...indicator. Regular readers will know that I have been following a simple market timing indicator for UK indices in recent months based on a simple trailing moving average based system. With the volatility of the market in recent months this has demonstrated the danger of being whipsawed by a system like this with several sell and buy signals in short succession.
However, with the strong showing from UK indices in February and all the hype as the FTSE 100 finally surpassed its closing high from 1999 you'll not be surprised to hear that these indicators are now all showing as bullish / invested.
The mainstream indices like FTSE, 350 and the All share are all around 3% above their moving average, while the stronger performing Mid 250 is 5% above and the small cap index which has struggled in the last 12 months is now 1.7% above its moving average.
So for what it is worth these indicators are saying you should be invested but I guess it remains to be seen if 1.6% total return from the All Share in February can be sustained and built on in March or if the old highs around here will act as a break on progress as the reporting season gets into full swing and the General Election in the UK approaches.
Nevertheless as markets are often said to climb a wall of worries it will probably continue to pay to ignore market levels in the main as valuations, in the UK at least, remain reasonable and focus on finding attractive individual stocks. So keep checking back here and I'll see if I can help you with that challenge.
...by a process of continual improvement or Kaizen the Japanese term for this which became prominent in the 1980's when it seemed that Japanese businesses were dominating the world and their stock market was on a crazy rating which it has never recovered from to this day. Any way that doesn't stop the principle being a good one and with that in mind I have been applying it to the Compound Income Scores this week.
If you are a regular reader you may recall that I recently added an extra column to these to calculate an estimated sustainable growth rate to help with longer term projections. So this week I have hopefully taken this to its logical conclusion and introduced some suggested expected return columns. These are based on the forecast, five year historic dividend growth and the suggested sustainable rate which are already in the sheet.
By way of explanation, these are simply the current yield plus the calculated growth rate. I have headed these columns up:
MIN (the lowest growth rate for a conservative estimate), MEDIAN (the middle growth rate) AVERAGE (the average of all three) and MAX which should be self explanatory. Obviously as I say this is a simple suggested expected return and actual outcomes are likely to differ depending on how the market overall moves and if the stock concerned get re-rated or de-rated over and above the movement in the dividend or if the company ends up disappointing or surprising on the upside in the short term.
How should you use this? Well I think you would do well to take these figures into account when picking your stocks and compare it to the valuation, which is what the EVER ratio on the sheet does using the one year growth forecast.
if a stock is highly rated there is a risk that the growth may not come through in the rating or it could be more vulnerable to a de-rating if it disappoints.
Overall I would tend to look for an expected return on this measure of 7 to 9% or say 8% on average and you might want to look for say 10%+ which is a nice round figure for a margin of safety, especially if you are looking at a smaller or AIM listed stock. However, this type of analysis is probably of most use for steady growing / compounding type stocks. As those with a low minimum figure will probably reflect limited growth or previous cuts so you may not be able to rely on them delivering consistently in the future. I would also tend to ignore the maximum figure because again this may just reflect dividends being reintroduced from a low base, an artificially high ROCE or a short term ramp up in the dividend which may not be sustained in the long run.
Now why do I say you should look for 8% or so suggested return?
Well, in the long run the average real (after inflation) returns from UK equities have been 5.3% per annum since 1900 and 6.2% between 1965 & 2014 (Source: Credit Suisse Global Investment Returns Year Book 2015 - see page 57 in file attached at end of this note.) So lets say 5.5% for the sake of argument. So since you are looking at equities here it would seem logical to want to at least get an average and preferably, an above average real return on your investment for taking on equity risk. There is a good discussion of real discount rates and equity risk premiums in the Credit Suisse document starting on page 29 if that is of interest to you, but I'll discuss this in a moment in any event.
You will need to factor inflation into the calculation to compare with the expected return figures. Looking at data from the Office for National Statistics in the UK I note that CPI between 1997 and 2014 has averaged 2.1%, while RPI over the same period has averaged 2.9%. So while the Bank of England likes to target 2% on CPI and you could use that I think I'd prefer to use the average of the two so lets say 2.5% for the sake of argument.
So we now have a suggested long term nominal market return of the expected equity risk premium of 5.5% + inflation assumption of 2.5% = 8%, but of course you could use a higher or lower figure depending on what assumptions you want to make and what margin of safety you want to factor in to allow for disappointments.
I would then tend to combine this expected return figure with looking at the valuations. Ideally you might be able to find a stock with a decent yield - say 3%+ combined with a reasonable PE of say less than 15x and a decent earnings yield of 7 to 8%+ and a better than average Compound Income Score. However with regard to these figures and the Compound Income Scores, please remember to use them as a guide to potentially attractive shares which may be worthy of further research, as you need to assess the underlying business and its likely prospects which underpin the numbers.
Hope you find this useful - the Scores have been updated today to include these return columns. If you are not already signed up and would like to gain access to them then please read more about them and how to sign up here.
