Time to get defensive?

The Footsie hit a low in March 2009, at about 3530. Two years later, it stands at about 5957; an increase of about 70%. That's a huge rebound, and investors may be wondering where the market is headed next. What areas should we look at to maximise our returns: cyclicals, growth stocks, defensives, bonds, something else maybe?

In his article Focus: Searching for Growth, Chris White argued:

The greatest value across all asset classes at the present time lies in large-cap, blue-chip, high-yielding equities. Equity income funds have come under fire for all being invested in the same stocks in this area of the market ... with UK FTSE 100 companies receiving 70 per cent of their earnings from outside the UK, our globalised stockmarket is not just aligned to UK GDP, but more to a blend of international economies, most of which can be expected to grow faster than the UK in 2011 ... Investors should start to look to sectors which benefit from rising inflation, interest rates and bond yields such as insurance, oil, tobacco, utilities and food retail.

The Motley Fool quotes the following recent statement by Neil Woodford in this article:

I am invested in some of the best quality companies in the UK stock market on ludicrously cheap valuations. In my opinion, this is the best investment opportunity since the tech bubble in 2000.

As an experiment, I sought confirming/disconfirming evidence for the bullish case on defensive shares. I chose 7 large-cap defensive companies at random: £AZN, £BATS, £CNA, £DGE, £TEP, £TSCO, £ULVR. I compiled the following table:
       PER PILE Y10  Y0
AZN    6.8   10 1.4 5.7
BATS  13.6   70 5.6 3.5
CNA   12.6   50 1.2 4.5
DGE   15.0   50 3.1 3.4
TEP   15.7   50 1.6 4.9
TSCO  11.7    0 1.9 3.8
ULVR  14.4   40 2.6 3.8
The key to understanding the table is as follows:
PER - is the latest rolling Price/Earnings ratio
PILE - "percentile" - the percentile to which a company's current PE ratio fits over the last decade. So, with AZN on 10, it means that only 10% of the time has its PER been lower. PERs have been taken at approximate year-end snapshots, rather than being calculated on a daily basis. They should be considered as indicative, rather than precise.
Y10 - the yield on the company a decade ago, in percentage terms
Y0 - the latest available yield on the company, also in percentage terms

Critics might argue that my sample size is small, and I accept such charges unreservedly. We notice two things:

1. the median PILE in the sample above is 50, indicating that, on the whole, there were as many chances as not to buy the companies at more attractive PERs. £AZN and £TSCO stand out as two companies that are on historically cheap terms over the decade, suggesting that there may be significant opportunities for selective bargain-hunting.
2. Defensives are now much more attractively valued than they were a decade ago - as evidenced by the fact that the yields have increased (Y10 compared with Y0) in all cases except £BATS. This shouldn't come as a major surprise to most people, though, as markets were at record highs at the turn of the millenium. Interest rates have declined over the decade, whilst yields on defensives have gone up.

In conclusion, it appears that defensives are cheaper than they were a decade ago, although it would be wrong to say that they are cheaper than they've ever been for the last decade.  That doesn't quite square with Woodford's statement about them being the cheapest they've ever been. Far be it for me though, in genuine humility, to argue with a man of Neil's stature. Perhaps he is arguing that the yield gap between general interest rates and top-quality inflation-hedging companies is very bullish for the latter.

Magic Formula Investing - some notes

In his book, "The Little Book That Beats The market", Joel Greenblatt laid out an investment formula for selecting a portfolio of shares that should beat the market over the long term. In this post, I assume some familiarity with his book and formula. His formula contains a few grey areas. Sharelock Holmes has a screen for Greenblatt; although it is unlikely to be an exact replication of the formula.

Greenblatt does, apparently, use the formula for selecting stocks for his hedge fund, Gotham Capital. Greenblatt likes to run a concentrated portfolio, but he advises readers to diversify into about 30 stocks. Having seen some of the companies produced by Sharelock Holmes, I readily concur. Specifically, HLO (Healthcare Locums) and RCG (RCG Holdings) spring to mind, and if memory serves, HMV (HMV) were given high rankings by the filter. All three have had their problems: HLO was suspended for accounting irregularities, RCG has been highly dilutive of shareholder equity and has engaged in a "rash" of  "confusing" acquisitions, to put it politely. It will likely delist in April. HMV is highly indebted, and may soon breach its banking covenants. Greenblatt's formula tries to find cheap and good companies. The three companies that I mentioned are certainly cheap, but are far from likely to be considered "good". In my opinion, there is a high probability of permanent impairment of capital with these companies.

