Small Cap Value Report (Mon 7 Oct 2019) - DUKE, RFX, BOOM, ANG, GHH

7th Oct by Graham Neary

47 comments 8608 reads

Good morning!

Well done to everybody reading this - you've survived a tricky couple of weeks in the markets.

The FTSE has stabilised around 7150, which from my perspective seems to price in lots of bad news, especially with the pound also rather weak.

The papers suggest that this is a critical seven days for Brexit negotiations. I'm sure we're all completely fatigued when it comes to that subject, however, so let's not dwell on it!

Personal trading update

I like to be as transparent as possible when it comes to my personal portfolio, so please note that I have today closed both my short position in Tesla and my long positions in the FTSE Index. That's why this morning's report has got off to a slow start - I've needed to tidy up a few personal matters.

To be clear, this has not been driven by any change in my view of the merits of these trades. I still view them both as extremely attractive. The reason is that I am in the middle of a house-buying process, and need to use the collateral for the deposit and fees. The potential returns from a trading account must be swapped out for the certainty of home equity.

On that subject, I wonder if readers here have any views on the home equity vs. stock market equity question? Do you carry a large mortgage while also building a stock portfolio? Or would you prioritise building home equity first, before venturing into the financial markets? I've always found this an intriguing question, and now I have to answer it.

Today's news

This is what I plan to discuss today:

Duke Royalty (LON:DUKE) - primary bid fundraising, announced on Friday
Ramsdens Holdings (LON:RFX) - trading update
Audioboom (LON:BOOM) - Q3 trading update
Angling Direct (LON:ANG) - interim results
Gooch & Housego (LON:GHH) - trading update

Duke Royalty (LON:DUKE)

Share price: 45.5p (-4.4%)
No. of shares: 197 million (pre-fundraising)
Market cap: £90 million

Fundraising of up to £20 million

Retail offer via PrimaryBid.com

This was announced on Friday, after…

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jonesj

7th Oct

I purchased my first property in 1995, having deliberately decided they looked too expensive in 1990.
I liquidated my Investment Trust holdings to have a 26% deposit.
The mortgage was about 2x income and I put together an Excel spreadsheet & adjusted the numbers until it showed the mortgage being paid off in 5 years. Which is exactly what I did.
I then went back to stock market investing from 2000, having had no exposure during the life of the mortgage.

With hindsight:
1 The property purchase was well timed.
2 I was much too conservative in paying off the mortgage, when I should have being doing a combination of paying off the mortgage and utilising PEP allowances. With the way I did it, I missed PEP allowances and missed the 1995~2000 stock market returns.
I did just fine from 2000 onwards, avoiding tech stocks and investing in breweries etc.

The situation now is slightly more complex, a a couple have 2x £20k ISA allowances, plus the opportunity to avoid a lot of 40% tax with a SIPP (£40k per annum ?). So it would need a good 6-figure income to live, fully exhaust these tax allowances and still have some left over to pay down the mortgage.

doublelutz

I would say few people consider other major purchases such as cars as investments because they know they are certain to eventually be worth nothing (unless it is classic car). Although I am aware that people can finish up at least temporarily with negative equity I believe that over a lengthy period your house can only be an appreciating asset. For one thing building costs increase. There must be many people whose houses like mine are worth 10 times what they paid. The investment return is that I do not have to pay rent. So if we say that my house which cost me £60,000 would now cost me £18,000 to rent that would be a pretty good return. Also it is an investment in that the ultimate value on my death is relevant to me in that one objective is to pass on as larger an amount as possible. As regards paying off a mortgage or investing the money I think it depends on age and whether the amount of the mortgage is something you are comfortable with. I went with paying off the mortgage.

golfnut59

"Do you carry a large mortgage while also building a stock portfolio? Or would you prioritise building home equity first, before venturing into the financial markets?" Graham, I think the answer to this comes down to your appetite to risk. Considering you can borrow money for next to nothing at the moment, this lends itself to carrying a large mortgage. It doesn't look like interest rates will be moving north anytime soon. If interest rate rises worry you, for peace of mind you could always take advantage of a 10 year fixed product. I notice you can get fixed rates at 2.3% on a LTV of 75%. Considering you are still a young man it seems sensible to have the capital work for you in the markets rather than have it tied up in property. Its really a question of opportunity cost. Personally, I think you'd be crazy not to take full advantage of the low interest rate environment and use it to your advantage.

bluecurve

Hi Graham, Your question about Home Equity v Stock Market Equity has generated a huge response, and rightly so. I've faced a similar decision recently, as I was in a position to pay a significant part of my mortgage early. I had 10 years to run and faced the decision: do I pay it off, or do I keep investing?

