Diary

Moving Averages bad for Magic Formula

An interesting article appeared on Turnkey Analyst on 27-Nov-2011. It has noted that MA (Moving Averages) rules have worked historically. Applying MA to a simple quantitative value actually destroys performance, including Magic Formula.

Bizarre, because it seems to overturn a lot of what I've been hearing about combining value with momentum.

Strategic logic

The ever-excellent csi (csinvesting) blog has run two articles on strategic logic, using Kodak as an example.

Part 1

Don't follow market mavens off a cliff [a point that Jim Chanos made at the recent Value Investing Conference, too].

csi says that Bill Miller probably got caught up in the turnaround story, the CEO, etc., but they didn't ask a simple question: "what competitive advantage would Kodak have in its new endeavour?"

There are only 3 types of competitive advantages:

1. Supply - it's a low-cost operator - maybe coming from privileged access to crucial inputs, but more commonly through proprietary tech. that is protected by patents
2. Demand - usually the result of network effects or customer captivity. csi dismisses the idea of product differentiation or branding [a view shared by Greenwald], because all competitors are able to differentiate their brands.
3. Economies of scale

Morningstar categorizes economic moats in 5 ways:

1. efficient scale - the market is limited, so there is no incentive for competitors (e.g. WD-40)
2. network effect - large networks are more attractive to users, making it difficult for upstarts to penetrate
3. cost advantage - usually in a commodity industry
4. intangible assets - patents, tradcemarks, copyrights, government approvals, brand names
5. switching costs

Part 2

The death of traditional photography was recognised as far back as 2003. Faced with such a problem, Kodak seems to have a straightforward strategic solution: enter in digital photography. But that wont work. Digital photography is not as commercially attractive as chemical photography, and Kodak has no competitive advantage in digital photography.

Diary: enq, pic

ENQ - Enquest - Oil and Gas producers - 91p/£730.1m

BTW, whenever I quote a price in a headline, it's usually at yesterday's price - I pull it off of Sharelock Holmes. This will help explain some inconsistencies in the prices I report.

ENQ is one of my forays into growth investing. I bought in late August at 109.6p (including all costs). Shares are up 11% today to 102.5p on a great announcement:

EnQuest sanctions the development of Alma and Galia. Production guidance shows growth potential of over 20% p.a. Alma/Galia:: Medium term production guidance: CAGR of over 20% per annum, 2009 to 2014. Crathes exploration: exploration well, 21/13a-5 encountered a 52ft light oil column in excellent quality Palaeocene sands.

Here's what a poster on LSE (that's London South East, remember, not London Stock Exchange. I've never had much joy at the latter's site) said about ENQ:

To those who have only recently come across Enquest let me tell you some facts. The CEO of this companyAmjad Bseisu is perhaps the smartest guy in business today. Not just the oil business but any business. He is a very very sharp, polished smooth operator. As smart business men generally do he has already made a LOT of money. When he joined Petrofac he was considering the idea of setting up his own hedge fund specialising in oily type deals. Enquest has given him the option to do this in a practical way with real fields and bits of kit but be assured they are merely the means to an end which is making much more money for himself and his shareholders. Look at the investment he has made with his own money in the company he is running! Why do you think he is doing that? Because he can't think of anywhere that he can make more money! Enquest will continue to put together innovative value enhancing deals for years to come. I admit I know the guy well and as a result have approx a quarter of my SIPP invested in Enquest at prices up to !35 but I'm relaxed as presumably Amjad is who also bought more shares at a much higher price than they are today. Long term this is a highly professional steady business that will make money for years to come. It's not a Wessex or a Chariot but as safe core high quality holdings go they don't come much better than Enquest.

OK, a bit rampy that one. There's not much other good stuff on the BBSs.

I'm pretty happy with this one so far. Directors do have an enormous stake in it. Bseisu has £68.7m, Hares has £3.5m, and the others total about £1m.

Shares are trading on a PER of 15.3, so as oilies go, they aint cheap. RDSB is on 9.3, and poor old BP. is on 6.6. ENQ has net cash of £149.2m, negative gearing, but a low z-score of 1.59 (although that seems to be normal for oilies). ROE is currently 8.4%.

The future is of course imponderable, but I'm pretty happy holding this one.


