December proved to be a positive month for the UK market as a “Santa Rally” finally arrived despite the on going concerns in the UK & elsewhere about the spread of the new variant of the Corona virus. It seems that although it has spread rapidly & become the dominant variant it doesn’t, as I hoped, seem to be as severe in terms of the illness that it causes. While some existing vaccine booster shots seem to reduce the risks of hospitalization further and new pills for treatment are either imminent or on the horizon. Thus it seems it was right, in the short term, not to panic last month.
As we entered the New Year traders seemed to be bidding up travel and leisure stocks which seems to indicate that the general consensus is thinking along those lines on Covid. Hopefully we might be through the worst of the latest bout by Spring / Summer without too many more restrictions and learn to live with it longer term thereafter. What follows is a review of the performance for the year & over the longer term for the Compound Income Portfolio and a few outlook comments.
If you are pushed for time you can skip the the Summary and Conclusion which tries to sum it all up briefly.
The UK market as measured by the FTSE All Share index (which I use as a benchmark) produced a total return of +4.68% in December and +18.32% for the year. The Compound Income Portfolio underperformed this month with a 3.66% return but did still have a terrific outcome for the year of +29.9%. I calculated the returns that could have been had from just holding the same portfolio from the end of last year and also one selected from the Top Scoring Stocks alone. Both of these returned around 20% for the year, so still a modest outperformance, but it does suggest that this year at least, the process of monthly screening have added value – which is what I have found in the past too So I’ll stick with that again for the year ahead.
Big winners during the year included Ashtead (AHT), Airtel Africa (AAF) and IMI which have all grown to become top 10 holdings. While Renew Holdings (RNWH) which enjoyed a re-rating and Ultra Electronics (ULE) which received a bid were also big contributors although they have since exited the portfolio. Another former position that did well was Dotdigital (DOTD) which I managed to run quite successfully by relaxing my normal value tendencies to sell on valuation ground until such time as the rating and growth rating did not marry up for me. While a risk control reduction of Sylvania Platinum (SLP) at 130p also helped as they subsequently slumped to under 100p.
Talking of slumping, spread betting company CMC (CMCX) disappointed as lockdowns lifted and subsequently sold. I regretted selling Ultra Electronics early in the bid timetable to buy Qinetiq (QQ.) as they came up with some disappointing contract news and Hikma Pharmaceutical (HIK) proved to be worthy but dull and therefore drifted off despite performing reasonably well as a business. Finally some exposure to other precious metals miners like Polymetal (POLY) and Caledonia Mining (CMCL) & the more diversified Rio Tinto (RIO) failed to pay off in price terms but they did pay good dividends which they continued to pay and increase.
Dividend / Income Commentary
Here it was encouraging to see that the income from the portfolio bounce back strongly this year after the Covid inspired cuts seen last year. The income from the portfolio increased by 125% from the 2020 figure which had fallen by 31%. This meant it was up by around 56% from the level of income achieved in 2019 & 2018 pre Covid. This represented a yield of 5.1% on the starting value of the Portfolio – so a bit better than the suggested income yield of 4.5% which expected from the Portfolio at the start of 2021. Obviously it does reflect some changes to stock positions along the way as I’m not comparing a static portfolio and there were also a few large special dividends included in that which will have boosted the total. So I wouldn’t be surprised if the headline total were to decline a little next year if some of those are not repeated.
On these dividends, it is worth pointing out that I don’t target a particular yield from the portfolio. It tends to be a residual result from the stocks selected from the top decile and held along the way, although obviously the process does direct me towards dividend paying stocks and no zero yielders are held. That’s just the way the process is managed, although others may wish to target a certain level of income or yield and try to increase that each year. Personally I do like to see my income rising each year and try to keep it up with or ahead of inflation in the medium term, which I have managed to do generally over the years.
It is worth noting that the RPI Index has grown at 3% per annum since 1989. So assuming the Government / Bank of England are not trying to inflate away all the debt that has been taken on before and during the pandemic then it might be worth factoring in inflation of at least 2.5% to 3% to your run rate calculations for real returns. It is also worth remembering that UK equities have generally returned around 5% per annum in real terms (after inflation) - so you would probably need a total return of around 7.5% to 8% to maintain the real value of your portfolio in the long term.
Fortunately that was not so difficult this year as dividends bounced back strongly as inflation came roaring back & the market was strong in capital terms. The coming year may be more difficult if inflation remains elevated and various cost pressures such as energy, labour and supply chain issues cause Companies to be more cautious on the dividend front.
Longer Term Performance – 5 years in a row and 6 out of 7 years of outperformance.