Presented below is a list of resources that I have assembled on MFI (Magic Formula Investing), that readers may find interesting; albeit that they are focussed on US stocks. This site is the official site by Joel Greenblatt, although it is not particularly useful as a resource. None of the sites listed below are officially affiliated with Greenblatt.

• Magic Formula Pro - a blog by an unknown author. The blog also tracks Ackman, Berkowitz, Buffett, Einhorn, Li, Klarman and Schloss. This page spells out the author's own calculation of earnings yield.
• MFI Diary - commentary and tracking of a portfolio of stocks using the MFI approach by Marsh Gerda
• Yahoo Group - this group discusses the MFI approach, and is open to public participation. The main page provides links to other blogs, and an Excel add-in.

On this page, Marsh spells out his calculation of earnings yield and return on capital. I cannot vouch as to just how accurately it reflects Greenblatt's own computations, but it certainly helps clear up some of the grey pronouncements in Greenblatt's book:

• Working Cash = Max(0,[(AP + Current Liabilities Other) - (AR + Inventories + Other Current Assets)] 
• Excess Cash = Cash & ST Investments - Working Cash

AP is Accounts Payable, and AR is Accounts Receivable.

Update 29-Mar-2011: Magic Diligence is also a good site that I had located before, but it dropped through my net. In this post, the author reports a very interesting point from his analysis of Warren Buffet's 2011 letter:

Farther in the letter, I thought it was interesting that Buffett actually comments on the earnings on un-leveraged net tangible assets that some of his businesses have. This is almost exactly what Joel Greenblatt's Magic Formula Investing strategy measures for its return on capital number. Buffett even gives ranges: "terrific" 25-100%, "good" 12-20%. This jives very well with what I've seen in MFI. Very few companies with sub-30% return on tangible capital ever get screened, unless they are absurdly cheap.

The author has an other very interesting recent posts:

• Be wary of Magic Formula stocks that grow through acquisitions, and suggests a way to counteract that is to restrict your search to companies where goodwill and intangibles represent less than 10% of total assets.
• Should price momentum be important to value investors?

A Pyad share

Perennial curmudgeon Stephen Bland writes about his new pyad share, MLIN (Mollins). It is interesting because the value parameters he looks for, and the trade-offs involved in value shares. MLIN is a tiddler of a company at only £12m.

Re-routing ports using iptables

The usual command for rerouting port 80 to 8080 on Linux is:
iptables -t nat -A PREROUTING -p tcp --dport 80 -j REDIRECT --to-port 8080

Fedora is a little bit stranger. You have to type:
/sbin/iptables -t nat -A PREROUTING -p tcp --dport 80 -j REDIRECT --to-port 8080
If you don't type the exact path, Fedora thinks it is a package, and asks you if you want to install it.


To save under Fedora:
service iptables save

Forum thread

List of (Unix) Open Source Programs

Ubuntu created this page listing free software by category:

# Desktop Applications

   1. Communication
   2. Engineering
   3. Educational
   4. Financial
   5. Games
   6. Productivity
   7. Management
   8. Misc
   9. Multimedia
         1. 3D
         2. Audio
         3. Drawing
         4. Other
         5. Video
  10. Security
  11. Software Development
  12. Utilities

# Server Applications

   1. Content Management
   2. Database
   3. File Server
   4. Messaging
   5. Security
   6. Web

I'm looking for a program that will work will enable my webcam to work with a Yahoo account. Kopete comes close, but no cigar.

Shares to consider

Here is a list of companies that recently crossed my path, for which I thought I'd do a quick write-up. This is in no way a recommendation to buy any of the shares I mentioned; they were just suggestions that were made to me in passing. I'm paying them a cursory glance, and you can investigate further if you are interested.

