Um, it’s all gone slightly insane in portfolio-land. I’m up 26.5% this year and it’s only the end of March. The total cumulative performance is 129.9% since inception (17.9% annualised), and 80.8% since the end of March 2009. For comparison, the FTSE 100 with dividends reinvested is up 39.6% (6.8% annualised) since the same start date (10 March 2005) and is up 50.7% since the end of March 2009.
Well, maybe I’m due a ‘correction’, or maybe value investing with a concentrated portfolio of undervalued securities is a smart way to compound capital. The great thing about blogging for the past 16 months is that it records some of the thoughts going through my head during the period, thus avoiding the perrenial problems of hindsight bias.
A few further statistics worth noting are that of the 16 securities I owned over the period, just 9 were sold for, or are currently showing, a profit. Of the total monetary gains, 91% have come from 3 securities (32% Berkshire, 17% Hallin Marine and 42% Lo-Q). The maximum percentage loss was a 49% loss in RBS, but this only comprised 2% of the total P/L over the period. When I really liked something I bet big and when I wasn’t sure I bet small.
In a world of mixed fortunes I’m now working as a professional again, 7 years after first starting out as an Equity Analyst but with over a 5 year gap during the period. I feel pretty much self-taught, although working at a small fund a while ago certainly taught me a lot about investing in general and investing in the stock market in particular. I wonder how much use the leveraged global-macro betting was in coming to terms with my fallibility, a lot I suspect. It also taught me a great deal about how markets react to news and the various capital flows that ebb and flow over the credit cycle.
Whilst it’s great to be working again, I can’t just buy and sell for my own account as I might like to any more. I also have a lot less time to look at small-cap shares as I’m spending it looking at larger stocks at work. I’m learning a great deal from some guys with loads more experience than I have, and the game has changed somewhat as the size of shares to look at has grown.
Whilst I can simply read a set of financial statements and feel I have an edge on other market participants with the smaller £10m or so companies, it’s going to take an awful lot more work to feel like I have an edge (most of the time) while looking at £500m and upwards companies. Suddenly the market is far more efficient and effectively smarter. This is not all bad, as reasons for a re-rating should be uncovered faster, but the ultimate goal of maximising post-tax returns is simply a lot harder when investing tens of millions over tens of thousands of pounds.
By way of completion, I did say I’d post my portfolio up here with prices and so on. It’s moved around a bit since I said that but the current situation is as follows:
Stock........Price Paid......Current Price........% Value in Portfolio
LOQ.............£0.80.................£1.21..............................59%
MTEC..........£2.03................£2.22..............................17%
EMG............£2.05................£2.42................................7%
WMH...........£1.62.................£2.11................................4%
GMG.............£1.57................£0.98...............................2%
(Cash)...........................................................................11%
If I were starting from scratch I may have similar holdings, but weighted something along the lines of 50/20/10/10/10 (%-weight in the order of stocks listed above). In fact, Lo-Q isn’t looking quite so attractive any more as the price has risen, although it’s still reasonably cheap and my other ideas for inclusion aren’t so great or developed at the moment, so there’s no need to sell just yet.
As a final note, I’m happy to think that you can still pick up the odd bargain in the mid-cap pool of stocks. Game Group is a great business; the market leader in its niche in almost all its territories. The earnings are strongly cyclical, and Myopic Mr Market has some trouble looking more than 12 months ahead, so it’s selling at around a 60% discount to its fair value. I could well be wrong on this, as the world of tomorrow won’t look like the world of yesterday, but at least I feel I have a Variant Perception. Hopefully they’ll be dishing out some more profit warnings soon and the market will become even more depressed and the bargain even more attractively priced for all the long-term value investors out there.
Wednesday, March 31, 2010
Sunday, February 28, 2010
On Market Inefficiencies
Where could be better to dig for an overlooked gem of a business than in the small-cap space? Nowhere as far as I'm concerned. This does not mean that there aren't bargains to be found in other areas of the markets, but the glaring inefficiencies in the form of undervalued assets are far more likely to be found where nobody is looking.
