Having had a question from a subscriber about how I pick the the constituents of the Compound income Portfolio by using the scores. i thought the response might be of interest to others too, so I set out the answers below.
I aim to select new investments from the top decile (90 and above) of the Scores to replace stocks which have seen their Score fall below the top quartile (75 and less), although on occasions I will give some stocks that fall into this sell category the benefit of the doubt if there has not been much news flow or it is quite marginal, as over trading can detract from performance.
In terms of the new positions I do also take into account existing holdings as I like to try and get diversification by sector and type of business. So for example while Redrow & Barratt Developments both Score well at present, the portfolio has held Bellway for a long time and I have not felt that I want more than one house builder, although that's not a hard and fast rule across all sectors as some are more varied by business type. So they would be excluded on that basis, although other may feel comfortable with having several house builders in their portfolio or if they felt particularly bullish on the sector or the theme, each to their own I guess.
I also like to apply some value discipline when buying new positions, in the same way that Terry Smith tries to buy quality companies at reasonable prices. I tend to use a maximum of 20x PE and a minimum dividend yield of at least 2%. I also look at the earnings yield (EBIT/EV Yield) & would like this to be 5% or more ideally. These metrics are all readily available alongside the Scores. Thus again in terms of current highly rated stocks that has tended to rule out (rightly or wrongly), two examples are currently high Scoring stocks like dotDigital & Rightmove. Again others may choose to be more relaxed about this and pay up for quality.
In the past I also used these value metrics as guides for selling too, but I have chosen to relax this for current holdings as long as they continue to Score sufficiently well and updates etc. don't give cause for concern so as to "run the winners" which is often a common behavioural failing of investors in not doing this. Having said that I'm not averse to some top slicing if the valuation gets quite high (say closer to 30x & yield well below 2%) & the % of the portfolio gets large (towards 10%), with Avon Rubber being a current example of one that I am considering for that.
I would also not tend to buy anything less than £50m market cap. as a new position for liquidity / lack of investor interest reasons, although again others may see this as an opportunity. I also pay some attention to 12 month price momentum which might well put me off buying if it is negative, unless I think there is a strong enough contrarian value case for example with the purchase of Investec this month. This was in preference to Caledonia Mining (probably due to my personal aversion to / bias against mining stocks). It also reflected that fact that the portfolio already had one smaller precious metals miner as well as a diversified major so again the diversification / sector thoughts came into play there. While the negative price momentum also directed me away from NMC Health (amongst other things), Central Asia Metals and AA (plus debt concerns here) for example at the moment.
Beyond that I do some due diligence on the other high Scoring stocks not ruled out by the above factors to choose any new holdings. So there may be some of my own knowledge & biases creeping in there, which otherwise I try to keep to a minimum. On occasions I have forced myself to buy high Scoring stocks even though it felt like I was getting in late having ruled them out previously due to my own biases. Examples of these would be Games Workshop (GAW) which was first bought in October 2017 at nearly £20 having dismissed it at around £10 previously. This felt horrible at the time but turned out fine as did an uncomfortable purchase of Sylvania Platinum more recently, again a lot later than I could have bought it, having dismissed it much lower down too at under 20p, as I didn't have a strong feel for them and my natural aversion to miners personally mentioned earlier.
Equally on occasions a position that I force myself to buy based on the Scores, despite my own reservation, won't always work out as trades in PLUS 500 some time ago proved, although I have vowed to never buy that one again, which again may or mat not be right. Sometimes it does force me to buy things which I don't feel that strongly about personally which go onto pleasantly surprise on the upside, with Avon Rubber and Dunelm being two current examples of that, although they required some patience before they delivered.
Hopefully this has given you a feel for how I go about selecting positions for the Compound Income portfolio. Overall it was set up to demonstrate how one could use the Scores to help construct a portfolio and also to see if the Scores had any merit in this regard. Thus far it has proven to be pretty good at selecting more winners than losers in the nearly 5 years that it has been running, although as all investment marketing says the past is no guide to the future & I can't offer any guarantees or provide any personal investment advice.
I wouldn't expect subscribers to follow the portfolio fully (although they can if they want) but for it to act as a guide to what might be attractive stocks and help people in selecting their own portfolio after doing their own research. Indeed I use them everyday myself to help run my own portfolio in addition to the Scores portfolio, so I'm definitely eating my own cooking as it were, as I believe it is a recipe for success. The current Compound income portfolio has a weighted average PE of 15.7x with prospective dividend yield of 3.5% based on the forecast dividend growth of 15%.