One source that I found really useful when thinking about this was a series of articles by "Big ERN" on his blog https://earlyretirementnow.com. He's done a lot of research into the "sequence of returns risk", and how the sequence of returns affects your actual return over time. His worked examples are extremely detailed. He also discusses the merits of paying off the mortgage early.

As a quick example, say you choose to pay off the mortgage early, so pump as much free cash as you can into that goal. You're mortgage free, maybe 10 years earlier than planned. Is that a better scenario, than pumping all your free cash into the stock market and running the mortgage out for the full term? If you go with option 1 then you've potentially lost 15 years savings, PLUS all the compounded returns. You also start investing 15 years later, and although you may now be in a position to invest more cash, you have less time left to benefit from the compounding effect. The risk due to the sequence of those returns is also greater because you have less time left to invest.

Inflation also plays a serious part here. Although the interest rate may fluctuate, the amount you owe will not be affected by inflation. In fact that amount will become less significant over time. By investing alongside the mortgage, inflation works in your favour, as your returns should benefit from inflation, whilst your mortgage amount remains unaffected.

If you fancy a podcast that provides and good summary of this subject then he appears on the Choose FI podcast - this one discusses sequence of returns risk https://www.choosefi.com/035-sequence-return-risk-early-retirement-now/ .

batt

On buying a home versus investing, I think that this country's obsession with bricks and mortar has been damaging to the UK economy. On top of which we have continual government meddling. Help to Buy etc.

RichardK

Henry, I had a very similar experience with the Duke Royalty (LON:DUKE) PrimaryBid offer. In my case I had two Lloyds debit cars rejected because of errors in the expiry date (both in 2022). PrimaryBid has yet to respond to the message I left. PrimaryBid seems unusable for me.

Richard

Ned Kelly

At age 70 I had to payout my previous mortgage on my home but found I was able to remortgage at a fixed rate for 5 years at just over 2%. This seemed a no- brainer to me rather than taking the money out of the market. Effectively the mortgage money is now in a Fundsmith ISA earning 17% plus so far, so will pay it off when the 5 year fixed term is up.

Henry Walpole

I've always thought of any houses I've owned as investments. There are massive regional variations but where I live in Norfolk renting seems cheap to me compared to buying. We sold our house last year as prices had got 'silly' (they may yet get 'sillier'). This has freed up lots of cash for investing. We're now renting a very nice house on a long term secure lease and I reckon the landlord is grossing about 2 to 2.5% pa. Happy to take the other side of that trade.

You could take the house out of the equation and ask would you be prepared to borrow, say, £100,000 at a low rate of interest to invest in shares. Younger people may find this hard to believe but at one time you could get tax relief on interest borrowed for any purpose. At the time tax rates went up to almost 100% when the investment income surcharge was taken into account and it was often the case that persons on high earnings would borrow money, get tax relief on the interest at their top rate of tax and hope to secure a capital gain which was entirely free of tax at the time. It is not something I would do at the present time as the £100,000 borrowed could become £60,000 in short time but, of course, if it came off it would be a good idea.

aflash

Two factors do not appear to have been clearly pointed out so far:

First: Real Estate prices are cyclical, moving from Buyers to Sellers' markets over periods of about 25 years. There are cycles within cycles, moving from the developed world to individual countries to individual regions. So one has to judge where one is in the cycle for where one wants to buy. In North America prices have surpassed the peak of 2006-7 but in South America there are some great opportunities.

Unfortunately few of us have the time to shop, invest or settle in those areas.

Second: Property with a mortgage is a leveraged investment just like one in the stock market and if you buy at the right time the underlying asset is fairly stable. The fact one can live in the asset if it drops in value helps.

So then it comes down to a question of cash flow. How much mortgage debt can you service? If you have tenants you can service more.

pka

Bluecurve wrote:

"As a quick example, say you choose to pay off the mortgage early, so pump as much free cash as you can into that goal. You're mortgage free, maybe 10 years earlier than planned. Is that a better scenario, than pumping all your free cash into the stock market and running the mortgage out for the full term?"

