Thoughts on value investing

Tuesday, May 15 2018 by
40

My aim here is to give some thoughts on my approach to value investing to try and spark conversation. I've had reasonable success applying this approach but still make mistakes and want to be a better investor so have decided to outline my approach with the hope that others will comment constructively. For reference, I have been managing my pension since early 2016 and to date have achieved an IRR of c.26%. That includes some funds, all of which I have outperformed so I guess that the IRR on my equities is somewhere between 30-35%.

My professional experience is in banking; I was a restructuring banker for a large UK bank following the financial crisis and have then had a business development role in a large corporate and now work in alternative credit. I am fascinated by what drives a business forward. Given my banking background and experience I have seen a lot of failed/ under-performing businesses and have developed some thoughts regarding risk which I will outline below.

Howard Marks, founder of Oaktree, has written an excellent book on value investing - "The most important thing". The big point I have learnt from Marks is that price is a key component of risk. Given that there is always uncertainty in investing, the higher the price you pay for an asset the greater the risk you are taking. I seek to apply that insight by categorising my investments as follows:

1) Deep value. These are situations where the market cap of a company is far lower than its tangible net asset value ("TNAV"). An example of an investment in this category which worked for me was Hargreaves Services (LON:HSP) , a legacy coal mining company which had large amounts of excess land. Earnings where declining but the company was seeking residential planning permission for a large site. Even before allowing for a valuation uplift for consent, the company was at a c.30% discount to TNAV. I was able to buy in at around 160p and sell out at 330p about a year later once permission came in. It was possible to research the development proposal using public information and doing the leg work paid off.

A case which didn't work for me was BCAPII a fund which tried to buy and turnaround struggling businesses. Despite…

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NEXT plc is a United Kingdom-based retailer offering clothing, footwear, accessories and home products. The Company's segments include NEXT Retail, a chain of over 500 stores in the United Kingdom and Eire; NEXT Directory, an online and catalogue shopping business with over four million active customers and international Websites serving approximately 70 countries; NEXT International Retail, with approximately 200 mainly franchised stores; NEXT Sourcing, which designs and sources NEXT branded products; Lipsy, which designs and sells Lipsy branded younger women's fashion products, and Property Management, which holds properties and property leases which are sub-let to other segments and external parties. Lipsy also sells directly through its own stores and Website, to wholesale customers and to franchise partners. The Company's franchise partners operate approximately 180 stores in over 30 countries. more »

LSE Price
5988p
Change
2.9%
Mkt Cap (£m)
7,978
P/E (fwd)
12.7
Yield (fwd)
2.9

Bonmarche Holdings plc is a multi-channel retailer of womenswear and accessories. The Company offers clothing and accessories in a range of sizes for women through its own store portfolio, Website, mail order catalogues and through the Ideal World TV shopping channel. The Company's subsidiaries include Bluebird UK Topco, Bluebird UK Holdco and Bonmarch Limited. The Company has approximately 310 stores across the United Kingdom. more »

LSE Price
8.5p
Change
 
Mkt Cap (£m)
4.3
P/E (fwd)
3.9
Yield (fwd)
18.2

Goco Group PLC, formerly Gocompare.com Group plc, is a holding company. The Company's principal activity is providing an insurance price and product comparison Website. Its segments include Insurance and Strategic Initiatives. It operates a United Kingdom-based price and product comparison Website, Gocompare.com. Gocompare.com offers an online service that enables consumers to compare the prices and features of products. The comparison services provided under the Insurance segment include over 400 brands and are split into three categories: motor, property and other. The Company operates its own Website platform for car, motorbike, van, home and pet insurance comparison services, displaying a range of products offered by its panel of insurers. The products compared under the Strategic Initiatives segment include over 250 brands and are split into three categories: money, home services and other. The Company's subsidiaries include Gocompare.com Finance Limited and Gocompare.com Limited. more »

LSE Price
75.8p
Change
-0.3%
Mkt Cap (£m)
317.2
P/E (fwd)
13.1
Yield (fwd)
1.6



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13 Posts on this Thread show/hide all

doug2500 15th May '18 1 of 13

Is that all you holdings? Quite a concentrated portfolio if so, but that's fine as long as your comfortable.

I agree totally about Howard Marks book, one of the best I've read.

