Small Cap Value Report (Fri 29 Oct 2021) - BEG Red Flags, MTW, GYG
Good morning, it's Paul & Jack here, with the SCVR for Friday. There's hardly any relevant news today, and I (Paul) have to pack up my airBnB and move to a hotel in Funchal now, so will sign off for the day. Have a good weekend everyone!
Agenda -
Paul's Section:
Begbies Traynor (LON:BEG) - Q3 Red Flag Report, interesting improvement, but rise in CCJs augurs badly. I broaden this into another ramble around topics like inflation & supply chains.
Gyg (LON:GYG) - bid talks with major shareholder are off, with a reasonable explanation given. The company confirms it shouldn't need to raise any fresh equity funding, despite uncertainty over contracts.
Jack's Section:
Mattioli Woods (LON:MTW) - wealth manager that has recently made a few acquisitions. The group reports revenue growth amid uncertain conditions. There are some signs of a decent company, one that can potentially continue to grow, but it looks fairly valued for now.
Explanatory notes -
A quick reminder that we don’t recommend any stocks. We aim to cover trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.
We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).
A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.
Paul’s Section:
Begbies Traynor (LON:BEG) (I hold)
145p (pre market open) - mkt cap £220m
Q3 Red Flag Report & further rambling from Paul
These reports from insolvency practitioner Begbies Traynor are always an interesting brief read, so worthwhile for all readers to have a look.
There’s actually some good news this quarter - with a sizeable (14%) fall in the number of companies in significant financial distress, compared with Q2 -
...This fall can most likely be attributed to rising corporate revenues as pent-up customer demand has fuelled a boom in consumption and allowed some companies to improve their short term debt position, whilst improving cashflow. Whilst this has eased the immediate threat to many companies' survival, there is uncertainty if these trading patterns will continue.
Outlook - Begbies flags up some of the challenges that lie ahead. Begbies doesn’t mention the ending of the rent moratorium, in March 2022, which could potentially tip many companies over the edge, with rent arrears becoming punishable with evictions again. Although there is talk of the Govt introducing an arbitration system.
Unfortunately, considerable challenges lay ahead for UK businesses, including constrained raw material availability, rising inflation, labour availability, spiralling energy prices and rising COVID rates, combined with a winding back of government COVID support measures that could yet impact failure rates in Q1 2022 and beyond.
Rising CCJs - an ominous sign -
CCJ's are often a bellweather for future insolvency and the latest data paints a gloomy picture. Official data shows there were 9,101 CCJs lodged against companies during Q3 2020, rising to 21,769 during Q3 2021, a 139% uplift. This acceleration in CCJ's was also evident between Q2 and Q3 2021 with a 51% increase.
The latest official figures show that court activity is picking up as creditors, become more aggressive in chasing debts.
Sectors - this surprised me. We hear every day about struggling retailers & hospitality companies, but they’re not particularly high on the most distressed sectors list today from Begbies -
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My opinion - given what’s happened, with the pandemic, and some disruption from Brexit (although in reality Brexit has been nothing approaching what we were pre-warned would happen), then I think the Govt support measures for business and households have worked brilliantly. Nothing like this has ever been done before. Also the whole lot has been funded on magically invented new money (QE) so the illusion of high Govt debt is just that - an illusion. I’ve yet to find any mainstream journalist that understands QE, so they’re generally still peddling the myth that Govt debt is high. Govt debt is actually quite low, by historic standards, once you net off QE (Govt debt owned by the Govt [the Bank of England]). Also it’s very cheap to service. So there is absolutely not any kind of crisis, or even problem, with Govt debt.
I heard a remarkable statistic in the Budget - that (the OBR, I think) was expecting unemployment to peak at 12%. That has now been revised down to a peak of just 5.2% - which is pretty close to full employment. Astonishingly good.
Who would have thought the recovery would be so strong, as it turned out, it was a V-shape? Hats off to Rishi Sunak, his policies have worked a treat, so credit where credit is due.
Supply chain disruption seems to have sent UK small cap investors into a complete meltdown. Yet it’s temporary. Christine Lagarde said yesterday that supply problems will ease in 2022, although not as quickly as previously expected. It will take a “good chunk” of 2022 for the private sector to resolve the issues, she says. But, she says the new factories to build more computer chips are being built, as are the new ships needed to increase shipping capacity.
She dismissed ideas about “stagflation” returning, commenting that there’s no sign of stagnation - essential for stagflation to happen, and that economies are strong, with good growth.
Black & Decker CEO - I watched an interesting interview with the CEO, on CNBC. He said supply chain problems are a big problem, with previously $300m of finished goods in transit in normal times, having swollen to $800m right now, with lots of product stuck in the flotilla of ships at anchor outside Los Angeles.
He also indicated that $1bn of extra costs (materials, labour, transport) would be added to its existing $16bn costs, all of which will be passed on to customers in price rises. That remains the crucial issue - passing on increased costs to customers. That's what will determine which shares are the winners & losers in our market too.
He mentioned that Black & Decker is trying to re-shore production back to the USA, by automating factories, instead of using cheap labour abroad. Bravo, long overdue generally, I would say.
Reinforcing my point that we are seeing both cost push, and demand pull inflation at the moment (I know one reader strongly disagrees with me on this, but that’s fine, it’s a debate and we enjoy all sensible discussion here, with all rational views welcomed) - Black & Decker said they are experiencing “tremendous demand”, which is partly why they're struggling to match supply with demand. Plus of course, you can only pass on price increases to customers if there’s strong demand, and people are prepared to pay up, and have the money to do so.
What happens in 2022 then? It seems to me that inflation is likely to continue rising for a while, but as supply chain problems ease, then it should logically moderate again. Remember that inflation requires continuous rises in prices, otherwise it declines once one-off spikes in prices annualise. We saw that in recent years when sterling lurched down, triggering a short term rise in inflation to about 5%, which promptly subsided the following year. So there is recent evidence to support the theory that inflation should be transitory (i.e. maybe a 1-2 year phenomenon), but nobody knows for sure.
Going back to the Begbies report, I see insolvency risk as more of a problem for smaller businesses. Most of the listed companies we look at here, are in robust financial health, and at little to no risk of insolvency. There are still some that need to raise fresh equity, and if interest rates do rise, then that could put them under increased pressure. But for the time being, overall I’m seeing current issues as probably temporary. For that reason, I’m becoming increasingly bullish about small caps, given that we’ve had something like a panic sell-off recently. It looks like a good time to be sniffing around for bargains, and putting fresh cash to work, possibly, where good companies have been sold off for no good reason.
EDIT: Just to clarify, what I'm thinking of, in terms of buying opportunities, is companies that have put out positive recent trading updates, with no problems flagged, yet their share prices have sold off say 20-40% in recent weeks. That removes the guesswork. A good example is Sanderson Design (LON:SDG) (I hold) which put out excellent interim numbers recently, with a good outlook statement, yet its share price has slumped, possibly triggered by a Telegraph journalist writing some nonsense about it looking over-valued (which it wasn't). That's an obvious buying opportunity, unless of course there's always the risk that something might have gone wrong in the background that we don't yet know about. End of Edit.
I think a lot of the recent falls have been illogical, and seem to me more like traders panicking about losing their profits, rather than any long-term impairment of company valuations. Prices move on little volume, and people sell shares for all sorts of reasons, often completely unconnected with the performance of the company in question.
Who knows, it’s all educated guesswork, and I could be wrong, as always!
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Gyg (LON:GYG)
Bid talks with major shareholder Harwood Capital (run by renowned investor Christopher Mills) are off, but it sounds amicable.
Harwood’s statement is here
GYG’s statement is here - which goes into a bit more detail, including some uncertainties over contracts, and it reassures on the financial position -
...the Board believes that the Group can generate sufficient cash to meet its working capital requirements and repay its borrowings as they fall due. As a result, the Board does not believe that it will need to seek additional funding from shareholders in the foreseeable future to maintain operations or to meet its obligations .
In the meantime, the Group continues to build its forward order book position, the superyacht market remains on a strong growth trajectory and the Board reiterates its confidence in the medium to longer-term prospects of the business.
My opinion - reading between the lines, it sounds as if Harwood might be back with another offer, once the uncertainties have been resolved. The trouble is, in the past I found Harwood whipped away the upside for itself, with a lowball bid for a decent company I was a small shareholder in, a few years ago. So whilst they’re very shrewd stock-pickers, they look after number 1, leaving limited upside for other shareholders, which is why I don’t follow them closely any more.
