Small Cap Value Report (12 May 2017) - FTC, IPX, ETO, TTG

TT Electronics entered a conditional agreement for the sale of its Transportation Sensing and Control division to AVX, for £118.8 million on a cash free, debt free basis. As a result of the disposal, TT Electronics will be in a much stronger position to focus on its strategy of investing in structural growth markets where there is increasing electronic content, with the benefit of significantly enhanced financial capacity.
Share price is up 8% on this news. Could be a lot further upside to come from this now they are better positioned.

Regarding the UK market, Stockopedia's home page currently has the median PE ratio at 14.5x, dividend yield at 3.13% and earnings growth at 13.8% - those seem like entirely normal metrics to me (taking into account that earnings forecasts usually do tend to be overly-optimistic at the market level).

Furthermore the headline FTSE100 index has heavy weightings of commodities and financials - sectors which have been out of favour for the past few years and which would benefit hugely from higher inflation if it does come through. Considering stock markets are priced nominally, if you gave me a choice I'd put my money on the index being 10,000 rather than 5,000 in a few years' time.

However I have thought that the US market has been verging on overvalued for the past couple of years, and if it corrects others will follow. My main concern is we're clearly coming to the end of a multi-decade bull market in bonds (since the early '80s!). While you theoretically can't lose money on bonds when held to maturity, this is a huge beast of a market where investors have gotten used to capital gains, and these will soon turn into paper/mark-to-market losses when yields do rise.

Thought provoking discussion on where we are in the market cycle at the moment.  An often used analogy is that as investors we are "climbing the wall of fear" - as the market goes up the views improve but there is a growing fear that as and when we eventually fall off we come down with a harder bump. The less risk averse climb down into cash earlier, the braver/more foolhardy keep climbing (often fueled by leverage) and either get down in time (having made more on the ascent) or end up in the back of an ambulance (or hearse!).

I'm by no means a TA (and apologies to those who are if the following stream of consciousness jars), but in the spirit of “a picture painting a thousand words” I thought the attached chart might be worth considering:-

The main chart gives a long term monthly view of the FTSE All Share index since 1981 (the maximum data set on Stockopedia) re-based on an exponential basis (otherwise the current data trends would swamp the old).  I’ve superimposed the Bollinger Bands as well as two simple long term moving averages for 12 and 60 months.  At the top there is a chart of the RSI for the same period.  A few observations:-

• The chart shows a generally upward trend with 2 major corrections in 2000 and 2008 with historically minor downturns in 1987, 1994, 2011 and 2015.  Interesting to note that for those with a relatively short term investing experience, the bumps in 2016 in Jan/Feb and post Brexit vote that seemed pretty bad at the time barely register.
• These market corrections tend to follow on when the positive divergence between the shorter 12 month moving average is furthest away from the longer term 5 year moving average.  At the moment the gap is quite marked but perhaps not as wide as 1999 and 2008 (I’m doing this by sight – a more thorough analysis of the underlying data is probably required).
• There seem to be numerous instances where the market drops but appears to bounce back up from the shorter 12 month moving average.  When it does cross below the 12 month average this often, but not always, presages a significant further sell off.  We are well above both moving averages at the moment.
• The 12 month moving average has only crossed down through the 5 year trend on two occasions and both times there was a significant further sell off after this point in time.  Not so much a leading indicator as a prompt that things can go from bad to significantly worse if and when the market does turn.       
• We are currently at the top of the Bollinger Band range having bounced off the bottom seen in 2015.  In previous parts of the long term cycle this has been a point of resistance from which there has been a downward correction of varying degrees.
• The RSI chart at the top shows a small number of periods where the RSI has risen above 70 (often interpreted as a sign that the market is “overbought”).  These can last for several years but in the three cases where the market has been at this level for an extended period this has been followed by three sharp downward corrections. We are currently nudging up against the 70 level but are not presently “in the red”.  To my untrained eye this appears to be quite a key indicator as to an impending downturn although I would add that plenty of money could have been made by investors from holding on during the “red zone” which can last for a few years provided they manage to bail out in time.
• In a similar vein, the MACD in the bottom chart suggests we are below the 1999 and 2008 peaks but still in slightly elevated territory.

The chart is deliberately long term with slow moving averages to try and give more of a historical perspective.  One thing I have learned in 30 years or so of investing is that when bombarded with the daily market cacophony of “white noise” it is really difficult to take a step back and see the bigger picture (terrible mixed metaphor!).  In my layman’s view, while the markets might seem “expensive” at the moment, I think we are in the upper quartile of valuations rather than being at or beyond boiling point. 

