th Jun '14 by Paul Scott

5 comments 5894 reads

This is the second in a three part series of articles from the May 2014 London Value Investor Conference.

Part one, on Jon Moulton's speech is here.

This article concerns the speech from Charles Heenan of Edinburgh-based Kennox Asset Management, who describe themselves as "true value investors". I very much like the approach that Heenan outlined & illustrated in his speech.

Although on checking Citywire for the performance of their fund, it appears to have only been average over the last five years - it is ranked 93rd out of 197 in its sector. Although note that it scores very well for risk, and limited drawdown (9th and 10th respectively out of 197), so I suppose they would argue that they are meeting market returns, but with lower risk, which has something to be said for it.

However, these returns really are nothing to write home about, and if I couldn't beat the sector average over five years, personally I'd go back to the drawing board on strategy. Hmmm, does that undermine the speech too much in advance? Maybe I should move this section to the end? No, facts are facts, so I'll leave it here, as it was still a useful speech.

The Joys of Pessimism

A quirky title for the speech, and Heenan began by quipping that he's been a pessimist from an early age;

I always carried a raincoat as a kid!

So the theme of this speech was all about how pessimism can help you make better investment decisions, and is an advantage in value investing.

He explained how his Fund is long only, unhedged, and concentrated - 29 stocks at the moment - which doesn't sound very concentrated to me. Maybe he meant in terms of weightings? On checking Citywire again, their largest holding is 5.35% in Statoil ASA, then 5.06% in Royal Dutch Shell, 4.75% in Western Union. That may be concentrated by fund management standards, but it's not concentrated in private investor terms - many of the best performing private investors I know quite routinely put c.20% of their portfolio into their top stock - which is why they out-perform, because they concentrate money into their best ideas, and usually get their best ideas right!

Heenan explained how they find cheap companies, then question why the company is cheap. "Can we get conviction?"

Fujikon Industrial Holdings (927:HK)

Heenan…

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jetstar

29th Jun '14

Written on a Sunday! maybe 'cos there's no tennis?

Anyway thanks

Paul

toddwenning

Thanks, Paul. Seems like "scepticism" would have been a better label for him to use than "pessimism", but maybe I'm just splitting hairs. Still, I fully agree with him that investors should be careful not to extrapolate growth off of peak-earnings.

Finding that mid-cycle or "normalised" profit level is a challenge. One trick I use when valuing more cyclical companies is to take the average ROE over the last business cycle and multiply it by the current book value to arrive at a normalised net income figure.

Best,

Todd

Sully8786

3rd Jul '14

Thanks Paul,

Where do you think we are in the cycle at the moment? From your reports, I'd say quite late??

The Zulu Principle has some handy pointers to help spot the cycles and type of market. I'm keeping my eyes wide open at the moment :|

Best,

Sully.

Paul Scott

5th Jul '14

Hi Sully8786,

Where do you think we are in the cycle at the moment? From your reports, I'd say quite late??

It's tricky to say. As regards the economic cycle, we're probably in the relatively early stages of an economic recovery, which could run for say 5-7 years. Although that's complicated by distortions caused by interest rates having been left too low, for too long (e.g. pushing house prices up to unrealistically high levels in the South, relative to incomes).

As regards the stock market cycle, we would appear to be in the late stage of this bull market, which is confirmed by euphoria taking hold, especially in smaller caps, the glut of IPOs, both classic signs of an overheating market. QE is also distorting things heavily, as that directs money into the stock market and property, as bonds and savings accounts are so unattractive when interest rates are near to zero.

Although the bubble has burst for many stocks that reached euphoric valuations, and we've had a bucket of cold water thrown over us in Q2 of this year in small caps, which is very healthy in my view.

I just ensure that I don't overpay for anything, and if stocks I hold get too pricey, then I sell them. That discipline should stand you in good stead wherever we are in the cycle. Whilst it feels like there should be a major correction in equity markets, and everyone seems to be expecting one, you don't get bear markets starting when the economy is in the early stages of economic recovery. Why would you get a bear market, when earnings are rising, confidence is returning, and the signs of increased investment are all around us - building work increasing, businesses expanding and taking on more staff, etc. It feels like an economic recovery in the South anyway, although it doesn't seem to have flowed up to the North yet.

So to my mind, a correction is needed, but I don't see a bear market as being likely in equities.

It's all guesswork though! As long as we're in good quality stocks, which are reasonably priced, then we should do fine in the long run. Best not to agonise too much over the market as a whole, as it's unknowable.

Regards, Paul.

6th Jul '14

Hi Paul,

Thanks for your reply. I hear what you say regarding some valuations and re reading the section from the Zulu Principle does tend to suggest that we are near the top.

A couple of things make me wonder though.....

1. The forecast PE is just under 15, whilst not cheap it doesn't seem too expensive either.
2. There seems to be more worry around than optimism - I don't see too many people saying that stocks are the way forward.

As regards my portfolio, I think that the forward PE is under 10 supported by a forward yield of around 5% but I suspect I shall be starting to build a cash position going forward :)

Best,

Sully.

London Value Investor Conference, May 2014 - Part 2 - Charles Heenan

The Joys of Pessimism

Fujikon Industrial Holdings (927:HK)

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Paul Scott

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