GYG shares are small & illiquid.
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Jack’s section
Mattioli Woods (LON:MTW)
Share price: 810p (pre-open)
Shares in issue: 50,571,600
Market cap: £409m
Mattioli Woods is a specialist wealth and asset management business providing pensions and wealth management services.
The group recently completed the acquisition of Ludlow Wealth Management, which expands its presence in the North-West. This follows the acquisitions of Maven Capital Partners and Richings Financial Management. The M&A activity is driven by MTW’s medium term goals of extending the group's existing investment proposition and adding scale, distribution and product to its client proposition.
You can see the group is expected to be significantly larger through its revenue forecasts:
There has been a general trend of broker EPS upgrades here and the stock is rated as a Strong Buy.
There’s no numbers here, just an AGM statement from management. Slim pickings today.
It says:
In September, we were pleased to report revenue growth for the year ended 31 May 2021 despite the continued economic uncertainties that persisted throughout the period.
Market stability and investor confidence are showing signs of improving, despite the wider economic uncertainty, with net inflows into the group's investment and asset management services ahead of the equivalent period last year. The number of new clients on-boarded in the first four months of the financial year exceeded the prior year, thanks to existing client referrals and business initiatives including virtual seminars during the pandemic. That means the pipeline of new business enquiries is outperforming the prior year.
Along with underlying growth in its core pensions consultancy and administration and investment management segments, total organic growth is in excess of 10% in the first four months of the year.
The financial performance of the acquired businesses are in line with expectations and a final dividend of 13.5p per share (2020: 12.7p) will be proposed at today's meeting, making for a proposed total dividend for the year of 21.0p (2020: 20.0p).
Outlook -
The further easing of lockdown restrictions and continued roll out of the COVID-19 vaccination programme are supporting improved investor confidence and we expect the increased client inflows and new business enquiries seen in both the prior and current financial year to continue. Current trading is in line with management's expectations and we remain confident that we are well positioned to secure future growth, both organically and through further strategic acquisitions, which will allow us to continue to deliver sustainable shareholder returns.
Conclusion
This is not a stock I follow but, clearly, Covid has impacted numbers over the past year or so.
MTW has generated a reasonably good StockRank over time but there has not been much in the way of share price progression over the years (although there has been a rerating from the 2020 lows).
Shares in issue have been stable over time (barring the past year), the group is cash generative, a rising dividend is being paid, and there’s a net cash position, which all point to a sensibly run company. MTW seems to make quite a lot of small acquisitions judging from the cash flow statement, and revenue and profits have been rising fairly steadily.
The group generates fairly stable revenue from a large fee base, which is good, but on the flip side, a fall in NAV could really dent profitability at some point. This could be an under the radar stock, quietly going about its strategy, but I’m wondering what the shares need for a serious rerating.
FY22 and FY23 EPS are forecast to be 51.4p and 61p, which would suggest the PE falling from 15.8x to 13.3x. It seems reasonable, but not enough to get excited about in my view.
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97 comments
"I’ve yet to find any mainstream journalist that understands QE, so they’re generally still peddling the myth that Govt debt is high. Govt debt is actually quite low, by historic standards, once you net off QE (Govt debt owned by the Govt [the Bank of England])"
The Bank of England isn't owned by the Government. And you will not find any evidence for this. Please show me, if you find it.
The BoE says “We are wholly-owned by the UK government”
So who do you think owns it?
Cloudcall (LON:CALL)
new research note released for perennial dissapointer cloudcall, hills have a target price of 500p compared to the current shareprice of 56p
Meethinks the hills peeps may have been smoking some funny stuff before they put pen to paper here.
http://www.hillsresearch.com/w...
Page9 is a laugh. Yes, it is 80% undervalued to peers. But the peer set are all well established, 9 or 10 digit enterprise values, and all profitable. Not the loss making tiddler like Cloudcall (LON:CALL)
Hi Paul.
I very much enjoyed reading your morning ramble about inflation & supply chains, and in fact all your rambles are good to read, so keep them coming please.
I recall that when during the later part of 2020 and the earlier part of 2021 when UK small caps were motoring along nicely, I kept finding and reading financial articles that stated that UK stock markets were some of the cheapest in the world. So now with the current issues that have caused the weakness and drop in share prices, we must surely be looking at some compelling opportunities in some small caps on even just a two year view.
Anyway, I wish you an enjoyable weekend in Funchal.
regards Neville
The Small Cap index is still up from March 2021, there has been some levelling off in the last 3 months, the index peaked on 1st Sept, 2021: https://www.stockopedia.com/in...
Some shares have fallen back but certainly not all, hence the index is only 3% off it's peak.
Yet it’s temporary. Christine Lagarde said yesterday that supply problems will ease in 2022, although not as quickly as previously expected. It will take a “good chunk” of 2022 for the private sector to resolve the issues, she says. But, she says the new factories to build more computer chips are being built, as are the new ships needed to increase shipping capacity.
So, what we've learnt here is that Christine Lagarde knows nothing about semiconductor manufacturing! If she thinks you can get a semiconductor manufacturing plant built and up and running at the yields needed to be viable in such a short timeframe, she' s having a laugh. For example, Intel recently announced project start on two new fabs in Arizona which will not be on-line until 2024.
What Apple said last night was interesting. They have no problem with the availability of the modern high performance manufacturing process they use to make their main chips i.e. Axx Processor, modems etc. Instead, the problem relates to a lack of volume of chips made on older, slower process nodes used to make some of the peripheral components used in the iPhone 13. In particular, they pointed to low tech chips from Broadcom and Texas Instruments. These older processes would also typically be used to make devices used in products where power consumption and performance is less of concern and where extended temperature operation may also be a requirement e.g. automotive, aerospace. white goods.
Given the amount of Capex required I can't see too many semiconductor manufacturers making the investment in building new plants with manufacturing lines which have lower margins and are already on their way towards obsolescence. Of course, there have been some issues that have contributed to the shortage which are temporary in nature and have no relation to manufacturing capacity e.g. Many chips are tested in Malaysia which has been shut down because of local Covid restrictions. However, I think this will go on for longer than most people predict. The CEO of Intel said it would be 2023 until supply and demand is back in balance.
All the best, Si
Yeah, the problems with chips for cars are largely the ancillary bits and pieces - the original brochure for my iPace said wireless charging pad and boot opening with your foot - but they weren't on the car I test drove, I asked and the dealer said they weren't included, and when I went back to the brochure they'd be removed from it (so I went in with my eyes open and was aware this was the case, I'm not complaining before anyone thinks I am :))
One of my colleagues who is getting a Mercedes got some money back on their company car order because these features were removed.
So, I think you're right, the semiconductor shortage is for particular and specific components, which makes sense given the fire at one of the fabs - there's lots of concentration risk in this sector.
So, I think you're right, the semiconductor shortage is for particular and specific components, which makes sense given the fire at one of the fabs - there's lots of concentration risk in this sector.
Yes, and so much so the USG now consider it a matter of national security and are trying to pass the CHIPS Act to increase domestic semiconductor manufacturing to reduce reliance on Asia.
https://uk.news.yahoo.com/inte...
All the best, Si
The founder of SMTC on the US efforts:
"If you want to reestablish a complete semiconductor supply chain in the U.S., you will not find it as a possible task," Chang told a tech industry forum in Taipei on Tuesday night. "Even after you spend hundreds of billions of dollars, you will still find the supply chain to be incomplete, and you will find that it will be very high cost, much higher costs than what you currently have."
https://asia.nikkei.com/Busine...
The founder of SMTC on the US efforts:
"If you want to reestablish a complete semiconductor supply chain in the U.S., you will not find it as a possible task," Chang told a tech industry forum in Taipei on Tuesday night. "Even after you spend hundreds of billions of dollars, you will still find the supply chain to be incomplete, and you will find that it will be very high cost, much higher costs than what you currently have."
Thanks, but I think you mean TSMC (Taiwan Semiconductor Manufacturing Company). I'm sure he's right in terms of replacing the whole supply chain (i.e. including wafer production, packaging, testing etc.) but it should be possible to move a significant amount of the manufacturing back to the US, although that will not happen anytime soon. And when you look at the geopolitics and what China is doing, it makes a lot of sense. Not good for TSMC, obviously, hence he's talking his own book a little :-)
All the best, Si
You're right Simoan, I meant TSMC. Getting my keys mixed up. Piano playing missed a Les Dawson in me.