If you have an offset or flexible mortgage, you don't have to make that decision until the mortgage reaches its full term. You are free to put any free cash into offsetting the mortgage (and thereby reducing your mortgage interest payments) or into the stock market as and when you choose.

simoan

We sold our house last year as prices had got 'silly' (they may yet get 'sillier'). This has freed up lots of cash for investing. We're now renting a very nice house on a long term secure lease and I reckon the landlord is grossing about 2 to 2.5% pa. Happy to take the other side of that trade.

If that's the case, what if the landlord comes to the same conclusion as you tomorrow, doesn't want to be on their side of the trade any longer, and decides to sell the property? This idea of a long term secure lease does not exist in reality and is a bit naive... and therein lies the rub - the vast majority of people in the UK want their own home with the peace of mind and security that brings, not just a house to live in as an investment.

I guess if you are a full-time investor like Graham and need to reduce equity exposure to fund a property acquisition you may naturally take a different view, however as someone who has paid a mortgage off entirely from the income gained through full-time employment, I don't see any need to conflate the equity in my home with my quite separate equity investments. Investing is difficult enough without that added complication IMHO.

All the best, Si

8th Oct

Hello simoan, we are renting an Ecclesiastical property so it is genuinely a long term lease, several of our neighbours have been here 20 years or more. None of the houses (100+) have ever been sold they're all rented. We can stay as long as we like as long as we behave!

I suppose they might have a change of heart and decide to sell up but I think that's unlikely after all this time.

Obviously, I'm glad you feel secure in your new environment but I hope you take my point that it is just a feeling, not a 100% guarantee that you get from owning your own property outright. I'm not sure how you put a value on the peace of mind offered by the latter? All I know is that it's worth a considerable amount to me given all the other things there are to worry about on a daily basis, particularly as you get older.

timarr

Obviously, I'm glad you feel secure in your new environment but I hope you take my point that it is just a feeling, not a 100% guarantee that you get from owning your own property outright.

To be fair, if you wanted a landlord that was pretty much guaranteed to give you peace of mind it would be Ecclesiastical. This was their response when Aviva tried to steal preference shareholders rights away:

Ecclesiastical notes Aviva's governance statement that "as one of the biggest companies in our sector, we aim to make our industry work better for everyone. That starts with us building trust with our customers, investors and shareholders by running our business honestly and transparently." Ecclesiastical trusts that Aviva will follow the principles set out in that statement when considering whether to pursue this course of action.

https://www.investegate.co.uk/...

Their annual report is well worth a read: https://www.investegate.co.uk/...

Of course, I've held hold a boatload of Ecclesiastical Insurance Office (LON:ELLA) prefs since the GFC, so I'm probably biased ...

I don't believe the feeling is any different to the one you may have owning your own property.

For example what if your neighbours decide to let their house to rowdy students, or a new four lane bypass is built that comes very close to your home, or a homeless/drug addict shelter is built on the other side of the road to your front door?

All these are real life examples I've come across where people who had a feeling of security with home ownership suddenly found that this wasn't the case. With an illiquid asset like property that can leave you stuck.

Not to mention what might happen regarding home ownership if we get a Marxist government!

Ah I probably expressed that ambiguously, when I said Ecclesiastical I meant church owned property - nothing to do with the Insurance office.

Ah. It was the capital E that baboozled me :)

For the majority of people that is simply not true in my experience. Most people in the UK want to own their own home not live in rental property and pay someone else's mortgage for them. Especially if they view their property as an investment! :)

I think we'll just have to beg to differ. All I know is, with low interest rates it makes sense to buy a house if you can afford it and need somewhere to live because the returns on holding cash are pitiful and being eaten away by inflation. Of course, that may change, but if I were to rent my current house it would cost 15-20x the final monthly mortgage payments before the interest was cleared. Why on earth would I sell it and rent?

john2

Or the Hell's Angels buy the house next door to use as their club house. Another true tale.

Small Cap Value Report (Mon 7 Oct 2019) - DUKE, RFX, BOOM, ANG, GHH

Personal trading update

Today's news

Duke Royalty (LON:DUKE)

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About the Author

Graham Neary

47 comments

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