PIC - Pace - Tech hardware and equip - 45.3p/£138.3m

A quick glance at analyst forecast show that they're getting increasingly bearish since the last time I looked. I'm getting EPS figures of 2011F 18.87p -16.5% 2012F 17.77p -5.8%. I still hold this share, what little left their is to hold, that is.

As ever, the basic reasoning behind holding is that the problems are only temporary. And it isn't all bad news. Here's an article that appeared today, for example:

Norwegian triple-play provider sees 35 per cent service user growth with launch of Pace Elements-powered VoD (Video on Demand) portal. The new portal provides Altibox subscribers with a simple, highly intuitive experience when searching and navigating its on-demand film and TV content.

PIC is doing some very neat things, they've just been finding lately that water and electricity make poor bedfellows (yeah, laugh it up, us PIC shareholders need a sense of humour). It's trading at a PER of 2.4. Ugly indeed.

I've taken some snippets from the ADVFN BBS - a site that I'm growing to tolerate despite the jiggling baloney and dreadful layout. Here's some very recent opinions, which pretty much capture the sentiment of the market:

You see, you read news like that and I just think wow.... This company is going places. If the software side comes off big time this could be a massive growth company. Such a shame regarding the disasters this year.

and

Terrific news HOWEVER, and as so often there’s no £-$ attached to that news! Are we charity?  Had the potential numbers to this been significant they’d be obliged to say so. The market will likely just react with ‘oh very good’ NEXT! IMHO bla bla

and

I just don`t see the long term Case for Pace . I`m no Tech` expert , but , often these `Tech Superior` company`s are overtaken by `New Tech` . I don`t rate their Global Reach anymore in the hands of these Directors , I have no confidence that they will be able to exploit it , in fact it may well be another cash gobbling distracting disaster in the making . Both the above require funding as well as expertise , and even the funding via cash generation looks wobbly . So , the three reasons I originally made the mistake of buying here , now look to be highly suspect and unattractive . I got it all wrong , but I am also holding a small residual stake in the hope of a takeover .

and

Even if business declines to the point they earn only £50m profits they will still be worth £2 a share when debt free in two years time. Personally I think they can hold £100m profts year on year as a absolute min, I'm not convinced £200m will be achieved according to strategic review.

Diary

The Quality Conundrum

Interesting post over at the Value Restoration Project:

The way we see it, we are likely embarking on an era where high quality stocks will significantly outperform low quality stocks as we work our way through what will be the third, and perhaps final, painful market decline of the secular bear market and continue that outperformance as the seedlings of the new secular bull market which will eventually drive the broad market indexes higher in subsequent years. The attractive absolute valuations of many high quality companies which trade at single digit P/E and cash flow multiples, around tangible book value, and with respectable 3-6% dividend yields will be the foundation for those eventual gains.

Diary: dsg, idh, phtm

Been looking at some shares that had been down a lot last month.


DSG - Dillistone - Software and comp services - 72.9p/£13.3m

Down 10% on 14-Oct-2011. There was a notice of general meeting on that day to be held tomorrow, convened to address a technical issue for the dividends paid by the company for the years ended 31-Dec-2006 to 21-Dec-2010. The problem seems to be whether the divvies were paid out of distributable profits rather than distributable reserves. Under the Comapnies Act, the company may be able to recover the divvies they paid out because they did it under the wrong reserve. The meeting tomorrow should rectify that - I don't think they're actually going to demand money back.

Company has a ROE of 32%, has always been high, but is decreasing. Directors own about £6m worth of shares.

Business activities:

Dillistone Group Plc is a leader in the supply and support of recruitment software to the search and selection market.  Dillistone was admitted to AIM, a market operated by the London Stock Exchange plc, in June 2006.

Dillistone develops, publishes and supports FileFinder, its executive recruitment software, for recruitment companies and in-house recruitment teams.  FileFinder is unique in providing tailored workflow and 24 hour support for global users, to mirror the profile and demands of an executive search assignment.  FileFinder has been adopted by more than 1,000 companies in more than 60 countries.

 2011F 5.3p + 4.1% 2012F 6.10 + 15.1%
PER 13.8, yield 4.42%, net cash £2.1m z score 4.87.