The US is not alone in this. Sony is discussing building a chip factory with TSMC in Japan, with first production slated for 2024.
Man who sees his strategic advantage and the literal security of himself, his business and his nation at extreme risk bigs up how hard and expensive it is to recreate the semiconductor industry. Th is the second or third time Taiwans semiconductor output has caused the world issues in the last twenty years. There’s been at least two RAM shortages that I can remember and the situation we’re in now. The world needs to decentralise these single points of failure.
I was thinking about Sanderson Design (LON:SDG) this morning before I read Paul's comments but I missed the opportunity to top up. I think they will recover unless they are affected by flooding again.
Others maybe to consider are Halfords (LON:HFD), Up Global Sourcing Holdings (LON:UPGS), Tyman (LON:TYMN)
Hi RayStraw,
I was thinking about Sanderson Design (LON:SDG) this morning before I read Paul's comments but I missed the opportunity to top up. I think they will recover unless they are affected by flooding again.
Recover? They've already recovered, that was my point - if you look at the interim results from 2 weeks ago, performance has fully recovered, and they're now well above pre-covid levels of profits.
Inventories have been reduced, and turned into a growing cash pile.
The outlook statement was positive.
So the drop in share price recently has been totally spurious. This is the type of buying opportunity I was flagging up - we're not guessing, or hoping that the business is trading well, it's been confirmed, recently. And the valuation is appealing.
I'm seeing other situations like this too. The selling at the moment looks indiscriminate to me, and that creates some lovely buying opps, but you have to be careful, to avoid the stuff where something might have gone wrong, and is not yet disclosed - e.g. look at Ig Design (LON:IGR) - although even then, they'll probably rebuild margins over time, so at some stage that would probably be worth buying. I was offered a call with mgt, but declined, as I thought the RNS was self-explanatory, and I don't want to get talked off the fundamentals by a persuasive sales pitch! That said, in time, it could be a good one to look at for recovery, possibly?
Regards, Paul.
Hello Paul, sorry I was not clear on Sanderson Design (LON:SDG), I meant the share price recover. I bought some after the Telegraph tip.
I think we need to be careful about stocks that have benefitted from lockdown or furlough, now furlough is over many people will be going back to work, so things like DIY may see a decline? Also household furnishings etc. Gaming?
Thanks for clarifying Ray.
Interestingly, I learned the word "maximalism" from a SDG presentation - the opposite of minimalism - in other words, fashions in high end interior decor seem to now be reversing from a long period of minimalism, to the opposite. That very much plays to SDG's strengths of lots of colour, and quite "busy", flamboyant designs, often with heritage, and presumably IP on the designs? There must be, otherwise they wouldn't be able to licence the designs to Next (LON:NXT) for example.
Also, have you seen the prices of SDG fabric, etc? It's real top end stuff, I'll never forget being asked to pay £1,500 for just one roman blind, on their website recently.
So I don't think it's going to be dependent on mass market spending.
I've got high hopes for SDG, it's potentially a valuable company, in my view, due to the uniqueness of its huge back catalogue, and the licensing revenues. Someone could bid for it, in my view, eventually. Meanwhile the excellent new CEO is executing so well. Lots to like, and still reasonably priced. But people who buy on tips, like to bank their profits along the way.
Regards, Paul.
No it is not the market I'm into I'm afraid, I fit my own blinds, Hilary's are far too posh for me.
I have seen this trend though on TV programs, going more towards bold designs, wallpapers etc. I hate wallpapering so I would rather stick with emulsion paint, far easier and cheaper.
But some of the new house sales in my road seem to have spent a lot of money on doing them up and having posh blinds/shutters, so there is some demand. I think it will appeal to americans, so could well be bought out. I was late getting into Sanderson Design (LON:SDG), I should have bought around 120p when I was looking at it.
Paul, I wouldn't read too much in to what the CEO of Black & Decker says. They certainly should be experiencing high demand for the same reasons that Kingfisher (LON:KGF) has been a pandemic winner. Alternatively we could look at a US pandemic loser such as cinemas. They are still struggling for the same reasons that Black & Decker are surging, with revenues way down on 2019 levels:
https://www.cnbc.com/2021/10/2...
The same behavioural changes explain both outcomes. What matters is what this adds up to overall and what this says about the future.
Overall, I'm betting on a reversion towards 2019. Black & Decker will see demand decline as people put away their power tools and go back to the cinema. Cinemas will see revenues gradually recover. The same kind of process will apply in the UK.
Note: these are gradual changes. Remember those claims that we would be back to normal in April/May (for Boris it was last Christmas)? That was never going to happen.
As I've said before, where I do see real long lasting changes is in the supply of energy and low skilled labour, particularly for the UK. These are the real substantive changes that will impact inflation and the distribution of profits and losses.
Thanks Chris, your opinions are always very interesting, and I admire your total certainty in your own analysis! ;-)
P.
My comment talked about "what I see" and "what I'm betting on". Some bets I win, some I don't. Respectfully, I don't read my comment as expressing any more certainty than you did in your preamble at the top. Regards.
It's the frequent use of "will" that seems to express certainty in the outcome! Don't get me wrong, I enjoy your comments, always very interesting & well thought out. I tend to emphasise in my comments that I don't know, and it's all guesswork, that's all.
Ok point taken. Just to say that if you were to look at my comment again you would see that each instance of "will" is preceeded by "what I see" or "I'm betting on" (I've just checked!). If I comment again on this this topic I will try to find a better way of expressing this while trying to maintain brevity.
Keep up the good work. All 3 of you blogging here have been excellent and the quality has been even higher than it was in previous years.
Thanks Chris! Have a great weekend.
Best wishes, Paul.
There definitely appears to be a lull in investor activity, particularly around the mid to small cap area, with a lot of shares drifting quite considerably off any recent highs for little apparent reason.
I went through a few of my holdings this morning where I'm scratching my head a bit at the drift and wondering if I'm missing something.
Reach (LON:RCH) are off 30% from high on no news. Now appear to be trading on around 7* PE which looks way too low. Taking into account it will have net cash of something like £75m and a decent dividend the drift appears odd particularly given it said it was trading ahead of expectations and now digital makes up around 27% revenues and increasing.
Ferrexpo (LON:FXPO) have around £200m+ in net cash - are paying 10%+ dividend yields (tho mind the Swiss WTH 35% gap!) and at current Iron ore prices are on a PE of 3 to 4. Seems bizarre unless we expect iron ore to halve again, which I don't
Tremor International (LON:TRMR) trading on a paltry EV/EBITDA of 7 less than half competitors with $275m net cash
So despite strong fundamentals well capitalised companies with bullet proof balance sheets such as these trade at 3-7 * earnings suggesting distress, when actually they are all trading well. I'm sure there are plenty of others out there as well.
Feels to me like there is small scale selling but little in the way of buying with money sitting on the sidelines waiting to deploy. Not obvious what the catalyst is at the moment.
I feel your pain David.
I don't hold any of the shares you mentioned, but plenty of mine are down, after being well up only a couple of months ago.
I'm not surprised about Reach (LON:RCH), shares doubled since the last figures in March which I did not think were that good. Yes digital is going up because printed media is falling. Pension deficit is a big issue.
Ferrexpo (LON:FXPO) iron demand has fallen and so have prices, there was a surge in demand earlier this year but that has reversed, there was also rumours about Kostyantin Zhevago apparently wanted by interpol. Evergrande also is a possible issue? Others in that sector have also fallen back such as £SLP.
I'm not sure what results you were looking at on Reach (LON:RCH) but they were very good! Ahead of expectations. EPS will be close to 40p and it is irrelevant if print is going down if digital is going up AND the overall numbers are going up....in fact it is a good thing! Pension deficit is not remotely a big issue.
Ferrexpo (LON:FXPO) Zhevago is a shareholder, nothing else. The political turmoil surrounding him is pretty irrelevant. He doesn't hold enough to take the company private.
In the same way that everyone makes up up semi-plausible sounding rationale for why stocks go up they are doing so in reverse at the moment. And that's why stocks are sliding.....not just this little selection but many others on similar commentary. Gear4music Holdings (LON:G4M) people were bailing out recently with investors panicking about "definite" supply chain issues.....which the company then said it didn't have in its trading update.
So this type of commentary gives me a good indication of where we are in the investor sentiment cycle. Will be time for me to start topping up soon but I'm missing seeing the catalyst for the sentiment change and I'm waiting to spot that first.