An efficient market is likely to have a relative balance of potential buyers and sellers and relatively little emotion from those participants. Thus the larger anomalies of market peaks and troughs coincide with maximum optimism and pessimism in market participants. Where more eyes are fixed on a given security, ultimately its price is going to be closer to its intrinsic value. In general, markets may not be precisely right all the time, but they are approximately right most of the time.
So, where a stock has very few followers, and relatively little understanding of its products out there in the investment community, you're more likely to find something significantly mis-priced than in the over-analysed world of large-cap investing.
Take Lo-Q. I first came across this stock when a friend told me about her family's outing to Legoland Windsor. The family had used a 'Q-bot' device to avoid having to physically queue for popular rides for the day. The device sounded a bit clunky, but the basic service of cutting down physical queuing times struck me immediately as something that society at large would happily pay a decent price for. The other great thing was that remote queuing remained 'fair' to everyone as you had to pay for the service and you joined the queue with the same waiting time as if you had joined the physical queue.
The next morning a technology sector stock screen at work showed the business trading at a very, very low price versus its prior year's earnings and cash on the balance sheet. For some reason the market thought that a business growing at 20%+ a year with £2m of cash and £2m of pre-tax profits (for the prior year) was worth around £10m. Fair enough if that profit level is illusory, but I felt it was certainly worth a little investigation.
Well, 6 months on and there is now over £4m in cash, still no debt, pre-tax profits are at £2.4m and the market cap still reflects a high degree of scepticism in the business model at £13.5m. To be fair the clearing price may actually be higher than the market cap as the brokers won't sell me as many shares as I want to buy - my first taste of the annoyance of illiquidity issues in small-cap investing.
Anyway, it probably helps that I learned the business has survived the attempts of over 20 competitors (all of whom have failed) over the years, but I found this out from a simple phone call. I honestly quite often wonder if many investors go to the trouble of reading an annual report (or even the balance sheet and income statement) before they invest in businesses sometimes. I certainly don't know many private investors who take even 5 minutes to do just that. Peter Lynch once lamented when asked what investors should look for in a stock, "Well, they could start by looking for some profits!”
So, as institutions can’t operate with much less than £20m, say, in assets (1% of which is hardly going to do much more than turn the lights on in The City), any business trading for much less than £50m or so is just going to have fewer people following it. And brokers see no value in producing research on a stock if institutional investors aren’t churning their portfolios through them. So you get some tiny companies growing at astonishing rates, valued as if they about to slide into an imminent decline.
Of course it may just be that you have missed something, but if you’ve done your homework and still think you’ve found a bargain, chances are that you are correct. As Mr Buffett says, “You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – and that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.”
An efficient market is likely to have a relative balance of potential buyers and sellers and relatively little emotion from those participants. Thus the larger anomalies of market peaks and troughs coincide with maximum optimism and pessimism in market participants. Where more eyes are fixed on a given security, ultimately its price is going to be closer to its intrinsic value. In general, markets may not be precisely right all the time, but they are approximately right most of the time.
So, where a stock has very few followers, and relatively little understanding of its products out there in the investment community, you're more likely to find something significantly mis-priced than in the over-analysed world of large-cap investing.
Take Lo-Q. I first came across this stock when a friend told me about her family's outing to Legoland Windsor. The family had used a 'Q-bot' device to avoid having to physically queue for popular rides for the day. The device sounded a bit clunky, but the basic service of cutting down physical queuing times struck me immediately as something that society at large would happily pay a decent price for. The other great thing was that remote queuing remained 'fair' to everyone as you had to pay for the service and you joined the queue with the same waiting time as if you had joined the physical queue.
The next morning a technology sector stock screen at work showed the business trading at a very, very low price versus its prior year's earnings and cash on the balance sheet. For some reason the market thought that a business growing at 20%+ a year with £2m of cash and £2m of pre-tax profits (for the prior year) was worth around £10m. Fair enough if that profit level is illusory, but I felt it was certainly worth a little investigation.