Interims issued 21-Sep-2011:

Revenues up 16% ... did not expect to see the full impact of our new product prior to 2012 ... acquisition of Woodcote

IDH - Immunodiagnostic Systems - healthcare equip and services - 728.2p/£206.9m

Down 6.7% on 14-Oct-2011. Stockopedia reported on 12-Oct-2011:

A leading producer of diagnostic testing kits for the clinical and research markets last week announced a trading update for the six month period to 30 September 2011. Turnover from continuing operations for the period is 21 per cent ahead of the comparative period for last year at £27.3m (2010: £22.6m). The Company has made continued progress in placing IDS-iSYS systems into reagent rental accounts as well as outright unit sales. During H1 IDS sold or placed 81 systems compared to 66 systems in H1 2010, an increase of 23 per cent. Overall trading continues to grow and the Board remains confident that, as in previous years, H2 revenues will exceed both those of H1 and of the corresponding period last year due to both the enlarged estate of IDS-iSYS system placements and an expanded IDS-iSYS product menu.

 By a quirk of fate, I see that it is the biggest faller reported by LSE (London South East, not the stock exchange, which has an aweful website), down 41.3% to 461.25p at the time of writing. IDH released an IMS today for the 6 m/e 30-Sep-2011:

Revenue up 21% to £27.3m. Gross profit up 22% to £20.7m. Net Cash £3.3m. The impending introduction of competing automated products has coincided with efforts to contain health budgets, particularly in the US.  As a result we are beginning to see increasing price pressure, particularly on our larger accounts, and some very recent disruption to equipment ordering patterns which we believe will persist in the short term. [This presumably is the killer]. Since its launch in 2009, revenues from IDS-iSYS have continued to grow and were £8.3m for the period, representing 30% of total sales, compared to £3.3m (14% of total sales) for the 6 months to September 2010.Although the total number of IDS-iSYS systems sold or placed is 33.6% higher than at March 2011, as we indicated in our pre-close update the period has seen a reduction in placements made compared to the second half last year. This is mainly due to a number of potential USA customers delaying purchase decisions beyond the end of the period as they wait to evaluate new products that are being launched shortly by competitors.

PER 13.8 (based on a SP of 778.2p. though), ROE 16.4%, z-score 7.88.


PHTM - Photo-Me International - leisure goods - 51.2p/£185.1p

This one was down 6% on 02-Nov-201. Trading activities:

The Company, along with its subsidiaries, operates coin-operated automatic photobooths for identification and fun purposes and a diverse range of vending equipment, including digital photo kiosks, amusement machines and business service equipment. Sales and servicing consists of the manufacture, sale and after-sale servicing of both the above-mentioned equipment and a range of photo-processing equipment, including photobook makers and minilabs. The Company’s products include photo booths, biometric solutions, digital photo kiosks, minilabs, photobook machines, kiddie rides, amusement machines and service machines. Photo booths include Easybooth, Minibooth1, Minibooth2 and Minibooth3. Digital photo kiosks include Speedlab 100 and Speedlab 200. Minilabs include Wet Digital Labs and Dry Digital Labs. Photobook machines include Photobook Pro and MyPocketbook.

 ROE 15.5%, ROE10 11%, z-score 3.53 net cash £40.7m. PER 12.98, yield 4.28%. 2012F 4.09p + 9.4% 2012F 4.51p + 10.3%

Diary

Analyzing Capital Expenditures

csinvesting is definitely a blog worth reading. An article on "Analyzing Capital Expenditures-Buffett and Sears Case Study" points to a scribd document of his. Sketch notes below.

His opening quote was great: "If you want to beat the S&P 500, here's what you do, you buy 500 stocks, and then you sell the airlines. You should do better." - Tom Gayner

owner earnings = a) net reporting + b) depreciation, amortisation - c) capex (maintenance & growth)


if a+b>c, then company is earning sufficient amount for the shareholders. I think that capex should only be maintenance capex (??)


You have to pay less for companies with a lot of "restricted earnings". Companies with a lot of restricted earnings often have high asset/profit ratios. They're "restricted" in the sense that inflation requires that some of the earnings must be ploughed back into the business.


owner earnings = net income + depreciation + depletion + amortization - capital expenditures - additional working capital

Diary: lms, weir, sge, sgp

Reasons to be bullish

Despite all the doom-and-gloom surrounding the world economy, there is actually some bullishness about.

