Monday, October 31, 2011

Diary: HSV, MCO, Magic Formula

HSV: Homeserve - Support Services - 337.9p/£1.5bn
Business: provides 5 million customers with cover against home emergencies such as broken boilers and burst pipes. An independent investigation by Deloitte found that their sales processes were sub-standard (which seems to be code for "mis-selling"). HSV immediately suspended all telephone sales and marketing activity until around 500 staff had undergone "retraining". The FSA (Financial Services Authority) could fin the company if it has breached sales regulation. Link. One commentor said "Homeserve is a non-stop menace".

The share price is down a savage 30.4% today on the news. Ouchies. What is instructive, though, is to see some of the comments from the pundits on HSV. It is instructive in the sense that "nobody knows". Anyway, here's what's been said about it:

30-Sep-2011 The Times said that it was attractive on growth, the shares are pricey at 17X, but was justified; buy on weakness.

08-Sep-2011 The Independent says it is a "rare British business", and the growth profile deserves a premium rating. It says that the price looks stretched, and advised taking profits (at around 482.2p). In some sense it was kinda right, but it never emphasised that rippy-offy nature of the business.

29-Jul-2011 Brewin Dolphin upgraded from buy to add, raising the price target from 566p to 600p. The PER of 16.9X was reckoned to be too low for the business which has "proven resilience and growth potential".

14-Jun-2011 The Scotsman rated it a buy, despite noting that the shares looked a little expensive at 19X (share price was about 524.5p).

Everyone was talking about growth, but no-one was talking about the legitimacy of the business. The company does have enormous returns on capital, no debt problems, but the company still isn't cheap even after the share price drop. So it isn't a buy. What is interesting is the severity of the decline. The share price opened at 240p - a decline of a little over 50% on the previous close. It's interesting because it's perhaps one of the most brutal savagings on a share price in a long while, and it's no minnow stock. At £1.6bn, it's heading towards Footsie territory (the smallest Footsie company has a market cap of £2.1bn).

There's a moral here, but first Moodys ...

MCO (Moody's Corp) is an American company, and provides credit ratings and economic research; although I'm sure you all knew that. Buffett has also been long-associated with Moody's, who likes a coke and a credity rating. On 13-Nov-2006, Emil Lee at Motley Fool waxed lyrical on the company. He didn't actually say "buy", but instead offered the more sensible advice: "All it takes is a single opportunity to buy shares of Moody's at a discount to reap the benefits of a decade worth of superior returns."

... or does it?  The article came out at almost the exact top of for MCO. If you had bought at the beginning of 2006, your shares would have declined 42%, compared with an increase in the DJIA of 13%. To be fair, Emil didn't actually recommend a "buy"; but he did think it was a great company. That reputation was tarnished during the credit crunch. That is not to say that no investment in MCO was a bad idea. If you had bought at the beginning of 2009, you'd be up 61%, compared to the DJIA of up 34%. All of that outperformace was attributable to its performance since about 2011. It is a very volatile stock, BTW.

This just in ... I see in my broker recommendation roundup, times at 12:27, both Panmure Gordon and Peel Hunt have downgraded HSV to "sell".One has to ask, rhetorically of course, "what's the point?".

And I think the point is this ... no-one really knows the future, and they tend to look at the wrong thing, or ommit important details that are more obvious in hindsight. I suspect that credit rating agencies didn't suddenly become rogue in 2006. Frank Partnoy wrote the book F.I.A.S.CO. (the title alone says it all!) in 1997, criticising rating agencies heavily. No doubt Buffett was aware of some of the dubiousness of the credit ratings business, but it didn't stop him investing.

All this is leading me to think that maybe Joel Greenblatt has it right all the time: look for beaten down companies where all the hideous news is out, but have good returns on capital. Worth thinking about.

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