CNMI - Camper & Nicholsons Marina Investment - real estate investment and services
Acquires, develops and operates marinas. It also provides servicea and consultancy to other marinas.
MKT CAP: 12m
SHARE PRICE: 20
YIELD: 0%
PE: -2.2
PTB: 0.4
Z-SCORE: 0.0
It has a terrible z-score, and an insolvency ratio of 6 years.

The company was floated (if you'll forgive the pun) in 2007, and has made losses in each of the last 3 years. It has no inventory, as a current ratio of 2.8. So it has an adequate cash position for now. Net current assets are £7m, which is a huge chunk of the market cap. Long-term liabilities are £26m.

Earlier this month, the board announced preliminary results for y/e Dec 2010:

• sale of 45% beneficial interest in IC Cesme Marina to majority owned subsidiary, transaction completion expected in March 2011
• CB Richard Ellis appointed to carry out a strategic review of the business which is now fully underway
• the board is "aware of the significant discount to reported new asset value at which the Company's shares continue to trade on AIM and are determined to address the situation"

The company issued equity in Nov 2010. Potential investors might want to check out how dilutive the company has been.

Scary company. I see a lot of risk in this one, so some digging would be required to see if this is a true asset play.

DVO - Devro - food producers

Produces "edible collagen casings", for salami, hams, and other cooked meat. Mmm, that's good collagen. It also produces non-edible collagen and casings for medical use.

MKT CAP: 447m

SHARE PRICE: 273.6

YIELD: 2.6%

PE: 15.5

PTB: 2.9

Z-SCORE: 5.4

Analyst forecast EPS growth of 13% in 2011, and a further 9% in 2012. Balance sheet is excellent. ROE10 is 17% (median ROE over last 10 years), and ROE for 2010 also 17%. 

This company has, clearly, a completely different risk profile to CNMI, and you stand a much better chance of sleeping at night with this one. The median PE for this company over the last decade is 12, so you're paying over the historic norm is you buy now.

In Feb 2011, the board made a preliminary announcement for the results to y/e Dec 2010. They reported the following outlook for 2011: 

We expect to see sales volumes increase further as the capacity from recent investments comes on stream and new products displace gut.  We will continue to seek margin improvements as the benefits of manufacturing efficiencies come through, and we are planning significant new investments to provide capacity for further growth in 2012 and 2013.  I am confident that our management teams around the world will maintain the excellent progress of the past three years.

Offhand, it seems like a fairly solid company, and a pretty safe long-term hold.  Not compelling value.

RNO - Renold - Industrial Engineering
It manufactures industrial chains (for power transmission and conveyor chains) and torque transmissions (car gearboxes and power transmission).

MKT CAP: 80m

SHARE PRICE: 36.5

YIELD: 0.0%

PE: 23.4

PTB: 2.4

Z-SCORE: 1.0

ROE10: 5.6%

In Feb 2011, the board announced an interim management statement, noting:

• market conditions had improved across all of our areas of operation with additional incremental gains in market share during the first half and that we expected the sales trends established in the first half to continue
• trading has increased in line with the board's expectations

RNO's earnings have been erratic over the last decade, and its ROE at a very low figure. The company also looks weak financially. EPS for 2011 is expected to be 1.56p, and in 2012 it is 3.55p, giving it a forward PE of 10.3 for 2012.

RNO seems like a fairly weak company, both in terms of its business model and balance sheet. It had an operating loss for y/e June 2010, which was the first loss in a decade. It's difficult to see much attraction in the share.

TIK - Tikit Group - software and computer services

Software consultants

MKT CAP: 38m

SHARE PRICE: 259.5

YIELD: 2.5%

PE: 13.4

PTB: 2.4

Z-SCORE: 2.6

ROE10: 23%

Over the last decade, revenues have grown from 9m to 27m, and profits grown from 1m to 3.8m. Balance sheet looks OK, but not as strong as it used to be. Analysts forecast earnings growth of 13% in 2011, and 9% in 9%.

Earlier this month, the board issued preliminary results for the y/e Dec 2010 noted:

The board is pleased with the progress made during the year. The group remains in a strong position and is well placed to benefit from the trend towards IT outsourcing, particularly in the legal industry. The fundamentals of our business are excellent, and we look towards the future with optimism.