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ISAallowance 15th May '18 2 of 13
1

Interesting post, thanks for sharing your thoughts.

One which came up with interim results today that I would put in your first category is EI (LON:EIG). Stated NAV of £3.26 per share vs. share price of £1.30, and almost all the NAV is tangible, almost all property. Their net debt is huge compared to both market cap and earnings on a conventional basis, but since it's all property-backed I think that can be tolerated. I really liked the clarity of their report, and the cashflow: 125m inflow from operations, 8m outflow for net capex, leaving 117m split between 72m interest charges, 21m share buybacks and 25m net debt repayment. Interest paid was down on last comparable half, as long as they can keep paying down debt from cashflow this looks like a value bargain to me.

I guess the risk is a domestic economic downturn results in cashflow failing to cover the interest just as property valuations get hammered. It would need a massive fall in valuation to prevent them surviving simply by selling a portion of the estate in case of cashflow problems though. With the excellent weather for May bank holiday continuing, and the World cup this summer, I can't see any short-term pain in the next 6 months. I bought an initial position today - would be interested in anyone else's thoughts.

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Tristan_Treacy 15th May '18 3 of 13

In reply to post #364067

Hi Doug2500. I have a few other positions, but like to stay around 15 stocks so that I can stay on top of them. One way that I manage that concentration risk is to hold some funds as well. That gives me the benefit of diversification without distracting me with too many stock ideas.

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Tristan_Treacy 15th May '18 4 of 13
1

In reply to post #364079

Hi ISAallowance. I had a good look at £EI recently and read their announcement today. Personally I am put off by the debt on this one. I worked on the restructuring of a pub group once and I was struck by how capex heavy they are - if they switch off ongoing maintenance capex to produce cash flow the underlying business deteriorates. They can get away with it for a short time but eventually it catches up. As I don't have a good feel for the £EI estate and they have such a high debt level I would prefer to steer clear. Also, as you say, in a downturn net profit could be wiped out very quickly. I would want to have a good understanding of their debt covenants before considering an investment as in a debt restructure shareholders could be wiped out.

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RustySpanner 16th May '18 5 of 13

I'm just starting out but have some shares in Bon Marche and am considering buying some more. The Ben Graham Rule of Thumb shows them as 215.2% undervalued. My shares are down 65% since buying them a couple of years ago but I'm holding on to them just for gut feel that they will improve.

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Tristan_Treacy 16th May '18 6 of 13

In reply to post #364259

Hi RustySpanner. Bad luck on your experience to date on Bonmarche. Judging when to buy into an under-performing business is tricky as they can keep declining. You have to decide when the valuation justifies the risk and have solid grounds for expecting a reversal in fortunes. For myself, I think that the new CEO is doing all the right things for the company and that the growth in online sales is a major positive. Time will tell if it is a good call!

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RustySpanner 16th May '18 7 of 13

Hi Tristan_Treacy I've just bought some more shares. The value investing signs point to it being a reasonable bet as far as I can understand. Bonmarche have good reviews on trustpilot and seem very responsive to complaints.

My wife doesn't like their stuff though!

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daveinthelakes 16th May '18 8 of 13

Tristan,

" I would be really pleased to hear views on the above and any suggestions for how to transform what is currently an intuitive approach helped by a useful tool (Stockopedia!) into something more systematic. "

I appreciate there are some who use a mainly systematic approach but I believe that any system is best used to produce candidates for further research. You appear to have an informal sytematic approach by the methods you currently employ. Creating screens based upon your current approach may be a good starting point and you may wish to look at some of the stocks produced by the stocko Guru's screens but not all stocks in any system will work and I wouldn't exclude any stock just because it did not fit into any given system.

I don't look at screens as often as perhaps I shold so maybe I am not the one to provide suggestions on a systematic approach.

Good Luck, Dave

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Carey Blunt 17th May '18 9 of 13
1

It will be interesting to see which of your 3 categories of approach gives you the best results. I listed recently to an episode of the "Invest like the Best" podcast (which I recommend if you haven't ever tried it) where part of the discussion was about the idea that "Deep Value Investing is Dead".