F958B has written on Motley Fool:

Of all the asset classes out there, shares are among the least expensive asset classes. Shares are slightly cheap. Commodities are overvalued. Bonds are overvalued. Property is overvalued. Cash earns next to nothing. The last time that the dividend yield on shares was this attractive relative to bond yields was during the depths of the 1970's stockmarket bear. From the troubled mid-1970's to early 1980's, stockmarkets began a 25-year bull market (1975-2000), but the first several years were very erratic and volatile - but the trend was still up, on balance. The share-price lows were in the mid-1970's (several years after the mid-late 1960's peak), but the P/E lows were in the early 1980's (about a decade-and-a-half after the 1960's P/E peak).

 There's an interesting article on ValueWalk (does it ever print a boring one?) pointing out the bull case. Sketch notes below.

Investor sentiment in extreme pessimism range, although it is improving. Ms Sonders contends is that all macro is priced in. Flight to quality (I think she's refering to bonds though, not defensives) could backfire, as there has already been heavy outflows of equity funds into bond funds. Five-year normalized P/E slightly above median, but forward PEs are dirt cheap (her graph shows that they're almost at the cheapest levels they've been since the graph began in 1990).


LMS - LMS Capital - Equity investment instruments - 56.3p/£153m

Spotted this one on in an article on 24-Oct-2011 in Investors Chronicle - almost seems a no-brainer. It is currently trading at 0.72 PTBV. The idea is simple enough. LMS invests in a portfolio of quoted securities. The company is winding down in an orderly fashion. So shareholders should realise significantly more than current share price.

WEIR - Weir Group - Industrial Engineering - 1776.1p/£3.8bn

This one might be of interest to those looking for quality compounders. It has increased its divvies every year for the last decade, and analysts expect the trend to continue (don't they always?). It has a low yield at only 1.8%, trades on a PER of 14.1, and has a z-score of 3.77. Net debt is £289m, against net profits at the interim stage of £119m. So, debt situation looks very comfortable. It has a ROE of 21%, and median for the last decade is 18%.

Nigel Thomas, an "alpha" rated manager at AXA Framlington UK Select Opps, has it as his number one holding at 5.1%.

Business activities according to Google:

 The Weir Group PLC operates in three segments: Minerals, Oil and Gas, and Power and Industrial. The Minerals segment designs and manufactures pumps, hydrocyclones, valves and other equipment for the mining, flue gas desulphurisation and oil sands markets. The Oil and Gas segment manufactures pumps and ancillary equipment and provides aftermarket support. The Power and Industrial segment designs, manufactures and provides aftermarket support for rotating and flow control equipment to the global power generation and industrial sectors. Other segments supplies equipment to the liquefied petroleum gas marine and onshore markets.

Some sketch notes on the latest IMS issued 07-Nov-2011:

• market conditions remain strong
• reported order input was up 27% in the quarter
• macro-economic uncertainties haven't had any impact

I'm not sure how dependent all this is on the commodity "supercycle", mind.  Anyway, it certainly looks good.

SGE - Sage Group - Software and Computer Services - 265.2p/£3.5bn

Here's another one for you quality compounderers out there. It's been on my radar for awhile, and it's been part of my Defensive portfolio over on Stockopedia (just don't ask how the value portfolio is doing!). Business activities:

development, distribution and support of business management software, and related products and services for medium-sized and smaller businesses. It operates in four segments. Its products and services range from accounts, enterprise resource planning (ERP) and payroll software to payment processing, customer relationship management (CRM) and industry-specific solutions, such as healthcare, manufacturing, non-profit and construction.

Book-keeping software, in a nutshell. Quite a sticky product, and I think that many people would have heard of the Sage accounting system. SGE recently appeared in a Citywire article on "7 tech stocks help by top UK fund managers". I don't own any SGE, but it's a possibility, and the article also mentioned IDOX, which I do own, and has actually been doing very well for me. But I digress.

SGE has a z-score of 3.13, net debt of £73m compared with interim net profits of £118m. So debt looks perfectly comfortrable. It's trading on a PER of 13.6, which is fine by me. Yield at 3.0% is pretty good. Growth for the next two years is expected to be low, though. It currently has a ROE of 14.8%, compared with a decade median of 15.5%. Looks like it will be a solid company, if performance might be expected to be unspectacular.