TIK is a very small cap, which is a bit of a put-off for beginners. I would want to see much better value for money before being enticed further. just my opinion, of course. I'm also not fond of software consultancy firms, which seem quite vulnerable to economic fluctuations.

mcron - cron in scheme

If you like scheme, and you like the Unix cron command, then consider mcron:

The new idea is to read the required command instructions, work out which command needs to be executed next, and then sleep until the inferred time has arrived.  On waking the commands are run, and the time of the next command is computed.  Furthermore, the specifications are written in scheme, allowing at the same time simple command execution instructions and very much more flexible ones to be composed than the original Vixie format.  This has several useful advantages over the original idea.

For Debian fans:
apt-get install mcron 

Troll videos

I've recently been checking out the alt.comp.freeware newsgroup. The amount of trolling there has to be seen to be believed. This inspired me to check out some humourous troll videos on YoutTube. Here's my favourites:

• Internet Bridge Troll
• You've Been Trolled [The Remake]

Enjoy.

Bizarre spam

I don't know why, but today I decided to actually look at the contents of my spam mail, and came across a bizarre offer of a puppy. That's right, a puppy. It is such a strange concept that I thought I'd share the message with you. Here's the text of the message:

How are you today, My name is Esther Brown I am a consultant

gynecologist surgeon and oncologist doctor, I work for different

prominent hospital, me and my husband are giving out this little puppy

for free (Adoption),This little girl weighs 1.3Lbs at 9 weeks old &

should be 3Lbs when full grown only. She is very friendly with children

she fit in both Palms of your hands. She is AKC/CERF registered puppy

.Adorable and sociable with great Personalities and very good

bloodlines. She is vet-checked, up to date on shots and deforming, and

is health is guaranteed. Recently checked by a licensed Vet Doctor for

heart, knees, skin, correct bite, and eyes. Bottom and straight sides

and tender, she is A.K.C and CERF registered and shots are given up to

date. She will come along with Travel crate, AKC/CERF Registered

Papers, Toys and Food and Birth Certificate, I resided in the state

with my husband but after my son's death me and my husband moved to

Africa due  to our work and we have the puppy

Thanks,Esther Brown.

Unfortunately, I don't live in Africa, so any animals would have to be mailed to me personally. Esther is way ahead of me on that one, though, as the puppy "will come along with a Travel crate". Let's hope that the crate is small, to save on postage.

Thanks, but no thanks.

Aberdeen - hottest in UK

I just heard on the news that Aberdeen is the hottest place in the UK today. Excellent!

Worth noting, as you don't hear that very often.

RTN - Restaurant Group - director purachses

Director Tony Hughes buys £909k of shares in RTN.

At 303.2p, RTN has a market cap of £605m, a yield of 3%, a PER of 15, ROE of 27%, all achieved with tiny gearing. It has a z-score of 4.4, and analysts expect to see double-digit growth over the next two years.

A neat little company.

DPLM - profits beat expectations

This article reports:

H1 revenue to rise 25 pct ... aided by acquisitions and better margins in all three divisions. ... Diploma forecast adjusted pretax profit for the year ending Sept. 30 to be materially ahead of the market consensus.

 A post on The Motley Fool comments:

On the medical side, Diploma distribute more to hospitals, clinics and environmental testing labs, than it does to biotech/pharma labs. I would be concerned if it was the latter because the industry is scaling back on drug development plans. In general, Diploma's distributes more to the maintenance Capex budgets of companies than it does to expansionary. It tends to do ok in a slowdown, and if they use the substantive cash flow well, they can always 'buy' EPS growth.