Absent a “new paradigm” giving a step change in market valuations (which I agree with an earlier comment is usually a good indicator of when to head for the exits), the odds seem to be moving towards downside rather than upside but in the meantime could well run up further (nothing like sitting on the fence is there?).   Whether the downside is one of the occasional tsunamis a la 2008 or 1999 or just a short term corrective blip like 1987 or 2015 is moot.  Perhaps perversely, the longer the markets bulls continue to climb up the wall the harder the bump when we eventually fall off.  Given the often mixed messages of where we are in the cycle I’ve found it beneficial to avoid going “all in” on a particular strategy holding a pretty widely diversified portfolio of different asset classes and asset types within the classes.  Probably more cash and defensive assets at the moment than this time last year but still happy to keep a decent exposure to good quality stocks and funds (and a few Sucker Stock dogs as well).

Gus.

Anybody else worried that some companies may have been affected by the global ransomware attack?

The nightmare scenario is having all their data encrypted and no backups.

Interesting discussion here from the bulls and bears.

I noticed a few comments about the "safety" of large cap, defensive stocks. I agree these stocks tend to have lower volatility and can be good investment choices for risk off situations. However, in my opinion, all stocks are inherently risky. Just because you hold a portfolio of large cap, defensives such as Tesco, Unilever or British American Tobacco doesn't mean you are immune from irrational behaviour of investors/traders panic selling in a market correction. Just look at Sainsbury's share price in 2007/2008...

For me, the transition must be between equities & cash/bonds, not speculative and defensive stocks. Although the relative strength of defensive stocks are higher than speculative shares in bear markets, that does not necessarily equate to positive absolute gains.

I use technicals to identify whether we are risk-on or risk-off (Minervini inspired) and scale back into cash when appropriate. The technicals on my stocks are still bullish so I don't need to panic just yet. When the technicals begin to weaken i.e Burford Capital then I sell and lock in my gains.

I don't know if anybody out there has friends who can talk through an issue like this with - I know I haven't, which is why these bulletin boards/forums exist. Certainly most of my friends wouldn'know a PEG from a clothes line. But I do have one pal who is more of a trader than a long investor who i meet once a month.
For the last 6 months our conversation begins with "when is this bull going to stop". We still don't know and more to the point we still don't know what the trigger will be - Italian election, car buying on PCP, Brexit problem, mountainous debt, Corbyn winning the election, Trump emigrating to Russia, rampant inflation, ill judged interest rate rises- take your pick.

However we like to look at it, being hugely weighted in cash is sleep worthy but but not wealth enhancing. What I have not heard of yet is a mention of bonds. When I seriously started to make use of money from early retirement (after the 2007 crash) my thoughts about structuring a portfolio turned first to income (we all know about the reinvestment adage) to supplement pensions. With that in mind I looked at the ORB and the plethora of retail corporate bonds yielding a minimum of 5%. With this you get guaranteed payback (I trust) and a good yield. I know the new issues market has dried up but even now at heightened prices there is some security in this. I personally have about 30% of the portfolio in this area.

With this yield bias, first mega caps (little gains) were added and as more security was achieved small caps have turbo charged my portfolio so much so that like everyone else I do not wish to lose out.

My point is that it's not just a binary issue , cash or equity, there are other options.

My other point is that share prices are not just about Macro economics (yes baby and bathwater), good quality small caps with international exposure and no gearing are still good investments - maybe it's a question of the quantity of quality you are prepared to hold. A time for weeding or re evaluation maybe.

As always the decision is yours - just don't wait until circumstances decide for you.

Look forward to the ever interesting daily discussions

Steve

As a buy-and-hold investor all that really matters to me is that I'm comfortable owning the companies I'm currently invested in and I have confidence that those companies will provide a long-term stream of income that will on average grow over time. This is very much Buffett's view I believe, and he has stated that he takes no interest in the day-to-day movements in the prices of the shares he owns and is only concerned with the fundamentals of the businesses themselves.

He laid out his philosophy on pages 18 and 19 of Berkshire Hathaway's 2014 letter to shareholders, and I was comforted to find it matched my own approach (classic confirmation bias?). A couple of selected paragraphs:

"For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."

...

"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."

Despite getting a kick out of seeing a sea of green when I open up my portfolio screens in the morning, I don't particularly like it when markets become highly valued, and unless I think the world is about to come to an end (in which case it doesn't really matter what happens to the portfolios I manage) then I welcome major panics and corrections as it simply means that I'll be able to buy more stock at lower prices, both with fresh cash that I've been accumulating and from dividend reinvestment.

