Compound Income Scores Portfolio Performance
October didn’t turn out to be such a dangerous or spooky month as it has done in the past or as Mark Twain once joked. The FTSE All share produced a total return of +1.8%, while the Compound Income Portfolio saw a return to outperformance this month with a total return of +2.4%. This leaves the portfolio with a total return of +27.3% in the year to date which is some 11.7% ahead of the FTSE All Share which I use as a benchmark.
Meanwhile the longer term performance of the Compound Income Scores Portfolio compared to the index is shown in the bar chart graph above. It is pleasing to note that the portfolio has compounded at just over 15% per annum since inception just over 6 years ago, which is also around 10% ahead of the FTSE All Share. See the graph at the end of this post for comparisons with other UK Indices like the FTSE Mid 250 and FTSE Small Cap.
Top contributors to this months outperformance were Luceco (LUCE) & Sylvania Platinum (SLP) as they bounced back from particularly steep falls recently having announced Quarterly updates which seemingly reassured investors. The negative side of the attribution ledger was headed by Qinetiq (QQ.) as their updated disappointed on the back of Geo-political and short term supply chain issues which led to some small downgrades. Admiral (ADM) also tacked backwards for the portfolio this month for no apparent reason other than perhaps the fact that Munich Re placed around 12 million shares from their strategic stake at 2940p. While City Of London Investment Group (CLIG) featured on the negative side this month as the former founder Barry Olliff reduced his stake again at the 550p level and the earnings estimates continued their inexplicable yo-yo run with downgrades this month after last months upgrades. Seemingly one house may be marking to market and currency adjusting on a month by month basis maybe?
British American Tobacco (BATS), EMIS, & Paypoint (PAY) all featured again this month together with Renew Holdings (RNWH) as holdings with scores in the second quartile & as part of the process I therefore consider whether they should remain in the portfolio or if there might be better quality or cheaper alternatives available. Of these I decide to give BATS and EMIS the benefit of the doubt again as their scores were still not that far into the second quartile. BATS remains cheap as they continue to manage the decline of tobacco products and invest in new vaping products & the NHS even approved the use of their Vaping Products recently to help those trying to quit smoking, so that could be a drag on as well as a puff to BATS profits I guess. While EMIS continues to trade well as reported in the results recently and they are confident of hitting their full year targets. So I’ll continue to run that one for now as a quality compounder for even though the rating has got a bit richer, although it and BATS did both underperform last month.
As Paypoint came up yet again I decided to get back to following the process as their score remained anchored around 50, although I was sorely tempted to to hold it again ahead of the H1 results in November. These could still be good and lead to upgrades for the full year – or not as the case may be. So I wouldn’t put you off holding them if you want to. That’s just the way the process is supposed to be applied – so I’m getting back to that and locking in a total return of around 20% from Paypoint since it was purchased for the Portfolio in May this year. Indeed Selling Strix (KETL) on a similar basis last month worked out fortuitously as the shares subsequently fell on the back of some chunky directors sales.
Renew Holdings (RNWH) looked a more finely balanced call as their Score was 67 and they also have results due shortly after a recent positive update, although somewhat surprisingly this has led to some downgrades in the last month. While it seems OK and the results should be fine, I decided to sell this one too given it has re-rated to a fairer looking rating. I also have some concerns about their balance sheet and the way in which they finance their business plus the fact that they are quite acquisitive and seem to have had quite a few write off's subsequently along the way in the past. I could of course be too cautious there, so again feel free to carry on holding if you are so minded to do so.
In addition to the two natural sale candidates which I pushed the button on this month, since I have a lot of performance in the bank this year, I also decided to sell a couple of other higher scoring stocks too. The rationale here being that it was possible to switch into higher Scoring similar alternatives which looked better value.
One was City of London Investment Group (CLIG) mentioned earlier in the performance review. This has been a good performer for the portfolio and again I wouldn’t put you off continuing to hold it. I chose however to switch into one of their larger competitors which has also undertaken an acquisition and is also struggling to grow its assets. It is however trading slightly cheaper than CLIG on traditional value measures and around half their level in terms of its pricing to AUM, although the difference in profitability levels they are currently making may explain some of this.
The second relative value switch I undertook was by selling dot Digital (DOTD) which has been a big winner for the portfolio and nearly trebled since it was acquired in April last year. Now I know this goes against all the advice of running your winners, although that is what I had done already by relaxing my usual valuation biases to get to this position. My natural value tendencies just felt offended with this one on around 60x PE, with an earnings yield of less than 2% and a dividend yield of under 0.5%. They also have results due which should be good given their last update, but unless there are dramatic upgrades on the back of those I think the shares could be vulnerable like other highly rated stocks that have come under pressure recently given rising interest rates on the back of higher inflation. Or failing that going sideways for a while to grow into the rating perhaps.