The figures I saw in March for Reach (LON:RCH) were revenues were down, profits were down and pension deficit was up. You can argue with Paul over pensions.
Even Richard Leonard admits the pension is an issue.
I think you'd be better off reading the results out to the end of June
Pension deficit is down £137m, revenues were up 4% and earnings up !
David,
Re Reach (LON:RCH) -
Pension deficit is not remotely a big issue.
You're completely wrong there. Look at the ACTUARIAL deficit, and the cash outflows for deficit recovery. They're very large indeed. It's a huge issue.
Meanwhile you've got a highly cash generative, but dying, print business. They won't reveal how much profit the small, but growing digital business makes.
So it's impossible to value.
Just my opinion, could be right or wrong, only time will tell!
Good luck, Paul.
I completely disagree Paul and Ray
"Decrease in accounting pension deficit
The IAS 19 pension deficit (net of deferred tax) in respect of the Group's six defined benefit pension schemes decreased by £136.8m from £255.5m to £118.7m. The decrease was driven by an increase in the discount rate and as a result of Group contributions. Changes in the accounting pension deficit do not have an immediate impact on the agreed funding commitments. The triennial valuation for funding of the defined benefit pension schemes as at 31 December 2019 would usually be completed by 31 March 2021."
Given they pay approximately £74m into the deficit each year it will be eliminated on contributions alone in 18 months. However, since the tri-ennial in 2019 the mortality rate has gone down and yields are on the way up so I'd bet on this being broadly flat within 12 months.
Given cash collection is around 100% of profits they can easily fund the £74m AND generate a surplus cash position of £40m each year. So, no the pension deficit is not a major issue
Sorry David, I think you're completely wrong. You're muddling up actuarial & accounting deficits. Dangerous stuff, as accounting deficits greatly understate real world cash outflows.
Let's ask for some expert pension specialists opinions - over to you, readers!
I've got to add, no financial experts I know, are dismissive of the pension deficit at Reach, so you're definitely wrong!
P/
Paul - I'm not muddling anything up. The actuarial deficit calculation was last done in 2019 and is almost due to be renewed. An actuarial calculation allows for a very significant margin of error over and above the real expected liabilities of a pension scheme. In Reach (LON:RCH) case and based on 2019 the deficit will also be completely eliminated in 5 years time.
On an accounting basis it will be eliminated in 12-18 months.
However, the actuarial deficit has not been changed since 2019 and so in the next triennial valuation both the changes in the "real value of the plan" plus any amendments in the discount rate and mortality rate etc will be factored in. I expect all 3 of those mentioned will be favourable to the 2019 deficit and there will have been £150m+ in contributions paid in as well.
So - the point is that the company generates cash that already significantly exceeds the current actuarial deficit requirements and will be eliminated in 5 years. I would expect the new actuarial liability calculation to reduce (and thus reduce the annual deficit payments out to 2027 as well). Therefore, I see no real risk to Reach (LON:RCH) as a company or a going concern from its pension liabilities. It is able to generate significant excess cash, pay dividends and continue to transfer to a digital revenue based organisation with no signs that the gradual decline in print will jeopardise those earnings.
And do not forget that content is king and Reach (LON:RCH) have that in abundance.
Note : Excerpt from the Pensions Regulator that back up my expectations and align with what we are also seeing in the accounting deficit reduction (ie it is constant across both).
"Schemes undertaking valuations at 31 March 2021 will have improved funding levels and deficits compared to those reported three years previously."
Reach (LON:RCH)
Davidjhill
I couldn’t really disagree more strongly with your assessment of the lack of reach pension risks davidjhill as a summary to present for others. The size of their pension scheme liabilities per the 2020 annual report is a mind boggling 2.8 billion and annual payments to pensioners are expected to carry on increasing materially for more than the next 10 years. Surely the danger here is not the current state of the deficit but what if the future returns on scheme assets don’t grow in line with scheme liabilities. What happens if the scheme assets take a 20% haircut at some stage , I am not saying it’s a likely an issue but how confident are you that scheme assets will continue to grow in line with liabilities?
A pension scheme of this size will use LDI mandates (liability matching) hedging. Given the size of the scheme it will almost certainly be a segregated mandate and therefore a pretty accurate hedge.
Reach (LON:RCH)
But to what extent are the risks derisksed here ? they mention a proportion of Ldi’s in the pension scheme asset totals but that’s approx only 1/3 of the total. If this scheme really isn’t an issue future risk wise it would nice to see that lack of risk confirmed by authoratative source.
and that's part of what the actuaries do.
Let's do a very crude example for the sake of not writing a thesis here so excuse the simplicity.
The Actuary says that in 20 years time the company will have a liability of £100m. So the company can go and buy a 20 year UK Govt Gilt of £100m with a coupon of say 0%. In 20 years time when they need to meet the liability the Govt will be redeeming the Gilt at par so the asset and liability match completely. It doesn't matter what interest rates do or if the mark to market value of the gilt at some point during the period is 20 or 30% down because the scheme is holding the bond to maturity and unless the Govt default the asset is secure. Because the UK has a good credit rating then for prudence the company can also buy a CDS (credit default swap) that protects against any default quite cheaply and eliminate any residual credit risk.
So headline numbers of £2.7bn in liabilities are really meaningless, because they are closely matched against assets that are not at the whim of being offside at the point the liabilities become due.
A bank mortgage book is similar. It might look huge but all those fixed rate deals at 0.8% for 5 years are all hedged with an Interest Rate Swap so the bank doesn't incur interest rate risk on them, though clearly they have credit risk which they offset by the collateralisation of peoples homes.
So we establish that absolute size is irrelevant - what matters is risk associated with the assets that match the liabilities, and whether the liabilities themselves are certain. The Actuary will calculate the liabilities and then assess the assets and determine any surplus or deficit. However, they will take a very conservative view on both, allowing for a large margin of error.
Now, a scheme that is in deficit may fall upon favourable market conditions whereby the value of the assets does go up considerably more and eliminate a deficit (under accounting rules). Here a company could then choose to re-jig the assets and fully liability match their scheme. At the moment these favourable conditions appear to be happening to Reach (LON:RCH) and if they have eliminated the deficit at an accounting level in 12 months alongside the extra contributions this gives them a lot of flexibility in ensuring large deficits don't build again in future. When the Actuaries perform the triennial valuation this should also be favourable as life expectancy has also fallen. In essence it appears to me that Reach (LON:RCH) management and trustees are managing the scheme well and thus I am not concerned about it having a detrimental impact on the business going forward.
Mortality rates are important and if the scheme were still open I would be more concerned because if we take a big jump forward in life expectancy then that increases the liabilities. However, given the scheme was shut this risk is considerably reduced. and decreases further with time.
I fully get everything you are saying here ref where the deficit is at and the measures in place.
The issue i have here is that i have seen deficits jump about like yo yo's over the years - so i have traditionally defaulted to the higher the value of scheme liabilities and the less mature a scheme the more the risk. Ie what happens if they for whatever reason they have to plug a gap of 20% of the value of scheme liabilities if the assets are unable to generate enough return to fund any increase in liabilities in the future - due to future returns on assets being not great. IMHO unless i see it in writing from authoritative source i am not presuming there is "little risk" that the deficit couldnt easily jump by another £300-£400 million due to future actuarial changes.
Note when you say this is mature scheme - its not as mature as i would like. For example norcros is pretty much at the point now where there cash the are paying out in payments each year to pensions is at or near maximum levels . The size of scheme liabilities has also dropped 10% ish for norcros over the last 5 years. It looks like reach has another 10 years where the cash payouts are still increasing so not really at the point yet where they are over the hill with regard to "peak cash outflow". Note its not all bad here is i think they have more in their pot that Norcros when you simply divide the asset size by yearly amounts being paid over the next 10 years . Note they pot they have does seem a little more conservative than that of norcros when you divide pot size by annual payments that are expected to be made over the next 10 years.
There is obviously a chance here i am worrying about nothing here - if they are getting more hedged each year and deficit is trending to nothing i don't doubt the scheme has massively de-risked already.
I think that is my key point. The level of de-risking that has gone on here already and what I see likely over the next 12 months (and post the next triennial review) at both an accounting and actuarial level points me to being comfortable with the scheme and thus I don't see it as a reason not to invest - or at least not to the discounted level the business currently trades at.