Well, 6 months on and there is now over £4m in cash, still no debt, pre-tax profits are at £2.4m and the market cap still reflects a high degree of scepticism in the business model at £13.5m. To be fair the clearing price may actually be higher than the market cap as the brokers won't sell me as many shares as I want to buy - my first taste of the annoyance of illiquidity issues in small-cap investing.
Anyway, it probably helps that I learned the business has survived the attempts of over 20 competitors (all of whom have failed) over the years, but I found this out from a simple phone call. I honestly quite often wonder if many investors go to the trouble of reading an annual report (or even the balance sheet and income statement) before they invest in businesses sometimes. I certainly don't know many private investors who take even 5 minutes to do just that. Peter Lynch once lamented when asked what investors should look for in a stock, "Well, they could start by looking for some profits!”
So, as institutions can’t operate with much less than £20m, say, in assets (1% of which is hardly going to do much more than turn the lights on in The City), any business trading for much less than £50m or so is just going to have fewer people following it. And brokers see no value in producing research on a stock if institutional investors aren’t churning their portfolios through them. So you get some tiny companies growing at astonishing rates, valued as if they about to slide into an imminent decline.
Of course it may just be that you have missed something, but if you’ve done your homework and still think you’ve found a bargain, chances are that you are correct. As Mr Buffett says, “You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – and that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.”
Sunday, January 31, 2010
On Myopic Mr Market
Well, the market is fluctuating, which isn't much of a surprise. Every day events cause the prices of thousands of securities to gyrate with dizzying velocity. Perhaps the 'fundamentals' are moving at the same breakneck speed, and the value of all future cash flows is being efficiently priced in from minute to minute, and day to day. Or perhaps not.
With so many people excessively concerned with the next quarter's numbers for the company they have their eyes on that day, it's no wonder that stocks move in such manic-depressive swings. Frankly, it's unlikely that a company such as Man Group was correctly priced at £3bn in March 2009, £6bn in November 2009 and now at £4bn again in January 2010. This is, of course, quite good news if you are able to stay focussed on the long-term in your outlook.
Taking the view that companies are very rarely correctly priced by the markets seems the only rational explanation to me of why share prices move so wildly over a one year period or so. The fact that they can fall 3-5% in a day if they narrowly miss forecasted quarterly numbers, seems rather short-term biased to me. And it creates a nice opportunity for people to effectively profit from the short-termism of the market and it's gyrating prices.
Man Group (EMG) is a good example. I first took a good look at the business in the summer of 2008. Back then the company was valued at £8-10bn by the market, and there were some serious problems brewing with respect to redemptions and the future for the hedge fund industry in general. My view was that if any hedge funds survive, Man should be one of them as it's very well run by nice and dull looking accountants and lawyers (this is meant as a compliment!).
That view hasn't changed, but redemptions appeared to stabilise with the markets in general during 2009. Next came some unfortunately poor performance over the year within their flagship AHL fund. But that's one bad year in a string of performance that is quite astonishing over a far longer period of 18 years or so.
So, now you're faced with some relatively bad results for the quarter, the year and maybe even a year or two in the future. But the business hasn't fundamentally altered in any way that I can see. They just had a bad year, and that happens to even the best fund managers who aren't composed of computer algorithms.
Anyway, I could of course be wrong in my assessment, but it does seem to me that a business worth between 3 and 10 billion pounds (as assessed by the market) is selling on the cheap side as it's had a bad year. Which is really quite nice for me, as I think it will do fine over the next decade or so, and currently looks cheap on that basis.
The point here, is that short-term myopia is the norm in investment circles and those chasing strong monthly performance for their funds. It just seems way easier to me to be picking up these things that are punished by the markets for having a bad quarter or year, but have not really changed their businesses recently and are still well managed, than to try and predict the unpredictable.
Focussing on what's important and knowable, rather than what is unimportant and unknowable is the way to make money, and yet so few people do it! Maybe it's a worthwhile process to try and predict the next gyration, but it seems better to me to try and think for oneself and remain rational. Better, but perhaps not particularly easy, and therefore quite a rare virtue to keep working towards.
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