The stock I switched into, while still a bit rich for my own personal value tendencies, looks to be better value than DOTD after a recent positive update and massive upgrades ahead of their own results due soon too. So I guess time will tell if any of these prove to worthwhile. Subscribers will have seen full details of these in the transactions and the stocks that were purchased against them in the transactions and portfolio sections of their sheets along with brief bullet explanations in the Journal section.
Summary & Conclusion
After a disappointing end to the summer in the UK last month we have had a better start to the Autumn in markets and also for the Compound Income Scores Portfolio as we approach a traditionally stronger seasonal period.
I don’t have a lot to add to last months Macro type comments about the inflation outlook as that seems to remain a feature despite the slight fall back in the head line rate in the UK last month. Consequently some eyes are on Central Banks to see what the say and do with regards to easing back on QE or even raising rates perhaps in the case of the Bank of England. While the budget passed by without any further hits to investors.
I say some eyes as markets seem to have remained frothy (especially in the US) as they have rallied again towards their highs and some speculative rubbish and SPAC’s seem to be taking the lead again despite stretched valuations over there. I guess all we can do in poor old Blighty is be thankful that our market looks better value as it has been so far off the pace that it looks quite cheap and has big exposure to the non ESG sectors like oils and miners plus a fair share of Banks that it might just hold up better in a sell off if we’re lucky.
Any way as this is already over a thousand word post I’ll leave you there with the graph of the longer term performance that I promised at the beginning as a picture paints a thousand words and a couple of music videos. Otherwise may I wish you good returns from your investments this month and hope that it doesn’t rain too much in November wherever you are.
Compound Income Scores Portfolio Performance
So the brief spell of Summer like weather gave way to a more soggy end to the month and so it proved in the Stock market too. The FTSE All share after a strong start in line with the weather sold off mid month before recovering somewhat toward the end and returned -1% for the month as a result. This relapse in the market came as there were some concerns about a Chinese property developer going bust and that being a Lehman type moment for the Chinese economy. The authorities there seem to have that under control though, but on going inflation worries and supply constraints in certain areas also weighed on sentiment more generally.
Meanwhile the long run of outperformance by the Compound Income Scores Portfolio since last November finally came to an end in a very disappointing fashion as it returned – 5.9% on the month. The Portfolio has outperformed by over 10% in the year to date with a total return of 24.4% and it has compounded at just over 15% per annum since inception just over 6 years ago.
It is therefore perhaps not too surprising, given the strong run it had prior to this, that some underperformance at some point was probably inevitable. In addition the FTSE 100 held up better than the Mid and Small cap parts of the market where the portfolio has been and remains overweight. That’s just the nature of this investing game and you have to take the rough with the smooth as I always say and not get carried away when things are going well and equally not get panicky or depressed when you have a bad run. As long as you have confidence in your process and are prepared to accept some volatility in your capital in the short term for potential gains in the longer term, which is after all what investing is all about.
There were quite a few contributors to the poor performance this month with 6 stocks underperforming by more than 10% on either fundamental news flow or profit taking in the main. The two worst examples were CMC Markets (CMCX) which fell by around 30% on the back of a poor trading update / profits warning as markets became calmer over the summer and they saw some relapse from the extra trading they had seen in the previous quarters and last year when the pandemic was in full swing.
The other big faller to a similar extent was Luceco (LUCE) which succumbed to a heavy bout of profit taking as their excellent results didn’t lead to any further upgrading of forecasts. This profit taking was probably also prompted by their honesty in admitting that they had seen an extra boost from Covid trading and highlighting cost pressures, although they have been able to deal with those thus far. Their Score fell back to the lower end of the top quartile as they did see a few small downgrades on the month but it stays in the portfolio on that basis and it now also looks better value on a mid teens PE with a well covered 2.5% or so yield.
On the positive side of things there were not too many, but S & U (SUS) put in a good performance after their trading update which led to upgrades which I covered in the mid month update post. While City Of London Investment Group (CLIG) responded well to their full year results reported in mid month which led to some upgrades. While the 10% increase in the dividend for the year was also presumably well received given the dividend background surrounding the pandemic.
British American Tobacco (BATS), EMIS, Strix Group (KETL) & Paypoint (PAY) all featured as holdings with scores in the second quartile this month & as part of the process I therefore consider whether they should remain in the portfolio or if there might be better cheaper alternatives available. Of these I decide to give BATS and EMIS the benefit of the doubt as their scores were not that far into the second quartile. BATS remains cheap as they continue to manage the decline of tobacco products and invest in new vaping products.