MRW.L - Morrisons - results

Morrison(Wm.)Supermarkets PLC
10 March 2011

Financial summary

· Turnover up 7% to £16.5bn (2009/10: £15.4bn)
· Like-for-like sales (ex fuel, ex VAT) up 0.9% (2009/10: 6.0%)
· Underlying profits1 before tax up 13% to £869m (2009/10: £767m)
· Profit before tax £874m (2009/10: £858m including £91m exceptional credit)
· Net debt £817m (2009/10: £924m) after capital investment of £592m.
· Gearing of 15% (2009/10: 19%)
· Basic earnings per share 23.9p (2009/10: 22.8p)
· Underlying earnings per share up 12% to 23.0p (2009/10: 20.5p)
· Total dividend for the year up 17% to 9.6p (2009/10: 8.2p) - dividend cover of 2.4 times

....

http://fool.uk-wire.com/Article.aspx?id=201103100700126633C


 MRW is trading at 280.5p, with a market cap of £7.4bn, PE of 12.5,  yield of 3.3%, and a z-score of 3.5. Analysts peg FY12 with 7% growth, and FY13 with 10% growth. Share buybacks of £1bn are in the expected. Net debt has actually reduced during the year, and overall this is a pretty solid company with good prospects in a resilient sector.

High yield, low payout stocks perform best

In their paper High Yield, Low Payout from 2006, authors Patel, Yao and Barefoot concluded that high yield, low payout stocks performed significantly better than the S&P500, and was the best strategy overall.

Their backtest methodology was:

Specifically, we took a two-stage process of first creating three dividend yield baskets by yield, then within each of these three baskets, categorizing stocks by payout ratio: low, medium, and high. Equal-weighted portfolios of these baskets were created based on dividend yields and payout ratio as of each quarter end. We repeat the process each quarter. Our back test for this analysis is from January 1990 to June 2006. We use S&P indexes as our universe.

The HYLP (high yield, low payout) stocks returned, on average, about 19.2% pa, compared to the S&P of 11.2% pa, for the period 1995 to 2006. HYLP were consistently in the top half of the baskets for the period 2001-2006. The basket of stocks not paying a dividend also beat the S&P 500, although its relative positioning was spottier.

Their methodology might be a great starting point for building a value-based portfolio.

PIC.L - PACE - Update

Highlights from RNS prelim results for y/e 31 Dec 3010:
Numbers:

• revenues up 17%, organic up 10%
• return on sales increased from 6.7% in 2009 to 7.8%
• operating profit before exceptionals up 32%
• adjusted basic EPS up 24%

Operating highlights:

• completed three strategically importatn acquisitions
• broadened product portfolio
• continued to gain market share across all markets

Outlook:
"The Board expects 2011 revenue growth of a similar level to that achieved in 2010. ... The Board expects further return on sales progress as Pace develops its new business opportunities and further leverages its established and highly efficient operating model."
http://www.investegate.co.uk/Article.aspx?id=201103080700094...

So, more growth in sales, and improved margins. What's not to like? The stock market "rewarded" this excellent performance by the share price dropping about 12% in price. Its adjusted diluted EPS is 22.7p, and on a share price of 194p, it is trading on a PE of 8.5.

Follow-up:

Pace Plc , the world's biggest maker of set-top boxes, said a U.S. customer was delaying a big order to 2012, reducing its 2011 sales growth and wiping some 100 million pounds off its stock market value. ... "One customer on a specific project decided to accelerate a new piece of technology, which meant the revenue from that client has shifted from 2011 to 2012," Chief Executive Neil Gaydon told reporters.

Woodford's exposure to private equity at all time high

Citywire has an article where they comment about Neil Woodford:

he is finding more value in private firms than at any point in his career. ... "We haven’t had this much exposure to unquoted companies since I joined Invesco Perpetual"

In a recent post, I mentioned that some private equity investment trusts were trading at discounts to NAV in their 30's. I expressed particular interest in CYS.L (Chrysalis VCT), a VCT where there were director purchases, share buybacks, a discount to NAV of nearly 40%, and a yield of 6%. The shares have fallen in the meantime from 50p where I first bought, to 48.5p, although the shares have gone ex-dividend during that time. The dividend amounts to 1.5p. The reported NAV seems to be steadily creeping upwards, too; on 25 Feb 2011 management reported that NAV stood at 83.20p as at 31 Jan 2011. The shares stand at approximately 40% discount to NAV.

Shares to consider

Here is a list of companies that recently crossed my path, for which I thought I'd do a quick write-up. I don't necessarily have any strong convictions about them, but thought they might be interesting.