That said I'm happy to wait for the pension scheme mechanics to become much more apparent over the next 12 months or so.
edited
Paul,
OBR confirmed 4% hit long term due to Brexit, in line with original forecasts & double the impact of covid. Not sure what you were expecting the impact to be, bearing in mind ‘no deal’ didn’t materialise. Also remember we’re yet to impose customs & regulatory checks on our imports yet due to lack of resource/infrastructure, delayed again till next year now. That will likely further impact supply chains as & when it’s brought in.
Same OBR that forecast 12% unemployment in Paul's ramblings? And probably about as accurate.
Agree there is still more impact to be felt as the red tape gets worse but hopefully the N Ireland solution that will be reached might be the start of more rational and constructive dialogue between both parties, instead of beggar thy neighbour. Of course the French over reaction on fishing might scupper all that.
Accept we won't be as well off in 10 years time as if we'd stayed in the EU but expect we'll still be better off than we are now. Let's crack on and stop lamenting the fact it's over.... I have too many friends still ranting about the Referendum.
Well the case for the OBR prediction being more accurate is it’s been updated to reflect actual trade flows post January, so isn’t just a spurious forecast based on future events. Also the fact it’s in line with previous estimates should add some weight to the accuracy.
Not interested in discussing referendum/Brexit rights/wrongs, just was a bit surprised to read Paul’s comment given the OBR feedback this week. Then again I know Paul is a very enthusiastic Brexit supporter these days!
You might want to change your friends?
I might be over thinking this, but it feels to me like the calm before the storm. Stocks were on a post covid tear but have come right off the boil the last few weeks and a lot of my big gainers are drifting seemingly unsure what to do next.
I also note, though I don’t have quality evidence of this, that the number of posts across the bulletin boards has dropped in recent weeks.
Even the faangs are splitting - those that use supply chains coming off whilst pure digital plays still heading up.
It's a bit mixed on my folios, some of the laggards have bounced up in the last 2 weeks, apart from Boohoo (LON:BOO) and Asos (LON:ASC), October has not been a bad month for me, September was far worse. Some of the ones hit by supply issues may have bottomed out.
Fear not IGotPoesJacket, we've just been through the May-Oct period, otherwise seasonally known as the 'Worst Six Months', 'Sell in May..'. etc.
From here, the probabilities move in favour of investors as we enter the 'Best Six Months' Nov-Apr, in which the vast majority of net returns have historically fallen.
There's no doubting that's historically true, on average. This year is shaping up to be a bit different I think, and it's my impression that lots of people are sitting on the sidelines waiting to see what happens next. From the price falls at the smaller end of UK markets (and it's worth noting the S&P 500 is being forced up by only a few name, more than half have fallen recently) it looks like a lot of money has been taken off the table recently so I guess we're at "risk off" or certainly "not as much risk on as usual".
I thought it was interesting that the recent falls have corresponded to a noticeable fall in bulletin board activity so it's not just the professionals drawing breath. Over previous years I haven't noticed a massive drop off in the amount of comment (like I said in original post - I don't have any quantative evidence for this , it might be me seeing what I want to see) even as the markets pause so I think we're in an unusual situation right now as everyone looks at supply chains, inflation, interest rates and consumers who have a lot of cash reserves built up but are spending fairly freely as far as I can see (used car prices rocketing for example).
I remain 100% invested, let's hope Santa brings us a good rally. This time next year Rodders... :)
LON:SLP I hold .For shareholders in Sylvania there is a very extensive research report from Edison Group (free) issued today. Their valuation comes up with 175p. Plenty of potential upside and good dividends but South African risk also needs to be factored in.
If I'd bought Sanderson Design (LON:SDG) at 40p in June, I'd be much more likely to be thinking of taking a profit at 160p with the market as uncertain as it is , than buying more, despite the drop.
Sanderson Design (LON:SDG)
"If I'd bought Sanderson Design (LON:SDG) at 40p in June, I'd be much more likely to be thinking of taking a profit at 160p with the market as uncertain as it is , than buying more, despite the drop."
I am in this boat having added at sub 40p - i did think about taking something off the table at 220p+ when its spiked up . However now we are down 25% from the highpoint so it is completely illogical for me to be selling up now having refused the much better offer recently. so i am firmly in alignment with Pauls thinking here - main thing is the fundamentals have not changed for the worse other than the general "supply contraint issues and inflationary and labour issues" that seem to have taken a turn for the worse in the last couple of months. I am not mystic milly though so where the share price goes from here know not.
Vodafone (LON:VOD) I hold. My strategy is to hold on to good quality companies showing good growth and a long term strategy I understand. Following a report by Paul I did further research and bought a big pile in 2 lots at 112. I saw that at one stage I was up 100% but this to me was not a signal to top slice. I find I am unable to time the market. When I have tried to, ultimately, I was down more than up. Of course if the financials of a company change to the downside then a review make me sell my complete holding.
With the greatest respect I would strongly disagree that Vodafone (LON:VOD) is a 'quality' company. By that I don't mean that it has a bad brand, nefarious management or even a bad product. I am a happy customer. But it isn't a quality company from an investment perspective. And the reason is that it has an absolutely dire return on Capital Employed. It's a company that is constantly running to stand still. It operates in an industry requiring never ending high infra investment not to mention having to acquire new spectrum licences from revenue strapped governments. And all at the end of the day so as to be a commoditised 'dumb pipe' enabling the real value added to be captured by the content providers (Netflix) or the handset makers (Apple). No wonder its share price has gone nowhere and IMHO will continue to tread water. Sorry, I don't mean to be patronising and of course I may well be wrong on Vodafone (LON:VOD) but it's just a topic I'm very passionate about, namely that most companies are garbage LT investments, and deservedly so. I strongly recommend reading the Fundsmith Investor Manual to the extent you haven't done so for what constitutes a quality company. Vodafone (LON:VOD) ain't one
Totally agree Phil, having sold the lot in July 2017 and have never looked back. Foolish me, I thought it was a Coffee Can share when I kept adding to company run by ambitious yet inept Directors. Luckily I got to keep my shirt.
Silver
As you will see I have corrected the helpful tip that shows VOD as an example. I was referring to Sanderson Design. I agree with your comments about VOD.
"most companies are garbage LT investments, and deservedly so"
Agreed, but that is the main reason why value investing has outperformed quality for most of history. Mostly, corporate performance reverts to the mean over time and value wins out. Yes, quality investing has massively outperformed over the last 12 years, but I see many people projecting that recent outperformance in to the future and I think that's a mistake.
I agree that Vodafone (LON:VOD) isn't a quality company, but that doesn't make it a bad investment. With a yield of 7%, it needs almost no growth to justify its valuation. I wouldn't be surprised to see it outperform Fundsmith over the next 10 years on a total return basis.
Overall, we should hope that value once again outperforms quality. If companies with entrenched positions are always able to repel their challengers and maintain fat margins then that doesn't bode well for the future of capitalism or the future of society in general. If free markets can't achieve this, then regulators eventually will be forced to.
Good luck with whatever your choices are.
Agreed, but that is the main reason why value investing has outperformed quality for most of history. Mostly, corporate performance reverts to the mean over time and value wins out. Yes, quality investing has massively outperformed over the last 12 years, but I see many people projecting that recent outperformance in to the future and I think that's a mistake.
I completely agree but I do wonder if we're seeing a once in a century change in business models? A hundred years ago electricty was revolutionising businesses, which had to reorganise around the production line to make use of the new power source. That needed everything from working practices to industrial architecture to change before it really yielded results. One outcome of that was consumerism, where people ended up owning all sorts of stuff.
Right now we're seeing quite significant changes in all sorts of businesses where we go from outright ownership to a SaaS model and that's happening at the same time as a move away from carbon based energy sources to renewables. I don't think it's too revolutionary to posit that some value investments are that way because they're going to be on the wrong end of history. Or that some stupid looking tech valuations will turn out to be cheap.
Sadly I'm not clever enough to figure out which are which so I'll continue to stick to the middle ground.
timarr
I'm in the middle ground too. I'm just saying that those who are placing all their chips on quality may come to find that they have been suffering from recency bias.
I don't see anything revolutionary in SaaS in this context. If an organisation has a particular CRM or ERP system, that becomes very sticky, but whether this is situated on the companies own servers or in the cloud, I can't see much difference as far as this question is concerned. If anything, if it's in the cloud it's slightly easier to change and so less sticky. Otherwise I agree with your characterisation of some revolutionary changes - but I don't see this as a reason for quality to outperform value long term.