The performance for the year and the last two, three and five years and since inception back in April 2015 is shown in the Bar Chart at the start of this post above, which are more meaningful periods of time to look at rather than one month or year to date figures. It is also pleasing to note that the portfolio has now outperformed for five years in a row (a pretty rare event in itself) & six out of seven years since inception in April 2015 so that one wasn’t a full year. This line graph at the top also shows that this and that the portfolio has now almost made it back to almost to an all time high value it reached this summer and significantly outperformed all the main UK Indices. While the table below shows most of that in numbers form.
The table above shows performance year by year has been somewhat volatile, with good years for harvesting returns followed by fallow drought type years for returns. So with that in mind, given the strong returns that the Portfolio and the market have delivered recently I can’t help thinking, along with most commentators probably, that 2022 may be a more difficult year for investors than 2021 was. This is especially so given that Central Banks seem to have started tightening and draining liquidity. While investors have gone all in with US individual investor stock holdings at record highs and the inflows into US equities in the last 12 months having matched those seen in total in the previous 19 years! (Source:Merrill Lynch). Breadth has also been poor with the FAANG stocks mostly driving the headline indices, where the ratings look to be towards the top end of their range seen at previous frothy occasions like 1999 / 2000. While margin debt over there is close to all time highs, although has come of a little recently, which can apparently also be a bearish signal.
Thus I think you couldn’t rule out a rougher ride for the market in the first half with a possible normal type correction if rising rates, slowing economic growth, Corona virus issues and continued inflation hit sentiment. Aside from that the economic indicators that I follow for flagging a recession and a more serious setback in economies & markets are all in positive territory, as are the market timing indicators that I compile. So while I might be a bit more cautious short term, beyond that I think we should be OK provided the Central Banks don’t lose control & have to overdo the tightening. In the absence of that they will probably come back in yet again if things do cut up rough.
Having said that though looking at the Portfolio valuation it shows that at the end of the year it had a weighted average one year forward PE of 14.4x which is around the long term average for the market I would say. While on the yield front the forecast yield for the portfolio for the year ahead is 3.8% with forecast dividend growth of 9.5%. This suggests that hopefully I’m being too pessimistic about the outlook as in the absence of a re-rating either way the portfolio could return around 13% which is not far off the 15.2% per annum achieved since inception in April 2015. Given that the UK market overall continues to look reasonable value compared to some other international market, maybe the UK could buck the trend even if things turn out less favourable elsewhere, but as ever I guess time will tell on that.
Summary & Conclusion
So a better month for markets and although this month the Compound Income portfolio didn’t manage to outperform, it did achieve another year of outperformance against the FTSE All Share. This make it 5 years in a row now that it has outperformed and 6 out of 7 years since inception. Compounded annual total returns since then have been 15.2% versus the 5.7% from the broader market.
Income from the portfolio bounced back well to more than double from the Covid induced cuts last year and represented a 5%+ yield on the portfolio value at the start of the year versus the 4.5% that was expected. This did include a number of special dividends which may not be repeated next year and it is most unlikely that the income will double again in 2022, indeed it could drop back a little if there are fewer specials and as I do not specifically target a level of income when constructing the portfolio.
The outlook for the market looks a bit less auspicious this year, especially in the US perhaps. There private investor seem to have gone all in at a time when valuations look stretched and the market has been led by a few big tech giants. While headwinds abound in the shape of the US Federal reserve aiming to raise rates and drain liquidity to deal with high and rising inflation as the economy maybe slowing a little from its rapid Covid induced bounce back.
While in the UK the authorities and the markets face similar issues in terms of inflation and rising interest rates. While the UK market looks more reasonably valued, having lagged the US and other markets for the last few years and private investors seem less enthused. Being heavily exposed to more commodity type sectors like oil and miners may also help the UK market to perform better if commodities continue to be strong in the inflationary environment. Of course though, an economic slow down and any restrictive measures from the Chinese government could of course undermine that view with a likely dampening effect on commodity prices.
Having said all that the Compound Income Portfolio looks reasonably well placed to weather some volatility if we see it this year. As the PE is around the long term average for the market at 14x and the dividend yield close to 4% based on high single digits suggests it might be able to deliver returns close to its longer term average of around 15% per annum in the absence of any dramatic change in ratings. Thanks for your attention and persistence if you got this far or just skipped to this bit and may I wish you good luck with your investments in the year ahead no matter what markets and the Covid virus throw at us.
Compound Income Scores Portfolio Performance
Further to the Mid Month Update - some masterly inactivity proved to be profitable again in August as the Compound Income Scores Portfolio outperformed again. This month it was by a more modest 0.72% versus the FTSE All Share Index which I use as a benchmark to measure the the performance against. This continues a run of monthly out performance since last November - so nine months in a row. So it is good to see the Portfolio delivering a scorching performance & plenty of blue even if summer in the UK has rather disappointing visage and tended to Fade to Grey.