SGP - Supergroup - Personal Goods - 475p/£381m

Riskier one that's been getting a lot of attention lately due to 2 management logistical errors. Business activities:

SuperGroup Plc, formerly DKH Clothing Plc. is United Kingdom-based retailer. It focuses on the youth fashion market with its clothing and accessories for both men and women. The Company has two segments: Retail and Wholesale. Retail comprises the operation of stores, concessions and internet sites. Revenue is derived from the sale to individual consumers of its brand and third party clothing, shoes and accessories. Wholesale comprises the wholesale distribution of its branded products (clothes, shoes and accessories) worldwide and the design and ownership of brands. It has 42 standalone retail stores and 56 concessions and a large number of wholesale relationships. Superdry is sold in approximately 70 countries worldwide via its websites, and in 36 overseas countries through a network of distributors, licensees, agents and franchisees. In February 2011, the Company acquired the Benelux and France franchise and distribution partner, CNC Collections BVBA, from its principal Luc Clement.

The words "youth fashion market" will be enough to make many run, not walk, away from this one.  SGP is expected to have fast growth in 2012 and 2013, having exhibited fast growth in 2010 and 2011 since it was floated. It has net cash of £32m, negative tangible gearing, and a whopping z-score of 7.0. It currently trades on a PER of 9.6.

The FT has an article on 05-Oct-2011:

• shares lost more than quarter of value after it warned that stock management problems would wipe up to £9m from full-year profit
• the IT system problems has led to delays in moving stock to UK stores and forced it to rent temporary warehouse space
• international and wholesale operations are unaffected
• almost two-thirds of shares are owned by senior management
• the shares floated in 2010 at 500p in March 2010, rose to almost £19. Ouchies!

 There's a thread on Motley Fool, which raises the points:

• paulypilot was tempted (at 685p on 05-Oct-2011)
• it's significant to note that the problem is with the back end processing, not with demand

FT Alphaville notes the following:

• suspicion surrounds the timing of the warning. It wasn't raised at the AGM on Sep 22, nor in the preceding week when staff sold shares, nor a month ago at the trading statement
• poster speculates that the real reason for the slowdown in sales were not with warehouse issues, but with brand coming off the boil
• "exacerbated by the unseasonal weather" [oh dear, I hate it when companies talk about unseasonal weather], and "uncertain economic outlook" [and I especially don't like that]
• Brokers Espirito "maintain sell", saying that 16X forward PE is too high given riskiness of growth. They thought that the market may re-rate the shares [turns out they were exactly right. Their we go then. Analysts. They're not just for show].

Should be interesting to see how this one plays out.  My guess is that they will sort out their problems and the stock will be up again. Long term: French Connection, 'nuff said!

Diary

Index relegation

Saw this yesterday; All the following leave the FTSE250 in a week or so.

Unite Group
Pace
Premier Foods
Mothercare
Thomas Cook Group

Not sure if the trackers will have already dumped them.

Tweets

I picked up a few interesting tweets a couple of days ago. I shall probably return to them in 6 months time.

23-Nov-2011 paulypilot Paul Scott
IND on sale at 205p - mkt cap £15m, £5m+ in net cash, plus trading well again (recent buoyant Tr Stat). Probably best value its ever been


24-Nov-2011 MrContrarian Mr Contrarian
Sold Thomas Cook Group (£TCG) at 14p for a 75% loss. Peel Hunt recon up to £700m recap needed, in which case equity of £122m @14p worthless.

24-Nov-2011 paulcurtis123 PAUL CURTIS
Just spoken to oil company focused Hedge Fund. Redemptions forcing sale of anything with no immediate upside. Value irrelevant.


24-Nov-2011 MrContrarian Mr Contrarian
Hampson (£HAMP) FD buys 100k at 2.96p. That's only £3k worth - a token buy. He now holds 125k. Not impressed by that. I bought at 4.9p.

Recessionary times evidence

I was going to post this as part of my growth versus value investing post. I knew there were comments by Kelpie Capital, but I just couldn't find them. Anyway, I'm going to give some sketch notes on his blog post.

Recession expected in 2011Q4 ot 2012Q1, likely to be global.

• business outlook indicator is down, which is often a leading indicator
• Hussman's composite of stats suggest bad outlook
• Achuthan's broad range of stats indicates recession. His track record is unblemished.
• emerging markets will not save us
• we are at peak profit margins, so contraction is likely
• corporate profits are at the highest ratio to GDP in history