Wednesday, 29 June 2011

Less is More?

Having been on an extended holiday and had a change of personal circumstances, I am no longer able to publish blog posts as frequently as I have done previously. To combat this, I have decided to be more selective in the quality of the opportunities that I look at.

I am therefore re-working my rules to screen the population (via Sharelockholmes) and spend time looking at the select few. My new rules have borrowed the thoughts of the great and good, including the likes of Greenblatt, Buffett, Graham and esteemed fellow bloggers. The emphasis is intended to be on 'quality first, price second'. I like the prospect of buying a share and tucking it away for the long-term...and watch it grow and grow.

Hopefully, less will mean more.

10 Ingredients

1 - ROC > 25% - ROC is a proxy for Greenblatt's ROA;

2 - Earnings Yield > 15% - Greenblatt has it as a relative measure, but I'm going for an absolute measure of 15% as this feels aligned with my target return of 15%;

3 - ROE10 > 15% - a Company needs to be be able to demonstrate enhanced shareholder value over the long-term, ideally over a ten year period;

4 - ROCE > 15% - I'm just being greedy now on my financial ratios;

5 - PER < 16x - a la Graham;

6 - PER on EPS10 < 20x - slightly higher to allow for an element of growth;

7 - Yield > 2.5% - I want to hedge my bets and at least get a return as I go along; 

8 - Gearing < 50% - a bit of debt is capital efficient, but I do not want too much;

9 - Piotriski >= 6 - a new one for me. Appears to be a interesting snap-shot for balance sheet health; and

10 - EPS 5 year growth >27.5% - this is the equivalent of 5% annualised growth over five years. EPS needs to grow to drive value over the long-term.

And More...

Once I've got my candidates, I will then be looking at:

- quality of earnings - past and future
- cash generation and what happens to it
- director buying and motivation
- relative valuations versus historic trends and peers


The First Cohort

Throwing all of the above ingredients into the mix comes up with five candidates which tick all of the boxes.

They are, in no particular order:

1 - Braemar Shipping
2 - Clarkson
3 - JD Sports
4 - RM
5 - Unilever

This is not a recommendation to buy these shares! I have a stake in Unilever at the time of writing, but I am intending to drill down into all of these companies, and more besides, in the coming weeks and months. On the face of it, these look like quality candidates, but time will tell.


  1. Hi Yorkiem. Hope all's well. I have also joined the converts to quality as you may or may not know. So your list of 5 is interesting in that I own numbers 1 and 3, and the others all appear in my lists in one way or another.

    I have looser entry criteria than yours but then sort on a few things to get the better ones at the top. Clarkson is currently pretty high on the list, as you may have seen in my recent 'beefy stocks' post.

    I look forward to seeing where you go with this and how your analysis differs from mine.

    All the best

  2. Hi John

    Yes, I've been following your work with interest. We seem to be ending up with similar targets...ever decreasing circles and all that! I'm chomping at the bit to get stuck into the analysis, particularly as I will need to engage a slightly different mind-set, but availability of time is a bit more of a limiting factor these days.

    Keep up the good work

  3. Seems like everyone is switching over to quality ;)

    It has to be said that I, too, am taking a much more "quality first, price second" approach. I'm finding that the problem with the cheaper, lesser quality companies is that the results tend to be very mixed. You never really know what's going to happen.

    I think you might be interested in a portfolio I run over at Stockopedia: Actually, I think that Marks & Sparks is not a good fit for the intention of the protfolio, and should be removed. It's doing pretty well, and there's hardly a dud in there. it's too early to say, though. I think that over the last few months the market has been derisking the last few months, so it is entirely likely that I hit a kind of market "sweet spot" through sheer luck.

    The markets seem to be rebounding just now, so don't be surprised to find that the cheaper stocks put in a much better performance. Remember, also, that Neil Woodford has been underperforming the market for the past few years; so even the great and the good can have their off periods.