While EMIS continues to trade well as reported in the results recently and they are confident of hitting their full year targets. So I’ll continue to run that one as a quality compounder for now although the rating has got a bit richer. I also decided to keep Paypoint again as they enter their close period ahead of the H1 results in November. A further director purchase by the General Council and Head of Compliance just before that helped to sway my decision, while the coming energy price hikes should help to boost their declining bills paying business.
I did however decide to let Strix Group (KETL) go as a bit like Luceco, even though they did report good results they also struck a note of caution on current market conditions and saw a few small downgrades. In addition the rating was not that cheap on still over 21x PE and with a Score of less than 50. Nevertheless it does appear to be a good quality business with a well protected dominant market position, so I wouldn’t put you off holding it for the long term. That’s just the way the Scores process works and it also felt like the time to rotate into some better value given the inflation / interest rate outlook. With the proceeds from this sale and some cash which had accumulated from dividends over the summer I was able to add a couple of better value situations.
One was a housebuilder, despite my own personal reservations about the timing of this, but as several had appeared towards the top of the list I decided to follow the Scores even if they may be a bit rear view mirror in this case. Housebuilders will probably never be highly rated given their cyclicity, but they currently look fairly cheap within their usual 7 to 10x PE rating ranges. This probably reflects concerns about over heating post the ending of the stamp duty holiday, affordability, plus labour costs and materials pricing and availability. Against that interest rates remaining low (for now) and the on going supply demand dynamics continue to offer support. So again I’d leave you to decide if this is a sector you want to participate in. There was also a good Podcast from Money Week which featured an interview with Gary Cannon of Phoenix Asset Management, who had some interesting comments on the builders and remains a bull of the sector.
The other value stock I added, was even cheaper than the housebuilders and subscribers will have seen the details of this in their Scores sheet. In addition to this I also decided to sell CMC Markets (CMCX) on the back of their profits warning (even though it did not score outside the top quartile) and switch into the similar IG Group (IGG) where I prefer the business model and it scores more highly than CMC having had a positive update last month in contrast to CMC.
Summary & Conclusion
After a disappointing end to the summer in the UK we also had a disappointing start to the Autumn in markets and also for the Compound Income Scores Portfolio. This relapse in the market came as there were some concerns about a Chinese property developer going bust and that being a Lehman type moment for the Chinese economy. On going inflation worries and supply constraints in certain areas also weighed on sentiment more generally.
There seem to be concerns that this will retard the on going economic recovery and some of these pressure like supply shortages, commodity price increases and shortages of labour seem likely to put pressure on corporate margins which may well cause the market to continue to struggle in the short term until this picture becomes clearer. Some suggest that this could presage another leg of outperformance for value stocks in the short term if rates rise (or bonds sell off) on the back of higher inflation as hinted at by the US Federal Reserve.
With that in mind I used this months Screening to add a couple of more value orientated shares to the portfolio after taking profits in the more quality growth situation, Strix Group – which had enjoyed a re-rating during its time in the portfolio. While in the UK more widely, the market, for once, seems better placed with its bigger exposure to energy and commodity sectors.
While the UK economy seems to be suffering badly from the after effects of the Pandemic, the resultant supply shortages and the squeeze on energy prices. As a result stagflation fears have stirred given the hit to incomes and coming benefit cuts and tax rises. As a result some fear we might face a Winter of discontent much like the 1970’s which saw three day weeks and power cuts which I remember from my childhood. Despite this politicians have insisted there are no fuel shortages, that Christmas will be fine and that we won’t see power cuts even though some industry representatives claim otherwise.
Given that and the inflation outlook, bonds remain a no go area for me and so personally I continue to rely on a mix of equities and other real & alternative assets to try and maintain and grow my capital and income in real terms. I would highly recommend reading the recent final results from Ruffer Investment Company in this regard and particularly the Investment Managers comments starting on page 19.
After a recent visit to Thatcher’s farm to see their Cider production facilities, it put me in mind of Mrs Thatcher’s comment from the last time we had stagflation & as Maggie May have said "There is no alternative" in terms of sticking with equities. They are simply the best way for me, although I saw that Tina Turner has decided to cash in her royalties which may be the best way for her at her at the age of 81, although I do have a few Hipgnosis Songs Fund (SONG) as part of my alternative assets exposure.
Any way that’s all for now as I must get off down to the shops and get some candles, a frozen turkey before they sell out or go up in price. I’ll leave you with some music appropriate to the above comments.