I think it was episode 86, the interview with Jason Karp. His argument was that the internet has removed all chances of anyone discovering Deep Value in the way that might have been possible in the 60's and 70's when many of the big names in investing made their names and wrote their books. I think his argument is probably pretty true in the US, maybe less so in the UK and other places but it was an interesting argument (which I have summarized heavily here, please listen to it articulated properly in his words rather than mine!).

I think that humans are somewhat hard wired by society to favour value approaches when they start investing. We all equate at some level the idea of finding value though our own brilliance to success but actually we should be measuring our success more based on the profit we are making!

I think Growth is the better way to do this these days rather than value investing but it will be interesting to see if you agree.

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Tristan_Treacy 17th May '18 10 of 13

Hi Carey, thanks for the tip on the podcast - I hadn't heard of it before but will look into it.

You raise a great question. One of the points Howard Marks makes is that the market is cyclical and different opportunities present themselves at different times. In 2009 there were some great, maybe once in a lifetime, value opportunities. If you purchased the major housebuilders then you would have made over 10x. I actually hold Telford Homes (LON:TEF) and Barratt Developments (LON:BDEV) today as steady growth businesses trading at, in my view, attractive valuations for the risks they carry. So while there are few deep value opportunities out there today they may arise again in the future and having a structure and approach to be able to assess them could be highly valuable when that occurs.

That said, I am coming round to the idea the that steady compounders, of the likes Terry Smith goes for possibly provide the best risk adjusted returns over a long period of time. The advantage we have someone over Smith is that we can look at smaller businesses which have the potential to grow at a faster rate. (For the record, Smith's record to date is highly impressive and I hold both Fundsmith and FEET).

Ultimately what I am trying to do if find companies along the spectrum from deep value to GARP where I think this is mispricing for what is on offer and agree with you that today there are far more opportunities in the growth area of the market.

Tristan

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jonesj 17th May '18 11 of 13

These podcasts are a great resource. I was downloading them on the PC, copying across to the phone & listening when out walking.
Then, I discovered the Player FM app (Android). There, after some fiddling with the settings, it's possible to make it automatically download new podcasts from series I've subscribed to, when on WiFi only. So there are fresh Invest Like the Best & Meb Faber podcasts there every few days. Also, it's possible to adjust playback speed.

As for styles of investing:
1 Patience is important, as outstanding opportunities will present themselves.
2 Value has underpeformed in recent years, so is likely to outperform in future years.

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smatthews1 19th May '18 12 of 13

Hi Tristan, Enjoyed reading you thread, I find I like looking for value situations more than anything else, although this can be tricky in a bull market. I thought I would share my views on Luceco (LON:LUCE) for what its worth. This has been on my watch list for a while, so I want to pull it apart and see if there is underlying value, and a return to growing the business.

At current it seems to present good value, the share price got hit hard where there was an accounting balls up with regarding the value of inventory, which the financial controller left as a result. The company now claims this has been put right, and systems in place to prevent it happening again. So possibly a short term hit, but I really want to know if there could be any skeletons in the closet which could surface in the future, as there is a good chance of a recovery in share price here.

Negative points are the headwinds from foreign exchange, and commodity price increases (particularly copper). Net debt is up to £36m, just under 3 x pre tax profits, which is my own personal limit of where I would like to to be. Receivables have been creeping up over the last 5 years, is this in line with revenue growth? not sure but it could certainly be something to keep an eye on. Inventory now stands at £44m which is nearly half its market cap. Cash stands around £5.6m, good but need to keep on their toes and monitor the commodity prices closely

On the positive side, strong revenue growth over the past 5 years, even the latest reports show a 21% increase at constant currency. Most of its revenue is derived in the UK, and with sterling clawing back some strength, I would see this as offsetting any other currency headwinds rather than gaining from it. As a read across from other LED lighting manufactures the worldwide market for this seems pretty robust, and with growth in revenues across all areas, it certainly underpins their demand.

My worry comes after the errors with valuing their inventory, what else in the business has been overlooked, that could depress the share price further, either way I think this now currently presents decent value, and will buying a small piece next week, and add to any fundamental strength.

Be interested to hear yours or anyone else thoughts on this one.

Sean.

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Metatron 22nd May '18 13 of 13

Anybody like any notable stocks out there that have a low- price to book ratio?
Just feel as a ratio price-book has been so out of favour for so long it must come back sometime

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