I was somewhat surprised at the reaction to my comments a couple of days ago on the SCVR regarding the potential threat of driverless cars to long-established businesses in the motor distribution chain, but it made me realise that many Stockopedia investors likely have equity holding periods much shorter than mine. I have no problems with that and I'm sure for many it's a very profitable strategy - it's just a modus operandi that I'm uncomfortable with because I've never been successful at short- or medium-term trading and I'm a poor market timer.

In short, I like to sleep well at night whatever equities are doing, but if we do have a 30% market decline then I'll be the proverbial kid in the sweet shop.

This should be a discussion for Moday when the markets are open, not Friday when we have a weekend to worry about it all!

Yikes... this thread is giving me the jitters.
I'm heading over to ADVFN (might take the ostrich with me).

I think at this point of the cycle it's relatively easy to construct plausible sounding arguments on both the bull and the bear side.

Sure the markets look expensive but they can continue to look expensive for extended periods of time, so that by itself should not be considered a sell signal in my opinion.

I'm staying mostly invested but continue to watch the index trends closely as well as the wider macro picture.

There seems to be lots of advice that basically says you can't time market purchases etc. Which I obviously would agree with, but perhaps the time is ripe for another series of Stockopedia notes on the broad issue of exposure in a bull market.

Its like all sage advice it has to be keep given, because the old monkey mind is always jumping about. I suspect most on here fear that all the considerable time and effort invested in investing in this market, and associated gains could simply be wasted in effect, if a meaningful retrenchment comes along.

Now where's that banana!?

Here is a thought You started with a £100k at the beginning of January and you are sitting on a gain of 20%, most on this site will probably have more than that. You would have to have £4million or more in the bank to give you the same return. Investment is about beating cash, is that not a fair reward. If you cashed in and waited until you felt more comfortable about what is going on and the market continues to go up it will be a long time before you are worse off for being in cash. Wealth isn't always created in a hurry, that famous Rothchild quote when asked how come he was rich, still stands today, sometimes it is wise to leave the last ten percent for the next man.

I've read pessimistic commentary from lots of people for years now saying how the market is expensive and a crash is coming imminently and so on. Most of those have missed out on big gains due to their pessimism. Yeah we'll have a correction at some point but I'm not worried.

I share your concerns simoan. My portfolio definitely has a smallcap bias - the majority are high QM "high flyers" and a mix between balanced, adventurous and speculative. I don't use leverage and mainly insist on an income stream from my holdings. The stand out observation in my PF is the low value rankings. So yes, I would expect those valuations to correct at some point.

But therein lies the dilemma, "at some point". All of the smallcap growth shares in my pf are reporting strong results, a fair few are ahead of expectations with broker forecasts being upgraded. The tech sector is going through a bit of a purple patch business wise; next gen smart phones, augmented reality, the data revolution, SaaS solutions with recurring revenues, robotics, machine learning, fintech, adtech - the US is key to many of these sectors of course and if Trump gets his corporate tax cuts through, these companies are going to be making more money and throwing off even more cash. I can sort of understand why we are in such a strong bull market.

This feels to me like the whole initial internet boom and Y2K thing. Many, many people were calling the top a year or two before it all came tumbling down. But before that happened, fortunes were made (and some were subsequently lost) but only if you were in the market, owning the high flying shares.

I think the UK itself is in a different and precarious situation. Just around the corner we have rising inflation, rising interest rates and the challenge of extricating ourselves from the EU. My own take on this is that a lot of internally focused UK companies could begin to unravel this year with profit warnings and reduced outlook statements. Personally, I am mainly avoiding these companies and focusing more on exporters and those with a decent portion of trade in the US, in particular.

The other factor to consider with UK shares though is the prospect of increased M&A activity which I believe has already started - Waterman (LON:WTM) being a good example just this week. This could fuel the markets still further.

The other action I'm taking to try and benefit from this bull market while also being mindful of the downside risk of a crash/correction is to regularly top slice (and I mean "slice" not "chop") my winners into more defensive holdings which will also serve to increase the diversification. The problem with going into cash is that it hurts both the growth and income of your portfolio as I found to my cost last year when I held c40% cash between June and October.