Not much news around today, but a good US blogger called Eddy Elfenbein, who I follow on twitter and at his website crossingwallstreet.com, reminded me this morning that it was 28 years ago today that we had the Black Monday of the 1987 crash. Now hopefully we won't have another Monday like that today, although we do have the dreaded US import of the Black Friday shopping event to get through soon I believe.
Talking of the 1987 crash and US imports its funny how your brain works when you start thinking and reminiscing down Memory Lane. That got me thinking for some reason about another US import from that time - a TV show called Miami Vice which you can check out in more detail here if you are not familiar with it and enjoy the opening credits below to liven up a dull Monday.
My mind then went off at another tangent and got onto vice and and thinking about vice stocks after most of the favourites won in the Rugby World Cup over the weekend, which is probably good for the bookies. As an aside I had thought that Ireland might beat the Pumas and that Scotland would get thrashed but it turned out to be the opposite with Scotland so unlucky to lose out in the end. So probably good for the bookies and checking them out it looks to me like William Hill (WMH) might be interesting down here on a technical basis looking at the chart below.
It trades on 13 to 14x with a yield of around 3.7% including a 4.1p interim worth 1.2% which goes xd this week. It scores OK with a CIS of 65 and a Stockopedia rank of 78 so not too bad as the bookies tend to win in the long run. So...
...talking of vice stocks I personally don't mind investing in those, although some prefer not to and there are ethical funds available which screen out those type of stocks - armaments, drink, gambling & tobacco. With that in mind how have a collection of UK Vice stocks done in recent years? Well to find out I pulled together a quick chart to see how William Hill, Greene King (GNK), BA Ssytems (BA.) and BAT Industries (BATS) have done against the FTSE All Share over the last five years. As you can see on the chart, which shows percentage change over that period, they have all out performed the index and would also have had higher yields to boost returns further, with William Hill winning by several lengths.
So there you go if you don't mind investing unethically or in vice as it were then it seem it could be profitable for you. While in another strange mind tangent having coined the phrase UK Vice above I did a quick search and found that apparently there is a site / Company along those lines called Vice which describes itself as specializing in exploring uncomfortable truths and going to places we don't belong. Herein you will find people talking frankly about their hatred and love for various things, general heresy, the only culture, travel and news documentaries you'll want to watch, tons of exclusive new stuff, and probably not a lot of cats. So not sure I would recommend it but check it out if you dare and it has an accompanying twitter feed @VICEUK - so you really do learn something everyday by taking a mind detour down memory lane and here's an appropriate old song for the topic today.
..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.
BATS reported a good performance in what they describe as a difficult environment in the 9 month stage to 30 September.
This was due to continuing pressure on consumer disposable income worldwide and the slow economic recovery in Western Europe.In addition in common with other international businesses they also saw a negative effect from currencies
with movements in many of the Group's key trading currencies resulting in a 9.6% decline in reported revenue. Despite this they say "the Group continues to perform well and we are on track to deliver another year of good earnings growth at constant rates of exchange."
The shares are off a bit first thing as defensive stocks struggle a bit in a recovering market and the update was fairly drab. In addition they don't look especially cheap trading on around 15x to 16x earnings but as ever the main attraction remains the 4%+ yield which continues to grow steadily.
Computacenter (CCC) - the dyslexic computer services company also reported a fairly dull IMS in which they confirmed they are trading in line with their expectations for the year. Again currencies had an effect turning a flat revenue performance into a small fall. Otherwise the UK was good, Germany showing some signs of recovery and France just about through the worst. With cash on the balance sheet, a fairly positive outlook from the company and some prospects for improvements in operational performance in Europe it seems worth sticking with on a P/E of 12 to 13x and a likely well covered 3%+ yield.
Meanwhile if you are looking for excitement we have had a positive trading update from Plus500 (PLUS) today. This highly volatile Israeli tech stock which provides an online trading platform suggested that after a strong Q3 plus their own recent initiatives and with the recent increases in market volatility that they will see full year revenues and profits ahead of current forecasts. It looks like this could lead to them being about 10% or so ahead of the current 80 cents so say 90 cents maybe as the market has marked the share up by around that amount this morning.
This would still leave it on around 9 to 10x with a yield of around 4.5% in sterling post the Israeli withholding tax. This yield is about in line with the more stable and longer established competitor IG Group, although they do trade on a higher P/E of 14 to 15x. Given this and the fact that PLUS shares were trading much higher than this earlier in the year I guess there could be scope for some further upside if investors are reassured / excited by these numbers and choose to re-rate the shares further, but if you choose to buy / hold / trade them be prepared for a volatile ride as shown by the chart below.
Note they have a conference call and webcast at 10am today (see RNS for details) - so might be worth listening to that if you are interested in this one and I guess it could also move the shares depending how it is received.