    The sorts of things I've been looking at are good returns on capital (although you could use ROE), low debt (can it be repaid in 5 years?), and consistency of track record.

    To obtain the "consistency", I do a spearman's rank on the adjusted EPS. For example, Smith & Nephew has a rank of 99% - very high rank. Basically, it means that the company has increased its earnings each and every year for the period under review (12 years - I include forecasts), with a minor glitch.

    If you compare that with a housebuilder like Bellways, say, it has a rank of -41%. Not only are the earnings erratic, they've had a tendency to go down.

    Unilever gets a score of 94% - again, a high score, as you might expect.

    I'm a geeky guy, so I have developed the software to calculate this. A good alternative would be to simply do what something similar to Graham: namely, I take the median EPS of the first 3 periods in a decade, and the median EPS of the last 3 periods in a decade. Take the 7th root to obtain an approximate annual compound rate. I found that this method yields results very similar to a least-squares exponential fit.

    Mark Carter aka blippy

  4. Hi Mark/Blippy

    Thanks for the great feedback. I've been following your blog for a while, but have only just got around to adding you to my Blog List. Ok, end of fellow UK value blogger love-in... ;)

    Impressed with your portfolio performance. My performance is a game of two halves: I'm showing some similar upward trajectory, but only after ejecting my erroneous punt on HMV. One lives and learns...which is what this is all about I guess. I might consider starting again with my new found quality focus. One thing that doesn't quite work for me on the fantasy portfolio is that it doesn't appear able to cope with dividends. Given that dividends account for 90% of very long-term returns, and plays a significant part of my thinking, I think they may be a missing a trick. A lot of your constituents appear to be reasonable dividend payers too.

    The other thing that I'm thinking about is giving more weight to FCF per share rather than EPS, given that "earnings", and even for the large companies, can jump around due to mark-to-market contracts, pension deficits, depreciation policies etc. EPS is a quick and dirty, but cash is king. Do you get stuck into FCF much?


  5. "Impressed with your portfolio performance"

    Don't forget, this could simply be due to the market derisking itself. Now that fears over Greece have subsided, I expect the market to outperform my selection.

    "erroneous punt on HMV. One lives and learns"

    I got burnt on HMV too, if that's any consolation. Fortunately I bailed out a long time ago. HMV certainly has made sickening declines lately. Unfortunately, it looks terminal. This seems to be a classic case of companies which just get sicker and sicker.

    Talking of HMV ... I went into Waterstones today, and saw a book by Duncan Bannatyne on "47 Ways companies make mistakes", or something like that. I thought it might make an interesting read from a investor perspective. Didn't buy it though, although I'll certainly think about it. The book I'm going to read this month is "Problem Solving 101: A Simple Guide for Smart People", as I'm taking a break from straight-out investment books.

    "Do you get stuck into FCF much?"

    Short answer: no. I am tending now more towards the "quality" end of the spectrum (this month, anyway ;) ). So I think it is useful for companies to be able to compound their earnings by reinvesting profits. The problem with FCF is that it doesn't separate out maintenance capital and expansion capital. So if a company is expanding, then it tends to have low price to free cash flows.

    An alternative view would be that by Bruce Berkowitz, who has an extraordinary investment record. His basic strategy seems to boil down to "buy on a price to free cash flow of 10 in cases where I can't kill the company". He doesn't explain what the latter part means; but perhaps a good place to start would be insist on a good debt position in something that you felt wasn't in structural decline. Maybe one would have to do sanity checks to ensure there weren't exceptional events causing abnormal flows.

    An interesting example might be RWD (Robert Wiseman Dairies). It is on a PFCF of 7.6 - way better than 10. Its balance sheet is robust. Although it is facing some tough economic conditions, it seems unlikely that it will go kaput any time soon. It's a simple business, and I don't see Britain stopping drinking milk any time soon.

  6. ROC is fantastic, that's a no-brainer to own.