Small Cap Value Report (3 Jan 2017) - My Investing Themes For The Year

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3rd Jan '17 by Paul Scott

70 comments 33812 reads

Good morning!

There's literally nothing on the RNS today, in terms of results or trading updates for my universe of stocks. However, I'm in the mood to write an article, so thought I'd do something on my investing themes for 2017. This has been partly stimulated by me reading Gervais Williams' latest book, "The Retreat of Globalisation" over the holidays - which is an interesting macro overview of how Gervais sees things developing.

My approach with stock-picking is based on trying to find value & GARP (growth at reasonable price) shares. I look for shares with at least 50% upside, which are either;

Fundamentally under-priced as things stand now. Good examples last year were Lavendon, and Avesco, both of which just seemed the wrong price to me, as highlighted in these reports. They both attracted takeover bids, which was terrific.
Or, companies which may not look particularly cheap right now, but which have the potential to significantly out-perform against unreasonably pessimistic broker forecasts (a good example was Gear4Music, in which I hold a long position). And/or companies which are growing strongly, but this has not yet been fully reflected in the rating.

However, for me personally, I will flex my approach somewhat to suit market conditions. This has involved a notable shift in 2016 from value shares, more towards growth stocks. I've done that partly because my value shares kept attracting takeover bids, hence left the market, and giving me fresh (and increased) funds to invest. Also because it was increasingly obvious as 2016 progressed that it was the growth stocks which the market was getting excited about, and were rising in price. So if you spot a clear trend, then it makes sense to follow it - providing valuations don't get too bonkers.

Anyway, it worked well in 2016. Although I don't know whether the same trends will continue in 2017 - anything could happen. That uncertainty is why I don't tend to think too much in top-down terms. I can't possibly forecast what the world, or UK economies will do in 2017 and beyond, I haven't got a clue - and nor has anyone else!

However, there are some clear themes which are guiding my thinking for 2017. So I thought it would help clarify my thinking, and maybe you might find it interesting. So here goes.

My investing themes for 2017

Higher inflation - caused by the sharp fall in sterling against the dollar.…

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simoan

3rd Jan '17

I also work in data security and so understand only too well the problems you describe associated with IoT devices. Like all new technologies, it will take far longer to unfold than many people expect, and it will introduce as many problems as it solves. For all the good things, it will also introduce privacy and data security issues that most people cannot even start to imagine.

Apart from anything else, achieving proper security takes time and is expensive which is completely at odds with the make it quick and make it cheap modern culture.

All the best, Si

herbie47

Is that a buy signal?

ds1980

Leasing is the only thing keeping their businesses going. 18k is standard these days for oil changes and service intervals however uncomfortable you feel about it.

LE4R

As mentioned by more than a few - thanks for your informative and thought-provoking comments, Paul. A great effort for the first trading day of the year!

On the subject of the shift in the High Street, I would agree. I used to work at a RE investment manager in London and we had a designated shopping centre strategy - less focused on the shiny number one centres (westfields and the like), but more those focused on everyday staples / the value offering. I had my concerns about the longevity of this approach, given the direction of travel that you cite in your article, but one thing was abundantly clear: adding F&B was a winning formula. On the one hand, F&B tenants were performing well and signing good leases improving the NOI, but, more importantly, they were increasing dwell time and general spend in the centres. I recall seeing a very detailed piece of research - by CBRE, I think - confirming this y-o-y increase to F&B in centres, with figures now as high as 25+%, suggesting our experience was not unique! As you suggest, 'retail therapy' morphing into 'leisure therapy'.

Casabanker

Thanks for your reports in 2016. Paul, I always find them interesting and value the findings and the fact that they are impartial. A couple of comments on your absorbing article today firstly, is on inflation. I agree that inflation will rise this year but I doubt that it will reach much more than 3%. It may spike higher but fall back again imo. The reason I say this is that wages show no sign of any rapid increase which is a necessary factor for inflation to rise and stay high. There are some areas where we are witnessing strike action but they are not about wage increases....yet.