The one area where I do think there's a difference is in businesses built on network effects and those monetising big data. The internet has made these business models possible in a way they weren't before. They may be worth their valuations because they have such a powerful positive feedback loop. Growth begets growth.
That's why I mentioned regulators, because they may be the only ones powerful enough to create more competition and drive down margins. The telephone system is cited as an early example of a network effect and it took the regulators to break that up in to a competitive landscape.
I'm in the middle ground too. I'm just saying that those who are placing all their chips on quality may come to find that they have been suffering from recency bias.
Yes. At the very least some of the more insane valuations are a consequence of cheap money. If interest rates go up companies on high earnings multiples with poor cashflow will suffer.
As we frequently say - the cloud just means someone else's computer. But it's really the idea that we won't own things but we'll rent them as and when we need it that's the big change. SaaS is one example of that, which is allowing businesses to start up and scale very rapidly. Companies with business models that can't adapt to that may find themselves bypassed.
On the regulatory point, I agree. In fact I think the emergence of a group of de-facto hi-tech monopolies is clearly restricting innovation and competition. That's also characteristic of a changing business environment, regulators are always regulating the past, never the future.
However, for holders of those monopolies there's little risk - when the regulators broke up Standard Oil the successor 34 companies continued to provide investors with great returns. Ditto with AT&T and the Baby Bells.
In the long term I don't doubt value will outperform quality - but I just don't know how long that long-term is.
timarr
Instead of presenting your dilemma as a choice between quality and value, I prefer to see investing as a question of entrepreneurship. Do I want to own companies in dying industries ploughing the remaining productive niches for a few years profit before the world moves on? Or do I want to own companies with strong positions in surging markets driven by long term secular growth trends? Thanks to the distribution of market confidence, this almost always looks like a choice between value and quality, but in practice it’s a choice between, on the one hand, flitting regularly from one underpriced diamond to another without stepping in any turds and, on the other, paying up for an apparently expensive growth compounder that will provide years, a decade even, of remarkable returns. It’s not just FAANG but huge compounders like SPGI, Moody’s and MSCI before we even get to Adobe and its SaaS brethren.
Of course, if interest rates rise dramatically from here, then the game will change - tech stocks will become great value as their prospects won’t be altered, only their valuations. This already happened in the March 2021 inflation scare before prices recovered dramatically. Did you buy then?
I agree that it’s the total return that matters but the dividend yield in an of itself is a complete red herring. The only thing that matters for creating real long term value is Return on Capital and growth working together. Neither is sufficient in an of itself. Vodafone (LON:VOD) partially yields 7% because the market thinks that the current dividend is unsustainable as reflected in an ever falling share price. And the market is not wrong because VOD doesn’t really cover its cost of capital. So each and every day it is destroying equity value. And it doesn’t even have any top line growth either. Therefore there is no way that it or its ilk have any chance of beating Fundsmith over the LT provided the latter’s constituents maintain their market leading characteristics. And I agree that is the big question. Can they? I would say that there are a small number of exceptional businesses, such as a Diageo with its unique portfolio of brands that can thrive over decades and decades, and are somewhat protected from mean reversion. The second point I guess where I disagree with the deep value investor mindset is the obsession with entry multiple. Many studies have shown that entry price is much less important than the compounding effect of a great business in value creation. Now obviously this is within reason. I would argue anyone buying Tesla at these levels need their head examined. The current valuation discounts absolutely heroic levels of growth and market domination. The same is true with many other unproven growth stocks. This being a small cap board that is obviously the hurdle here. Often shorter track records and smaller scale to deal with whatever exogenous shocks life throws. This is just not the case for your average Fundsmith constituent all of which enjoy multi decade track records and large scale. They are arguably priced fairly or even undervalued relative to their exceptional characteristics. Just for the record I have no connection to Fundsmith but I don’t understand the hate their strategy gets. Perhaps people just see it as too simple. To me it seems logical that quality must win out over the long term unless you are an active (and lucky) Special Situation investor
Phil
You make excellent points. And I’m not agreeing just because I hold Fundsmith.
One thing I would add is that I tend to think of companies of this size in terms of their growth phase. They are clearly not early stage companies and as long as they can recycle their strong returns on capital employed into innovation that provides further growth I don’t buy into the argument that their pricing must revert back to lower multiples.
On the other hand, I see many large companies as no longer being in their growth phase. They are in their maturity and possibly starting their decline. In those scenarios, I think that value investing can work. But those companies are so well researched it’s unlikely that the market has the pricing far out.
Agree about Vodafone (LON:VOD) . Cheap for a reason.
"To me it seems logical that quality must win out over the long term..."
That's the problem because it's not logical. People seem to have been brainwashed in to this mindset by a decade of outperformance. Why should it be logical? There is no law that states quality must outperform regardless of starting valuation and reversion to the mean. If it was logical then why has value outperformed over the very long term (since 1926 in the US market)?
"The only thing that matters for creating real long term value is Return on Capital and growth working together."
This isn't true. The value of a stock is the present value of its cash returns. Contrary to what you say, the dividend is very important in this calculation. If interest rates ever get higher than 0% the market is likely to remember this. Also, note that it is not the return on capital that matters to equity holders, it is the return on equity (ask bank or insurance stock holders).
"Many studies have shown that entry price is much less important than the compounding effect of a great business in value creation"
Agreed, but these studies are sales material, not academic studies. They work by picking isolated examples of great companies. The problem is, in the real world, how do you spot these companies in advance? How do you know that your company is not one of the far more numerous examples that achieve great performance for a period of time and then revert to the mean?
“The problem is, in the real world, how do you spot these companies in advance?”
If the ride is going to last for 5, 10 years or more, you don’t need to know in advance. Just swallow the valuation and get on the bus. They aren’t hard to spot once you get your eye in - although I still make mistakes of course. You look for great operating numbers and engaged management in concert with a strong moat and powered by structural growth.
A good recent UK example is Calnex. I knew (and bought) the day I was introduced to it (although the day came later than I would have liked).
I think we are mixing different concepts. Forget the market for a second. Assume you have 2 private businesses of roughly similar size. One makes 50% Gross Margin and grows revenue at 10%. The other makes 25% Gross Margin and grows revenue at 5%. I’m super simplifying but surely its indisputable that the first business is the better, quality business and should the metrics stay the same will produce its owner a superior return. That is just mathematics and why the quality argument is logical. What you are saying is hang on. 1. If the first business costs 10 times more than the 2nd then surely it will have an impact on your eventual outcome. And 2. In any case it’s irrelevant because the first business must eventually mean revert through competition, obsolescence, scale or whatever. And the answer is that yes of course the entry multiple has relevance. There are levels where one will struggle to make a decent return. But in buying a low quality business cheap you can only hope for a small re-rating. A high quality business proves its worth through its financial performance irrespective of what Mr Market does at any given moment. And over time this will be recognised and in spades. And there are businesses that have that special sauce / moat that just don’t seem to mean revert. That’s obvious from people lucky enough to buy Coca-Cola or Disney or Hermes 40 years ago
Of course the yield is an important part of TER. But it all depends how that yield is generated. If the business is not covering its cost of capital or barely covering its cost of capital you are being bribed with your own money. You are giving VOD £100 to get back £7 but in the knowledge that the value of your original investment is being eroded. And that is why VOD is yielding 7%. Mr Market is essentially saying that the current dividend is unsustainable. And it is because VOD can’t cover its prodigious levels of investment and dividends without blowing up debt beyond what is comfortable ie it does not pay its way. Berkshire Hathaway by contrast pays no dividend and so what. As mentioned up thread by GrahamF it is able to reinvest capital at superior rates of return - although its now coming up against scale limits - and that delivers the TER. If someone needs income they can just sell stock as and when
You spot these companies in advance by screening their metrics - I guess what Stockopedia tries to do - and then looking at track record. To go back to Fundsmith their companies have decades of track record through multiple business cycles. And then of course you consider whether their models are still relevant. I agree with the points up thread that as the economy seems to evolve ever faster this gets harder. But some things seem to stay the same. People like a drink, they use lifts, they brush their teeth, they like to be entertained, etc. I don’t think it’s rocket science. If someone offered you one stock to hold today that you had to hold for 10 years and it was a choice between Vodafone, NatWest or Diageo which would you choose. I know which one I think would offer the most upside at the least risk
A lot of what you say is true, I agree with most of it, but despite what you say, the facts remain that (1) value has outperformed in most periods of history and (2) it has also outperformed over the very long term, despite the heroic performance of quality since the GFC and the collapse in long term interest rates. How do you explain that in your framework?