Of the top contributors two of the three that were mentioned in the last post on here namely: Strix Group (KETL) and Paypoint (PAY). While Luceco (LUCE) the LED lighting and electrical accessories provider continued its strong run and re-rating on the back of their strong operating performance and financial targets.
On the downside the three largest detractors included a couple of mining stocks Sylvania Platinum (SLP) and Rio Tinto (RIO) on the back of mixed results in the case of the former and weaker metals prices which hit sentiment & triggered profit taking on both of them. While Jarvis Securities (JIM) also suffered some price weakness after going XD two dividends totalling 12p in late July & during August & probably saw some profit taking after a very strong share price response to their recent trading update.
In terms of activity, looking back it is pleasing to note that the reduction to SLP at 131p on risk control grounds given the size the position had got to back in June worked well given it is now trading at just under 100p. This is especially so when one of the trades at that time included the initial purchase of LUCE at 344p vs the current 480p.
Looking at the longer term, aside from the recent monthly run of out performance it is good to see a sea of blue in the returns bar chart shown towards the top of the page, but that's a bull market for you as a rising tide generally lifts all boats. Nevertheless it is encouraging as an indicator of the power of the Scores to help with selecting decent income growth stocks. As evidenced by the fact that assuming the portfolio doesn't have a massive under performance in the next four months, then it should have outperformed the FTSE All Share for five years running too. While since inception in April 2015 it has compounded at 16.4% per annum versus the 5.5% from the Index over the same time period.
Finally on this I came across this graph which I think is quite useful in putting the above performance in context and probably helps to explain why the portfolio struggled from March to November last year during the inflection point / recovery phase, but has done better as we have moved into the expansion phase & they seem to have done OK in the other phases too.
This month I continued to await results on three stocks with second quintile scores - EMIS (mentioned last month), Renew Holdings (RNWH ) & Sureserve (SUR) whose scores this month had also drifted down on no news but have results shortly. I also exercised some judgement on one stock Paypoint (PAY) which again featured in the Scoring zone where I consider its position in the portfolio.
Having given it the benefit of the doubt last month this had paid off as detailed in the Mid Month Update post thanks to the OFGEM situation and the subsequent multiple director purchases which led to a strong share price performance last month. Thus it was a closer call as they have re-rated more towards the sort of initial rating and levels that I outline when I presented it in the Stockslam back in May this year. If that event looks like something you'd be interested in there is another one due next week which you can sign up for here but I am not be presenting in this one.
Thus it was a closer call as to whether to retain it this month after such a strong run had left the shares which had gone XD another 8.3p dividend too, looking overbought and vulnerable to some mean reversion potentially in the month ahead. On balance though I decided to keep given the directors buying & the proximity to the end of their latest interim period at the end of September. They do not normally put out an update on that but I'm gambling that given the directors buying, re-opening benefits and the pick up in card based transactions & imminent energy price hikes might force them to put out a positive trading update if they are trading more than 10% ahead of expectations. Technically they also seemed to have broken out of a tight range which could also target higher levels around 750p - 780p and previous rally highs in that range. So we will have to wait and see if that was some more masterly inactivity or if I have pushed my luck too far and get whacked by mean reversion & no positive update being forthcoming.
I did however break my run of masterly inactivity when I decided to lock in profits on the Ultra Electronics (ULE) bid situation which is not due to complete until Q1 2022. Now while there is still a fairly attractive return of around 9% or so available assuming the bid goes through at £35, there is also a small risk that it could be referred on national interest grounds etc. In that case I'd think the price could sink back towards £20 so the risk reward didn't look that favourable even if the risk is low. So on balance I took profits and reinvested in a similar space as Qinetiq (QQ.) made a return to the portfolio ahead of their September period end.
Summary & Conclusion.
So another positive month, helped by last months inactivity and some trades from earlier in the year & despite the summer doldrums in markets & on going concerns about inflation and the likely actions of the US Federal Reserve. This continues the run since last November and the vaccine led expansion phase in the economy which has suited the Scores more than the recovery phase from the initial inflection point from all the Central bank & government support.
As a result the Portfolio is, barring a disaster in the next few months closing in on five straight years of out performance, which in the investing world is quite rare I believe. Any way if you'd like to access the Scores to help you with your stock selection then don't forget you can sign up via in the menu section titled Scores. If that's of any interest you'll be able to subscribe for a years access for the equivalent of just £1 a week - about the price of a single cup of coffee in McDonald's these days!
There is also a short presentation about them in the sub menu of the Scores section there too, as well as the new feature for Subscribers to view the Scores in google sheets directly from the site if they wish. If any Dropbox subscribers would like to be able to access the Scores directly from the site like this then please get in touch via e-mail or the contact box on the site and I'll sort that for you.
Any way that's all for now thanks for reading if you got this far and here's to hoping the promised Indian summer this weekend last more than a few days here in the UK.