If that has whetted your appetite you can find out more about the Scores and how to access them by clicking here or in the Scores section in the site menu. You can also see the full performance history of the Scores Portfolio by clicking here, but as the standard disclaimer goes the past is no guide to the future, thanks for reading and good luck for the future with your own investing, however you choose to do it.
Investec (INVP) the Anglo South African investment group looks good value in a neglected / misunderstood / contrarian kind of way. So what I hear you say why won’t it stay that way? Good question and it may do for all I know. They do however seem to be trying to do something about it by proposing the de-merger of their Asset Management division which incidentally manages £121bn - bet you didn’t know that. That’s before you factor in the £50bn+ that they manage on the private client / wealth mangement side of things. Any way to cut a long story short I have been researching the demerger document and other stuff they have put out on their Investor relations website and I have to say I’m quite taken by it and think it could be quite undervalued, although as I said at the outset I guess it could just remain that way.
Nevertheless as it currently stands it does look pretty good value on around 7.7x earnings with a 5.7% dividend yield which is more than two times covered. The balance sheet also appears to have net cash of around £1.6bn at the interim stage as they have taken in more deposits than the loans they have made. Their lending also seems to be reasonably prudent as the loan losses are pretty low & it is not overly leveraged. They also stand on a price to book value of around 1x with an ROE of 10% or so which seems fair enough for a bank, although they have ambitions to push this up towards mid-teens in the next few years which could argue for a re-rating if they achieve it. So all in all it ticks a lot of value boxes (which I know is a dirty word these days) although it does lack momentum, certainly in price terms, but has had some earnings upgrades more recently.
A look at the sum of the parts is also quite interesting and is I think another potential indicator of some value being on offer here in addition to the above traditional metrics. Firstly there is the Asset Management arm which is being spun off and existing Investec shareholders will end up owning 70% of it given the 10% new stock being issued and the 20% held by employees. In the documents relating to this they seem to be assuming a £1.9bn valuation for this, which seems reasonable given the £121bn of assets they manage, the 30%+ operating margin and the decent growth in assets that they have demonstrated over the last decade. So if we go with a round £2bn 70% of that would be £1.4bn versus the current EV of £2.79bn - so about half of that.
Next they will still have the Wealth and Investment Arm which manages as much as Brewins in the UK plus higher margin assets in South Africa. So that’s probably another £1bn of value there based on Brewins market cap. They also have the broking arm within this which probably compares favourably to the likes of Numis etc. so that probably worth another £0.6bn or so, based on Numis's market cap. So that puts us up to about £3bn already.
Then that leaves the deposit taking and lending that they do, although some of that is undertaken by the Wealth and Investment arm so it is a bit tricky to work out how much of the book value one should ascribe to that. It seems though that 40% of the lending is to HNW’s & other private client lending. So to avoid double counting I’ll ascribe 60% of the book value to the Corporate/other and property related lending. So 60% of £4.6bn comes out at £2.76bn so I could use that, but I note in their group summary this year they detail allocating £3.6bn of capital combined to the SA & UK Banks. So I will probably use that as the base for the banking sum of the parts. Total that up and you get:
Asset Management = £1.4bn
Wealth Management = £1bn
Broking Arm =£0.6bn
Banking Assets £3.6
Total = £6.6bn & an Enterprise Value (EV) of £5bn
This compares to a current market cap of £4.4bn & EV of £2.8bn. Which based on the above rough and ready sum of the parts might suggest that it could be 50% or more undervalued.
Now lets look at the share price chart and earnings history to see if that seems reasonable or even possible. Over 10 years since the end of 2009 the shares have largely gone sideways with a couple of peaks along the way in the 630p region versus the current 440p or so. This would give upside of about 43% if they can make it back up to those kind of levels or equivalent once they split.