You seem like a smart guy, but I think you are misunderstanding how and why value has achieved this outperformance. You say "in buying a low quality business cheap you can only hope for a small re-rating". There is a partial truth in this but it's a misleading statement, because, I think, you are missing 2 key points:
1. Yes, often the return on a given stock is less than people see on their LTBH quality investments. But value isn't a LTBH stratgey. It has much higher turnover. So yes, one individual holding may show less return, but in the same timeframe you've achived that return multiple times. When you compare holding Vodafone, Natwest or Diageo for 10 years, it's a false comparison. Value investing isn't about holding for 10 years. It's about holding until the value is outed and then moving on.
2. Just as in quality investing, there will be many with multi-bagging returns. Take a look at Paul's case for Saga (LON:SAGA) as an example. Unlike many of his choices, it's a classic value investment, which he believes could easily 3 bag within a few years, despite its quality rank of 13 having a big red circle around it. The reason it could easily multi-bag is because mean reversion works both ways. It works negatively often for highly quality businesses, but positively often for poor quality ones, like Saga. Simply returning to average performance and an average multiple would see it multi-bag.
I'm not down on quality (I don't fight the market and I have several classic quality holdings. Of the 3 stocks you mention, the only one I hold is Diageo). But I question whether it will continue to outperform over the next decade. In assessing that, I think it's important to recognise and understand why it's value that has been the long term winner. For me, there are also some other key reasons to do with risk, but I'll leave it there.
Thanks for the really interesting debate! As you say I think we may actually agree on more things than it seems. The last thing I would just say is that I do have a big issue with these backward looking value studies in that they assume perfect execution and transition from one opportunity to another. To steal from Buffet it assumes you go from one cigar butt to the next seamlessly. In reality that's a very tall order because the fundamentals of the business are often against you. Hence you are often left depending on the greater fool theory for your return (re-rating) or some exogenous factor which the business doesn't really control. History shows that very few people achieve anywhere close to a respectable track record with this method. For every 1 Saga that triple bags or a Reach or Premier Foods there are another 3 that go nowhere or worse. I agree though that it can make for a much more exciting form of investing. But risk adjusted I really question the potential returns unless you are super concentrated (and by definition taking on a lot more risk, not just from the concentration but because you are concentrated in Cigar Butts) and / or very lucky and / or exposed to Insider Information. I mean just look at the travails at Crystal Amber. A really smart, driven team. And yet they have not delivered. And I would say that's because they have lumbered themselves with one tough strategy
But in buying a low quality business cheap you can only hope for a small re-rating. A high quality business proves its worth through its financial performance irrespective of what Mr Market does at any given moment. And over time this will be recognised and in spades.
You would think so, wouldn't you? Rob Arnott did some analysis in 2009, looking back, using what they called Clairvoyant Value, looking at what a clairvoyant investor should have paid based on the actual future returns:
The results for the entire period support the single period results reported in our earlier paper. In each of the 51 years—without exception—the market was able to assign higher valuation to stocks that subsequently exhibited faster growth than those that commanded lower valuation multiples. However, in the vast majority of the years, the market paid far more than the clairvoyant investor would have for growth stocks relative to value stocks.
https://citeseerx.ist.psu.edu/...
As Arnott says, growth stocks can outperform value stock for extended periods of time, but ultimately value stocks outperform not because they're better companies - they're not - but because people pay too much for growth. Maybe this time it's different, but the idea that suddenly a whole cohort of companies have evolved that are immune to the Invisible Hand seems pretty unlikely. In every generation there are a few superstocks but inevitably excessive earnings attract competition.
That said, I have no difficulty believing that growth stocks will continue to prosper over value stocks for the foreseeable future. Shades of Schumpeter's destructive-creationism are everywhere.
timarr
I wonder if what makes this debate harder to pin down is the old chestnut of "what constitutes value". To an investor in Tesla something like Diageo would perhaps be classed as a value stock. If that is the definition then I am more comfortable that value can outpeform Growth, with value more akin to 'Growth at a Reasonable Price'. To my mind when I hear value I think 'deep value'. It's Cigar Butt / Special Situations or low ROCE or Ex-growth Cash Cows. And here I massively struggle with the idea that investing in a portfolio of these can possible outperform GARP in a 'real world' setting i.e. without perfect hindsight and a lot of luck
I’m not necessarily disagreeing with you about Vodafone but (whilst acknowledging that broker forecasts can be taken with a pinch of salt) why do nearly all the broker forecasts project its value as 50% higher than presently? That, in and of itself, puzzles me.
I guess because brokers believe that Mr Market has overshot on the downside and that 7% yield is not a sign of its unsustainability but that VOD is too cheap. I guess they hope that the massive capex investment will eventually bear fruit. But then again they always have a BUY bias. But just look at that top line history. Revenue down to flat for years and years. An ultra competitive, capital intensive business. Barely has it upgraded to 4G and now it’s investing in 5G. But where is the benefit in the metrics. For consumers yes. For Netflix, Facebook sure. Regulators are blocking further consolidation. It’s always jam tomorrow. Is this a stock you want to bet on for that re-rating pop
I guess because brokers believe that Mr Market has overshot on the downside and that 7% yield is not a sign of its unsustainability but that VOD is too cheap. I guess they hope that the massive capex investment will eventually bear fruit.
As far as this discussion goes, IMO Vodafone (LON:VOD) is a really poor example of a value share, at least as I understand "value". If interest rates rise it will fall just like highly rated growth shares because in reality it is a utility i.e. it needs constant capex which leads to huge debt, no growth, and is highly sensitive to regulation by governments. This is maybe the reason it has been falling since the prospect of a near term rise in interest rates. I'm sure there are better, less utility like "value" shares, to choose for comparison.
It's a natural but dangerous thing to extrapolate the present into the future, but I'd say the chances of Vodafone (LON:VOD) outperforming in the next 10 years would likely mean the world has almost come to an end. In fact, I'd be surprised if if it still existed in its present form.
All the best, Si
Vodafone (LON:VOD) 's tragedy is that it's a utility as you say with all the associated capex but without the 'monopoly' element that many other utilities enjoy. In my view it's the worst of both worlds
You're right that higher interest rates should negatively effect all share valuation via the Discount Rate but I question why growth shares should suffer worse than value. If higher interest rates are a function of higher inflation then surely it comes down to pricing power and cost control. And here a capital light growth company with a strong brand might well be in a better position than a lumbering capital intensive value stock
As alluded to above I guess I really with struggle with the whole value / growth distinction. To my mind there are high quality shares and low quality shares. The former should relatively outperform the latter irrespective of the macro environment because they start from a position of strength through higher margins, better brand, lower leverage or whatever. Given the unknowability of the future I think you are safer navigating life's exogenous shocks on board a Quality Company than not. What constitutes Quality of course is then another discussion. To my mind Tesla is not 'quality' because it operates in an unattractive, capital intensive, highly cyclical, low margin sector. Like Airlines. Most companies and sectors are just not 'quality'. But the beauty is that as a PI you don't have to touch them
You're right that higher interest rates should negatively effect all share valuation via the Discount Rate but I question why growth shares should suffer worse than value. If higher interest rates are a function of higher inflation then surely it comes down to pricing power and cost control. And here a capital light growth company with a strong brand might well be in a better position than a lumbering capital intensive value stock
Don't worry, you're preaching to the converted. I agree! But then I'm not a "value" or "growth" investor. I apologise for getting involved as I have little interest in these kinds of high level discussions; I just wanted to comment on Vodafone (LON:VOD) which is an awful company. What we should concentrate on, and the reason this blog exists, is stock picking. Who cares whether a particular company is a growth or value proposition?
I don't find gross generalisations or macro waffle the least bit helpful, not that I'm accusing you of that :-). I keep hearing the US market is overpriced - this is a lazy generalisation. Maybe it is overall, but within it I can still find great companies on reasonable valuations, unlike the UK market, unless I want to hold mostly poor quality companies in old low/no growth industries. What about Intel on a forward PER less than 10 with a yield of 2.8%? What about Amgen on a forward PER of 12.6 and yield of 3.4% covered 2.5x. Or what about Qualcomm (the largest fabless semiconductor company in the world with many of the patents for 5G) on a forward PER of 16? On a long term basis I am finding it hard to get that interested in UK small caps currently when such good value is on offer in the US mega cap space.