CTN - Clearstream Technologies
Sector: Health Care Equipment and Services
It designs and manufactures medical devices.
Market cap: £20m (yeah, it's a tiddler)
Share price: 45p
PE 21.2, but forecasts are +174% for 2011m and +110% for 2012.
Z-Score : 3.1
Trading statement on 10-Feb-2011: The Board is pleased to report that ClearStream has enjoyed a good start to the year and that at the half year point results are anticipated to be comfortably in line with market expectations for the full year to 31 August 2011.

There's been major momentum on this share over the last 6 months.


EDIN - Edinburgh Investment Trust
Sector: Investment Trust
IT managed by Neil Woodford of Invesco Perpetual in his typical defensive "equity income" style.
Yield: 4.7%
Discount to NAV: 1.9%
I understand that Equity Income funds usually trade at fairly narrow discounts to NAV, so one should probably not be put off by this. The gearing is 123%.

HLMA - Halma
Sector: Electonic and Electical Equipment
Manufactures anti-theft devices, sensors and relays
Market cap: £1.3bn
Share price:  343.8p
PE 17.2
Forecast growth 2011: +20%
Forecast growth 2012: +9%
Z-Score: 6.9
Median ROE over last decade: 21%

RB. - Reckitt Benckiser
Sector: Household Goods
Owns a laundry list of brands, including Air Wick, Calgon, Cellit Bang, Clearasil, Dettol, etc. etc.
Market cap: £30.0bn
Share price: 3166p
PE: 13.9
Yield: 3.6%
Forecast growth 2011: +1%
Forecast growth 2012: +6%
Z-Score: 4.5
Median ROE over last decade: 35%

RTN - Restaurant Group
Sector: Travel and Lesisure
Operates restaurants. It runs concession stands in airports, and the brands Frankie & Benny's, Chiquito, and Garfunkel's.
Market cap: £575m
Share price: 288.5p
PE: 15.0
Yield: 2.9%
Forecast growth 2011: +10%
Forecast growth 2012: +9%
Z-Score: 3.9
Median ROE over decade: 28%

DPLM.L - director purchases

There was another director purchase a couple of days ago: Iain Henderson, a director, bought 25k @ 276p = £69k

Some recent notes by me:

*** 05-Mar-2011 SP 275.5p, MKT 312m, PE 14.6, YLD 3.3%, BSR 0.47, Z 5.8, 2011F +15%, 2012F +9%


*** 12-Jan-2011 IMS: Against a weak comparative, Group revenues in the quarter ended 31 December 2010 are 25% ahead of the comparable period in FY2010. ... Margins also strengthened, largely driven by operational leverage. ... Outlook: The continuing strength in revenues and operating margins, together with contributions from recent acquisitions, provides confidence that the Group should achieve good progress in 2011.
http://bit.ly/faM0W1
 


*** 12-Dec-2010 Acquires Carsen Medical Inc ("CMI"). Its revenues were £8.3m and PBT £0.7m. Consideration: £14.2m cash, and a further max of £1.9m deferred, contingent of operating profit. "This acquisition provides an excellent opportunity to build a broader and more substantial business erving the growing GI Endoscopy market across Canada".

The Bull Market Turns Two

In this article on TMF, a poster added the comment:

It is usually common to see the non-cyclicals play catchup as a bull market matures. This hasn't happened yet, but the first interest rate rises often trigger a re-rating upwards of non-cyclials. We may be just a few months away from the start of a slow-but-steady rate-hiking. When non-cyclicals start to outpace the cyclials over a one-year period, then we may be close to the end of the bull. The last cyclical bull lasted from 2002/3 to 2006/7; four years or so. This bull may well last a similar amount of time, so should run well into 2012. The last stockmarket crash generated so much fear that we're unlikely to see such a panic again for many years. The "wall of worry" - which bull markets are said to climb - is still quite strong.

PIC.L - Worldwide IPTV Subscriber Base to Double by 2015

According to this article:

 IPTV subscriber base in 2015 will exceed 70 million. Currently, the market size stands near 36.5 million. ... IPTV is also expected to play very prominently in the Hospitality market.  Set-top box shipments are expected to experience a 75% growth rate from 2010 to 2015, as hoteliers have begun to realize the flexibility and scalability of the platform. ... IPTV is the platform of the future