While over the same time frame the earnings have meandered their way up from about 43p to 53.6p last year which a fairly dull 2.2% per annum. While the dividend has done a bit better going from 13p to 24.5p or a fairly decent 6.5% per annum, although this did reflect bouncing back from a reduced dividend in 2009 when it was cut from 25p - so you could say no growth from there over 11 years or 12 years as the forecast for to March 2020 is only for 24.6p. If it did get back to say 630p that would equate to 11.75x & a 3.9% yield which doesn’t seem out of the realms of possibility to me. However, I have to say it is a bit disappointing on the earnings and dividend front so maybe the flat price over the piece is not so surprising? It does mean though that it has been de-rated as the earnings and dividends have progressed and the price has trended sideways and obviously the market did see fit to rate it more highly on a couple of occasions along the way.
Summary & Conclusion
So it does look potentially interesting value based on the ratings and my rough sum of the parts for what they are worth, but at least there seems to be a catalyst coming with the asset management de-merger due in March to close some of the undervaluation perhaps? Alternatively the market could continue to ignore it and some holders may be too lazy to do the work and just think oh I’ll ditch it before the de-merger, especially if they are worried about markets etc. Which could even throw up an even better buying opportunity closer to the bottom end of the range in recent years in the low 400’s perhaps? Nevertheless I've decided to take a ride on this Zebra rather than a Unicorn with little in the way of earnings, dividend or assets - but each to their own. As it scored well on the Compound Income Scores it also entered the Compound Income Portfolio after this months screening. See the highlighted links for more details on those.
January proved to be a little less favourable than December as the Corona virus took the shine off of an otherwise positive start to the year. There is an old saying that as January goes so goes the year. So it is therefore a bit disappointing / worrying perhaps that as a result of the virus related concerns most global equity markets provided negative returns in January. The exception to this was the Tech heavy Nasdaq which still managed a further rise as investors and index funds presumably continued to buy in despite the high gains / ratings already seen there - momentum in action I guess.
Compound Income Portfolio
Against a 3.25% negative return for the FTSE All Share Index in January, the Compound Income Scores Portfolio managed a 0.76% positive return for a 4% relative out performance for the month. This is a good way to start the year , but early days yet given the volatile market so far. Since inception nearly five years ago this leave the CI Portfolio up by 104% versus the total return of 32% from the FTSE All Share. You can see the full performance history here if you are interested in that.
The performance this month was helped by the two largest holdings in the portfolio both posting decent gains of 19.4% & 9.3% on the back of positive trading updates. At the other end of the scale there was one painful performer which fell by 24.6% although it was one of the smallest positions in the fund as it had warned last year too.
This one finally exited at this months screening on the back of its deteriorating score along with two other poorer scoring stocks with mixed looking outlooks that had small market caps. These were replaced by two larger stocks, one a reasonable quality play, if a little dull, which is popular with private investors I think, although it had suffered from fears over the virus scare in China. While the other is I think a terrific contrarian value play with an upcoming catalyst. It scores well and trades on around 7x with a near 6% yield which is more than 2x covered. It also has cash on the balance sheet and trades at around book value.
Subscribers can see full details of these trades in their Scores sheet in the transactions tab, but if you are not familiar with the Scores and think you might like to gain access then you can find out more about them for just and how to sign up by clicking here.
Market Timing Indicators
Despite the fall in indices this month these all remained in positive territory with the Mid & Small Cap indices being in a much more bullish trend thanks to the post BREXIT-Election boost. Interestingly the US Manufacturing ISM has also just bounced back above 50 suggesting that there was something of a recovery in sentiment going on post the China trade deal, although this may now ironically be snuffed out by the China virus.
Summary & Conclusion
So a disappointing start to the year which might be worrying given the old saying of "as January goes so goes the year." In any event I guess it may not be too surprising given the euphoria we saw as we came into the year and the complacency that seemed to be around despite the stretched ratings in the US. Aside from that Emerging markets and the UK are generally seen as better value and therefore less exposed, but the threat from the Corona virus and BREXIT may diminish those attractions in the short term I guess. Meanwhile investors continue to chase the likes of Tesla to an ever higher (dare I say ridiculous) rating.
I would assume that neither of those worries will be as bad a feared and as the timing indicators and other economic statistics are still suggesting to stay invested, in the absence of a more serious economic down turn in the US appearing, the CIS Portfolio will remain fully invested as a result bar a little residual cash. Given the value on offer in the UK market that it focuses on I'm comfortable with this & would like to think that the Scores will continue to add value in the months ahead. Good luck with your investing in the months ahead too and mind how you go.