All the best, Si
Is Vodafone (LON:VOD) a quality company? Stockrank Quality of 47, and it has a huge amount of debt. Shares have halved in the last 5 years, no wonder the FTSE does not do well, with large companies like this holding it back. Having had my mobile contract switched to them recently, I'm not all impressed with their service, there have been numerous complaints. Call centre I don't know where it is but certainly not in the UK. Loads of conflicting text messages about credit balance and bundles.
Sanderson Sanderson Design (LON:SDG) Just noticed that I did not correct the example. My comment related to Sanderson Design. Will be more careful next time!
Naked Wines (LON:WINE) US listing was up 35% yesterday so it could be interesting to see what happens in the U.K. today. The reason is Glen Kacher of Light Street presented it at the Sohn conference, below is the most I can find on what he said (if anyone finds anymore please share). He suggests it is the "Netflix of Wine". 4 bagger in 4.5 years and much better than 10 bagger in 10 years.
https://www.cnbc.com/video/2021/10/28/light-street-capitals-kacher-likes-the-netflix-of-wines.html
Here is the Stockopedia/PIWORLD StockSlam October 2021 including a pitch of Rbg Holdings (LON:RBGP) by Jack. Others pitched: Driver (LON:DRV) Crystal Amber Fund (LON:CRS) S&u (LON:SUS) Up Global Sourcing Holdings (LON:UPGS) Pebble Beach Systems (LON:PEB) Thruvision (LON:THRU) Mission (LON:TMG) Marshall Motor Holdings (LON:MMH). Leo Investor takes the pitch to a different level! All the pitches are excellent. Video and podcast
Please think about 'Slamming' next time. Thousands of you enjoy this investing community event but it's a handful who volunteer to pitch. We want this to be an inclusive event with everyone taking part. Who's up for it? Contact me via the PIWORLD contact page.
And, if you know anyone wanting to get noticed by the City. Do suggest they do a longer, more serious pitch to Andy Brough, Judith MacKenzie and Stephen English in Sell it to the City. If anyone mentors young investors or has contact with universities/educational establishments who would be relevant, get in touch. It's a great opportunity.
Finally, we have some investor webinars coming up with November results. The only one announced so far is Tracsis (LON:TRCS) register here. More to follow, which will be on the same link.
BBC report on NHS prescribing e-cigarettes for smokers looks like big news for Supreme (LON:SUP), which is the clear market leader in UK vaping (something like 1 in 3 UK vapers use Supreme’s 88vape brand). Supreme (LON:SUP) already supplies Her Majesty’s Prisons across UK, so they should be well positioned to win another UK government contract from NHS. They put out a trading statement about 10 days ago saying trading had been particularly strong with “significant year-on-year growth in profitability”. Consensus EPS for this year looks too low to me in light of that statement, my modeling shows EPS of more like 15-16p. So, high quality stock with huge growth opportunity is trading on about 12x this years earnings.
Additional thoughts. Many of the other leading vape brands in the UK are owned by Big Tobacco. The likelihood of the NHS awarding them a contract is extremely low so Supreme (LON:SUP) should be very well-positioned here. Also, Supreme’s 88vape is the best value brand on the market at £1 per bottle of eliquid (compared to competitors at more than 3 times that price typically) and they clearly have the ability to deliver at scale (1 million customers today) which also puts them in a v strong position for an NHS contract.
Begbies Traynor (LON:BEG)
Issues it's Q3 Red Flag report today - worth a read.
"562,000 UK Business Facing Financial Distress in Q3 2021 with Dramatic Rise in Court Action Fuelling Insolvency Concerns"
Phil
Would be great to hear your views on Naked Wines/Light Street Capital. Have a great weekend!
Good morning GBValue,
Would be great to hear your views on Naked Wines/Light Street Capital.
Funnily enough, I was watching CNBC last night, when a rather gushing America fund manager came on, and started saying how he reckons a UK-based company called Naked Wines would be a multibagger. He described it as the "Netflix of wine" - so I assume that means it creates a lot of content, and doesn't make any money!
Seriously though, he reckons Naked Wine is a multibagger opportunity, and thinks it has a strong moat.
Moments later, the CNBC host flagged up that Naked Wine shares (which are tradeable in the US markets, through some form of secondary listing) were up about 95%! I did try to see if I could open a short in the US market at that level, but sadly not possible.
The main liquidity is in the UK market, so a big spike caused in a peripheral venue for the shares, is usually a good opportunity to sell some.
That said, I see the spike has already moderated down to +12% in the UK market, so it looks like the trading opportunity has been & gone.
I've never liked all the hype around Naked Wines, nor the way it presents its numbers - supposedly very profitable, but spends it all on marketing, so not actually profitable. That doesn't sit well with my Value/GARP principles. That said, if the shares are going to the moon, then I'm as happy as anyone else to have a flutter on it.
I've just signed up for the introductory £30 package for 6 bottles, to try out the product. I didn't like all the faffing about looking for producers, etc, then finding there was no stock available, last time I looked at Naked Wines, years ago, but maybe it's more straightforward now?
My Mum's friend says their wines are very good, and mother agrees. So there we go, pensioners in Bournemouth seem to like it, a good starting point!
Regards, Paul.
Hi Paul,
Like you have always been a bit sceptical about their business model, and the level of ambition particularly in the US. However, even though I'm not a shareholder, I have been a member for about 4 years and their wines are generally excellent. So guess that means I shall continue to monitor for more signs of stable progress.!
Another main issue for me is how they grow the supply when most of their producers are small vineyards who don't have the scaling capacity of say Hardy's or Oxford Landing. It has successfully 'pulled' some suppliers through difficult Covid issues and there are some outstanding new growers on their sometimes exclusive books.
I was a customer about 10y ago.
If you want nice wine from a small supplier at a reasonable price, they are really good.
As an investment I was not so sure, saw the effective RTO of majestic was a 'we do not know what else to do' move but as it has not gone badly wrong , kudos to the management.
As you identified, the issue is scaling. I stopped because 500 cases from small supplier X sold out in minutes and so you were basically marketed a lot of nice things that you were not allowed to buy. Not a great business model.
As the supply of any one wine is fixed and finite, and digital streaming of any one film is not, that american analyst is missing some fundamental 'this is not netflix' points.
However , that problem is not insoluble. the same microtargeting techniques used on facebook can be used to send that marketing to the smallest set of people that meant the drop is likely to sell out. better, send the marketing to those who just missed out last time a bit earlier that the rest. A bit creepy but is should be possible to train the people who have a tendency to want wine like this to buy more , faster.
The question that still remains is whether it can make a profit. The magic words "scaling" "website" "usa" are used, but, when any one parcel of what is being sold is relatively small, how does that scale?
You could sell more small parcels, but, the only thing that actually scales well in this context is the website. The cost of the wine will not drop much and as DHL is moving 500 parcels from producer to consumer, neither will transport.
You could sell from producers that operate in bulk - probably why they took over Majestic. This space is very congested; supermarkets, laithwaites, the wine society (i am a member/owner - it is a co-op! and buy about 90% of my wine there) all compete here.
Moving from small scale short runs to stuff like what you see in Sainsbury's is a big identity shift and doing that will lose a lot of what made NW special.
That I can be bothered to write about a somewhere I used to buy wine from 10y ago is a tribute to their old business.
I do not forecast doom, but am still not sure there is a sustainable new business in there.
Naked Wines (LON:WINE) it depends how the expansion into the US market goes. Too many people focus just on the UK market, I saw the same thing with £FEVR
But there will be issues in the US, deliveries seem to be a problem there.
I have looked at Naked Wines several times and declined, exactly for the reasons you clearly articulate in your comments above. The model looks challenged, despite it being a very compelling consumer proposition. The investment case seems to hinge on their ability to sell signifcantly more small parcels, at increasingly 'exclusive' premium margins, to a growing segment of discerning and well educated wine drinkers, without marketing and complexity costs increasing. If they can execute this model then this can work beautifully, up to the point that boutique industry capacity is exhausted. I'll be interested to see how this works out.
Re. Skinbiotherapeutics (LON:SBTX) launch of psoriasis treatment - well spotted! (Coat please).
Gus.
You've only scratched the surface of possible jokes there.
Are you trying to get under my skin? Makes my blood boil ……
The level of humour here this quiet Friday for news, is now getting a bit flakey
I predict lots of people will take the psoriasis today and respond to your comment.
Far too many rash comments for my liking today.
"You've only scratched the surface of possible jokes there."
I suspect many people are simply itching to respond to your comment.