Secondly, I agree wholeheartedly about the broken financial state of the Eurozone. It's a question of whether the move to populist political parties with their ante Euro/austerity views causes a rift first or whether the "stress tested" banks implode causing another financial crisis. When this happens, it will cause pandemonium on the stockmarket. The EU has passed a law last January to try to protect banks by imposing a "bail in" instead of a bail out which will mean bank shareholders, bondholders and depositors will lose capital. Depositors have the guarantee that the first 100,000 euros/ £75,000 will be protected. However, the next financial crisis will be much greater than 2007/8 due to much higher debt levels, maybe the protection will be in name only ie you will be able to see the money in your account but not be able to draw it out. Of course credit will also dry up so only hard cash will be in demand. Hopefully, a situation like this will last for a few days. Of course it may not happen at all but I cannot help thinking that the Eurozone is so unstable and with debt levels so high in the developed world and China, the unimaginable is possible.

Casa.

danielbird193

Thanks Paul, great post as ever. Had to come back and read it again this evening as there was too much content for me to take in during my usual 30 minute reading slot during my lunch break at work!

I like your point about avoiding speculative 'jam tomorrow' companies. However your article also makes some good points about potential disrupter Purplebricks (LON:PURP) and I'm curious... Having seen the growth trajectory of shares like Rightmove (LON:RMV) and ASOS (LON:ASC) (who says the UK doesn't do tech firms!), at what point would you be tempted to buy in and join the ride? What would be a buy signal for you on a company like this?

Thanks again for a great article, looking forward to a bumper 2017!

Wildrides

It always pays to know where your trousers are .

matylda

4th Jan '17

As a note of interest - Merry Hill, one of the first major shopping centres, if not the first - Is located in the Midlands near my brother and a number of friends. Retailers are leaving in their droves and it's now filling up with charity/pound shops and a few bars.

gus 1065

Cambria Automobiles (LON:CAMB) trading update released this morning.

http://www.investegate.co.uk/cambria-automobiles--camb-/rns/agm-trading-update/201701040700202478T/

Concurs with some of the comments above. New sales slightly down attributed to pressure on £ and slightly increased economic uncertainty while used car and after sales profits have increased. Overall trading in line with expectations. Tone seems reasonably optimistic.

Gus.

Hi Charles,

Welcome to the club. It's never easy to know when to sell but remember that you do not necessarily have to sell 100% of your holding, you can top slice if you think the share price has got ahead of itself temporarily but still like the company. I am not familiar with D4T4 but it has a high StockRank and has good quality scores. The valuation looks punchy and It looks mainly a momentum play so could be viewed as a case of running your winners. Over to you!

Good luck to you also in 2017, personally I think we're all going to need it. I can't remember the last time a New Year started with so many "known unknowns".

All the best, Si

ACounsell

Hi Paul,

Interesting article and I agree with a lot of your thoughts for 2017. A few comments though:

1. With consumers under pressure from higher prices (exchange rate impact and the other factors you mention) credit card and mortgage indebtedness will probably increase. As with companies with high levels of debt/weak balance sheets not supported by strong cash flow (an area you identify) things could go very badly wrong for both consumers and businesses if interest rates rise more rapidly than expected.
2. Operational efficiency for 'online disrupters' is essential but the product also has to be of a good quality. I have heard from someone who works in a 'real world' string instrument retailer and repairer that they see quite a few instruments purchased from £G4M that have to modified/repaired before they can be played effectively. If this is commonplace it must be detrimental to brand reputation?
3. Your 'Beam me up Scotty' virtual fund has 5 stocks out of 18 that have a Stockopedia rating below 30 . This seems inconsistent with your view that you "very rarely buy shares with a very low StockRank, and I'm sure that has helped. A StockRank of say under 30, is really the Stockopedia computers talking to me, saying "Don't buy it!"." Are there special circumstances for Richoux, Purplebricks, Mobile Streams, Johnston Press and Cloudcall?