Regarding leverage being used on smallcaps, I suspect the launch of Stocko's risk ratings will serve us well. My own hunch is that those shares that have more leveraged positions are more likely to be highly speculative and speculative (although the wide spread on some smallcaps also increases the volatility). Personally, I have a lack of conservative ratings, so when I do my next rebalancing, I will be adding more ballast to my pf - larger caps, conservative risk rating, high yields.And I will continue to feed these holdings so long as my growth holdings are growing. I'm sure I'll still take a hit when the music eventually stops but hopefully, I will have recycled sufficient cash into defensive holdings to a) absorb the shock and b) provide funds for value hunting in the aftermath.

You asked!!!

Cheers
Simon

Graham,
Do you not think the market undervalues the potential monetised value of the Peppa Pig brand to ETO? Putting a value on this do you think the stock looks cheap?
Thanks

Filtronic, know them well both as a supplier and a customer. Wouldn't touch them with a punt pole. Mngmt seem to run from crisis to crisis, the thing needs taking private.

IPX, the spread is far too big and the Value Rank is way out of my league.

The current market cap is just 2% of AuM, which strikes me as rather low. Depending on their fee margins, many active asset managers trade at higher levels than that - for example, Jupiter Fund Management (LON:JUP) is currently trading at 5% of AuM.

Of course, it's possible that Jupiter Fund Management (LON:JUP) is overvalued too, but I'd be inclined to think it's more likely that Impax shares are still too cheap, despite how much they've already risen.

It could also be that the assets held by Impax Asset Management (LON:IPX) are far riskier and so a suitable discount is being applied by the market? It certainly seems that way to me when I look at where they are invested. Sometimes new approaches to things are unique for a reason! :)

BTW before I get flamed, I hold some £IPX!

All the best, Si

A lot of buy orders for Waterman this morning at 140p, the price offered by bidder ITC. Pure speculation, or do some people know more than I do?

I am a happy holder.

Richard

Hi Simoan. I am also slightly concerned but at the same time I fear that I would seriously regret it if I sold up now and watched all my holdings go up another 20%. My portfolio is currently 25% leveraged but as a complete amateur I'm fairly sure that isn't sensible and probably a pretty clear cut case of irrational exuberance. My personal view is that I am so far into profit in the last 12 months that even if my portfolio took a 10% haircut, I would still be in a good place. With that in mind I keep a mental 10% stop loss on growth shares and leave a little more room for manoeuvre on value shares. The big question is how easy will I find it to sell a share I like on a 10% drop. I guess only time will tell.

Hi Ben,

I suspect you are not alone in this position and that is why I asked the question. I think you need to consider what happens if you wake up one morning to find the market has tanked overnight, liquidity has dried up in the smallcaps you hold, and you have a margin call on your SB account? A 10% stop loss won't mean much in that scenario. I think it's been too long since we've had to consider this scenario as investors, and I feel there is now considerable complacency in the small cap retail market. 

Thanks for your candour, even though it's only reinforced my concern :)

All the best, Si

Hi Graham,
I know that Eagle Eye (EYE) is low on the Stock Rank register, but it might prove a future growth stock, so I have opened a small "starter" holding on this mornings announcement of a three year contract with John Lewis.
I would be very interested in your thoughts.
Nick

Thanks for the report on Impax Asset Management (LON:IPX) Graham, I am seriously tempted to have a dabble here, I am struggling to see what's not to like. What a great service you and Paul provide. Expert reports on request, well worth the Stockopedia subscription alone and that's not accounting for all the fantastic work Edward and his team do. Thanks also to Dave for flagging. I do think the sharing of information between readers is a big part of what makes the SVR such a great tool for people like myself who are at the very early stages of their investing career, and experienced hands alike.

Hi all,

Being as it's a Friday I hope others will indulge me in attempting to start a general discussion about valuations in the Small Cap space. It seems every time I bring up a StockReport the growth, value and quality bars on the right are a sea of yellow, orange and red and the chart looks like the north face of the Eiger. At first I really liked the colour scheme used by the StockReport but now I'm starting to think that maybe they are having a psychological effect on my normal thought processes.

I feel uneasy about valuations at the moment and that I've seen this story before and know exactly how it ends but at the same time seem completely powerless to act. It's psychologically very difficult to sell shares when you have cash to invest as I currently do, especially when everything is heading north at a rate of knots.

What particularly concerns me is how much of this is due to leveraged long positions. I never use leverage but would be interested to know others thoughts and how much leverage they currently have in small caps.

All the best, Si

Hi Graham, definitely interested in your thoughts on Impax.
A few years ago there was some question about the scaleablity...when they got above £5bn AUM were there enough assets for them to invest in? And also as "sustainable" investing becomes more mainstream, competition increases.
Disclosure...I own it. But interested in your thoughts.