..including RPS which I have mentioned recently who have come out with their final results for the year to 31 December 2014. After the recent positive trading update these still managed to pleasantly surprise with the adjusted eps of 22.04p coming in slightly ahead (3.5%) of the consensus of 21.3p probably helped by the tax charge being a few points lower than last year. Meanwhile the dividend was increased by their normal 15% which was therefore in line with forecasts at 8.47p.
This was achieved despite the factors outside their control such as the strength of sterling, the rapid fall in the oil price and unrest in the Middle East.
They also made £58 million of investment committed to acquisitions, further increasing the strength of their international platform and they recently completed their first acquisition of 2015, BNE in North America. They say these will enhance performance in 2015 and that they anticipate further transactions during the coming year supported by what they describe as their strong balance sheet, which saw year end net bank borrowings at £73.2m and facility headroom of £87m at the year end against their market cap. of just over £500m. They say their facility with Lloyds runs out next year and that the Board intends to refinance the Lloyds facility during the course of the next few months, which is likely to involve an additional bank providing part of their total facilities.
On the back of this they said "We believe our positioning and business model should deliver a successful outcome and further growth in the current year." While on the key energy part of their business they said:
"Recent market conditions have been unusually volatile. As a result, clients are likely, in the short term, to continue focusing on cost management; we are, therefore, reducing our cost base and concentrating on those parts of the market and projects likely to receive investment. There are, however, already some signs of stabilisation. With the global economy set to grow substantially in coming years, we are well positioned in what continues to be an attractive, long term market."
Summary & Conclusion
So looking forward RPS seems to be on around 10x P/E with a 4% yield and offers a reasonable earnings yield of around 8.4%, before any changes on the back of today's figures. So with that caveat and with that dividend yield reflecting a further 15% growth, the rating should still leave scope for upside if they can continue to deliver, so it looks like a strong hold.
Meanwhile we had final results from another support services stock - Interserve (IRV) which also reported better than forecast numbers. The turnover was stronger than expected at £2913m v £2711m forecast, eps came in at 58.8p (+23%) v 55.8p forecast and the dividend came in at 23p (+7%) v 22.8p forecast. They mentioned that they had grown this by 5% per annum over the last 10 years which might be useful information for longer term forecasting. They also flagged £4.1 billion of new business won in 2014 and a record future workload of £8.1 billion, up 26 per cent which provides quite a bit of visibility for the future.
Chief Executive Adrian Ringrose commented:
"2014 was a landmark year for the business in which we advanced our strategy and delivered 35 per cent operating profit growth including strong organic growth despite continuing challenging conditions in a number of our markets. We made two strategic acquisitions (Initial Facilities and the Employment & Skills Group), each of which deepened our presence in core outsourcing markets.
Our focus on providing high quality services to both new and existing clients resulted in strong work winning during the year, with our future workload rising 26 per cent to a record £8.1 billion.
Looking to the future, we are encouraged by the growth potential of the business. Our attractive positioning in our core markets and our ability to identify, invest in and deliver on attractive project and corporate opportunities is a powerful differentiator."
Summary & Conclusion
A busy year for Interserve with a potentially transformational deal to buy Initial which may help to boost underlying organic growth for the next year or so as it is integrated. I note that Interserve only scores in the 50's on the Compound Income Scores being dragged down by poor scores for dividend cover and financial security. The low cover scores is driven by poor cash flow cover & I note the cash flow / conversion looked weak in these numbers too. While the financial security score is dragged down by a low Piotroski score of 2 which is not good and I note that Stockopedia also have them down with a borderline Altman -Z Score of 1.79 (this measure bankruptcy risk), although interest cover seems fine at 11x. So a mixed picture on some of the financial and security aspects as far as the dividend and balance sheet are concerned, but probably reflecting the gearing up they did to buy Initial and an investment phase they say they have been through. This hopefully will be reduced in the years ahead and should return their cash conversion back towards the 100% which they normally target and thereby reduce the debt.
So with that caveat the shares look quite cheap on a P/E of around 9x and a forecast yield for the coming year of 4,3% while the current earnings yield of around 11% based on these latest numbers and a 4% operating margin. With forecast dividend growth of around 6% for the current year and their longer term 5% growth rate mentioned in the statement it seems they could offer a reasonable 9 to 10% total shareholder return (TSR) in the medium term ex of any re-rating or de-rating so again a strong hold I would suggest.
Finally a quick mention for British American Tobacco (BATS) who also reported finals today. I'll not dwell on the detail as it is all a bit of a drag, but I note the dividend was up by a better than forecast 4% in total which they say is in line with their intention to grow dividends in real terms. Earnings were down which meant the cover reduced and this is the main area of weakness in BATS CI score, otherwise it scores overall in the 70's - so a reasonable income stock as you would expect.
With the current 4% yield and trend dividend growth that seems to have slowed to 4 or 5% in recent years this one should also provide a reasonable TSR of around 9 to 10% if you don't mind investing in tobacco.
Talking of which I have been reading this week the excellent Credit Suisse - Global Investment Returns Year book 2015.