Enjoy reading the small cap report and can't decide whether to go down your route or take the easy route and use Ed's NAPs. The jury is still Out!!

hawkipa

5th Jan '17

Hi, I feel its worth mentioning that 'bail ins' don't in any way protect banks, they simply ensure that loses are imposed on those instruments which are risk capital, in the event of a default. They have evolved primarily as a result of the Irish example, where the Irish government rashly guaranteed senior bondholders, thereby putting the Irish taxpayer at risk. The UK bank nationalisation experience also resulted in the regulators desire to ensure that taxpayers couldn't be there to the benefit of bondholders. Many bond investors were buying senior bank debt upon nationalisation as it became arguably less risky upon nationalisation, which was simply wrong on every level.
The evolution of the Additional Tier one market is the primary outcome of this experience. These instruments which are bond like until the bank enters a distressed state as prescribed by their Core equity tier one ratio. Then they become equity instruments and as such suffer first loss along with traditional equity holders. As an aside, I am fascinated that the regulators don't want retail investors to buy them yet are happy for the same investor base to invest freely in bank equity.
Banks are undoubtedly safer and less risky than they were in the run up to the GFC and the regulators desire to de-risk them has been successful to that end. Who knows when and if there will be a repeat crisis, but the global regulators for all their sins, have made banks safer than they were and hopefully the endless legislation and evolution of rules will force bondholders and equity holders to suffer loses before anyone else does.

6th Jan '17

I agree that bail ins do not protect banks. I was trying to highlight the fact that bank depositors are now just as much at risk of losing capital as shareholders and bondholders. We are led to believe that the banks are "fixed" whereas in the EU, it's the stress tests that have been fixed. Banks may be safer than they were but the level of debt is many times higher than in 2007/8. Governments will not explain how bad the situation is. Depositors would be queuing in the streets again if they knew. How many of the general public know that the EU has legalised the bail-in system?

Casa.

smatthews1

Hi Charles,

I agree with Simoan, there's nothing wrong with using certain metrics as a criteria for when to sell, but just try not to be blinded by them and forget the bigger picture.

I find selling very difficult myself, but I have to be very ruthless and honest about the company, so I ask my self 'if I didn't hold these shares, would I consider buying them at this current price?'

That normally gives me a straight answer.

Sean

Does that not make you inclined to sell out too early?

It has been one of my biggest mistakes selling winners too soon.

cafcash49

Hi Sean,
Thank you for taking the time to reply, I appreciate it. You make a good point and I will add that to my thought process. It seems 'selling' is an issue even for the most experienced. I value the Stockopedia community and the wealth of advice we can glean from each other.
Thanks, Charles

Yes I have done in the past, but I once read somewhere that you should never aim for the very tops and very bottoms, as you will either be very lucky or skilled. Niether of which I am good at.

So for me I tend to look for more value than growth, so once I feel that stock no longer offers value and it has had a decent run in share price, I will start considering where I would be happy to get out.

ithomson1

8th Jan '17

He's put in brackets that he holds a long position.

There's a good article in finance section of the Mail on Sunday (today) about Purple Bricks. Michael Bruce basically outlines why the business model is so effective, progress in the Australian market is also mentioned - apparently they made sales of £600,000 in the first 7 weeks there. It's a good read, although unfortunately it might mean that you'd have sink to the lows of having to buy a Mail on Sunday (I was lucky and found one left on a table at the coffee shop I was in).

There's also a small article on ASOS and Boohoo.

MichaelFBS

22nd Jan '17

Hi Paul

A comment long after the event but I keep re-reading this post (possibly your best ever). I personally think that £AMZN is going to eat traditional retailers alive with the likes of Boohoo.Com (LON:BOO) filling in the gaps (possibly until Amazon buys them?). For that reason I would not touch the likes of Debenhams (LON:DEB).

There is almost nothing I personally dont buy from Amazon (I have just bought bin bags from them!!)

This article

https://www.bloomberg.com/gadfly/articles/2016-09-20/amazon-clothing-sales-could-soon-top-macy-s

is very interesting.

Kind regards
Michael

24th Jan '17

I would not be too sure about that, many people don't like Amazon (putting it politely) and don't buy anything from them. I hardly ever buy anything from them, the last item I ordered last year they sent out the wrong model, guess their staff were so rushed off their feet they picked up the wrong one.
I also don't agree with the way some of these american companies carrying on fiddling their tax either. Bin bags I get from Aldi, dirt cheap and they do the job.

Small Cap Value Report (3 Jan 2017) - my investing themes for the year

My investing themes for 2017

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Paul Scott

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