This features an interesting piece on Sectors and how they have changed in terms of their weightings as fashions and technology have come and gone. Tobacco featured throughout and had in fact been one of the best performing sectors over the century or more of returns that they cover - who would have thought it hey?
So I attach a copy of this for you below, as I'm kind like that, for some further reading and homework on Discount Rates and Equity Risk Premium as I planning a post based on those and an enhancement to the Compound Income Scores so see you back here soon.
In recent posts I have been discussing Europe, songs and also looking at the Compound Income scores in the context of some individual stocks such as Centrica. Today I am going to explore these themes further as I have another sell recommendation for you. This however, will I suspect be of quite limited interest, unless you hold it, so I'll try and keep it brief.
The stock concerned, as you may have guessed from the title is Phoenix Group (PHNX) - the closed life insurance business. I first switched into this one back in 2013 as a bond alternative with the prospect of some modest dividend growth. Since then it had a wobble about a year ago when the chancellor announced dramatic changes to the pensions industry, but has recovered well since then as you can see in the chart below. However I'm getting worried about this one now and thinking I should run for the exit.
So with a 6.3% bond busting yield, what's the problem? Well I said I would try and keep it brief so you can then do your own research and make your own mind up. So my three main reasons to run are as follows:
I prefer to try and avoid that type of thing in advance so as I don't like the look of the above three factors which makes me nervous and want to say or sing run run run, now seems like a good time for me to head for the exit as a precaution. However I could be wrong and if it just carries on churning out the dividends from its closed books I guess it could be OK, so do your own research and make your own mind up if you do hold it.
Finally talking of run run run and bringing back in the European theme I came across the following video from a French band which seems appropriate to this note, au revoir.
...as it has been a busy day for results today. Most of these I have covered recently when they announced year end trading updates so I'll just give brief comments today.
Firstly was Provident Financial (PFG) - the home credit and sub prime credit and instalment lender (click the name for previous posts or see the categories list at the side of the blog). They reported results which were probably just shy of best expectations with the dividend at 98 pence rather than 99 pence forecast, but then it was up by 15.3% which was better than expected at the start of the year. Thus not surprised to see the shares off a little first thing as they have had a great run and only look about average value albeit with a decent and strongly growing yield of around 4% which remains the main attraction of this one. The only real point of note is that I see they are scrapping their Polish Credit card pilot at little cost this year having seen start up losses of £10m there last year - so a small boost there.
Next onto boxes and firstly the cardboard variety as manufactured by Mondi (MNDI) amongst other things. In contrast to PFG their numbers seemed to be slightly ahead of expectations at the earnings level and as such the share have responded positively first thing. I note the dividend was perhaps 1c light of forecasts but was nevertheless up by 17% and well covered by earnings and cash flow. This one is obviously sensitive to general economic conditions (cyclical) and they say that the outlook for this to remain below average. They are also affected by exchange rate moves but these have tended to help them recently. They summed up by saying "Furthermore, the recently completed capital investments and ongoing projects should contribute meaningfully to our performance going forward. As such, we are confident of making further progress in the year ahead." The only other point I noted was that they flagged a little extra cost from planned outages this year which are expected to total €80m versus €55m last year. The shares have done well in the last year out performing by around 20% and they have re-rated somewhat as a result. Thus they look less compelling on around 15 to 16x next years earnings with a 2.7% yield, before any changes on the back of these numbers. The latest declared operating margin also leaves it on a fairish 7% earnings yield. Consequently the CI score has drifted back into the 60's as the shares have re-rated and as such they look like a hold up here and if you hold them I would suggest you need to keep an eye on economic developements for signs of weakness / recession emerging given their cyclicality.
Persimmon (PSN) was the other box provider that reported today and as expected reported very strong results and a welcome early payment (April rather than July) of this years planned return of capital of 95 pence. The problem here is that the share had travelled well before today's numbers so probably not surprising to see some profit taking as perhaps people think this might be as good as it gets perhaps. They are however committed to further capital returns over the next few years, although next years is only currently expected to be 10 pence, although this could be upgraded.
So with a fullish looking (for a house builder) PE of nearly 12x this years earnings and more limited yield support given the lower return of capital planned for next year I can see whey people would be taking profit up here ahead of the General Election uncertainty. Despite this the company say the year has started well and they still seem well place to prosper in the medium term so as I always say you pay your money and take your choice.
Finally digging deep into my reserves of endurance and as the coffee pot beckons just a quick mention for BHP Billiton (BLT) which reported half year results today. Not being a mining analyst I'll not get into analysing or debating the various possibilities for commodity prices. But in passing I note that they still expect an average investment return of greater than 20% for their portfolio of high-quality development options. In addition they say they expect to maintain or not "re-based" as corporates like to say these days, the dividend even after the planned demerger. This suggests that the 5%+ yield is safe for now but I note that earnings have been downgraded steadily in recent months and the cover is diminishing and will diminish further post the demerger. So if economies and commodity prices continue to struggle then this dividend could come under pressure in the medium term.