For the past 15 years I have been charged with running the Investors Chronicle’s annual Bargain shares portfolio. The idea behind the portfolio is incredibly simple: to invest in companies where the true worth of the assets is not reflected in the share price, usually for some temporary reason, but where we can reasonably expect that it will be in due course.
It is the very essence of stock-picking, and whatever fans of passive investment might say, it works: our portfolios have beaten the FTSE All-Share index in 13 out of the 15 years in which we have run them, during which time they've generated a compound annual return of 16.4 per cent and have massively outperformed the benchmark index.
For instance, my 2012 portfolio produced a total return of 31.9 per cent on an offer-to-bid basis including dividends, and my 2013 portfolio maintained this impressive track record, producing a total return of 36.4 per cent on the same basis. The stellar performances were largely down to the fact that both portfolios were mostly small-cap based - a segment of the market that benefited greatly from the marked improvement in investor sentiment over the past couple of years. It is also fair to say that over the long run our record has stood the test of time, which has been in no small part down to the performance from the undervalued small-cap shares we have consistently uncovered.
For example, my 2003 Bargain Share Portfolio rocketed by 146 per cent in its first 12 months and, if you held onto the shares, the portfolio then rose in value by a further 50 per cent in the following two years to produce a three-year return of 270 per cent. My 2004 portfolio produced a 17.1 per cent return in its first 12 months and then increased in value by a further 36 per cent in its second year to produce a 24-month return of 59.6 per cent. In recent years, both the 2009 and 2010 portfolios have soared in value, producing 12-monthly gains of 53 per cent and 46 per cent, respectively, and though the 2011 portfolio underperformed that year it has made up all the lost ground since and is now showing a total return of well over 30 per cent.
That’s not to say that the portfolios rise in a straight line. Shares rarely do. So by taking a disciplined approach to investing it is possible to take advantage of short-term price moves where some of the companies in my portfolios have fallen not only below my recommended buy in prices, but well below fair value too.
Accumulate value stocks at favourable prices
This year’s Bargain share portfolio is a case in point as half of the 12 companies I selected are below the opening offer prices in the market when the portfolio was launched on Friday, 7 February.
For instance, shares in Aim-traded clothing companies Camkids (CAMK: 56p) and Naibu (NBU: 63p), both of which I updated in extensive online articles a month ago ('Tasty Chinese takeaways'), 6 June 2014), have proved incredibly volatile. In particular, Camkids is proving a drag on the performance of the portfolio. Sentiment may be poor right now, but on fundamentals the shares remain undervalued and can only rate a buy on a cash-adjusted PE ratio of one and yielding 7.7 per cent. I am not changing my positive stance on either.
Others are only marginally down, like housebuilders Barratt Developments (BDEV: 372p) and Taylor Wimpey (TW.: 113.6p), both of which are performing strongly operationally as recent trading statements highlight. I have little reason to change my positive stance on either companies from my last update (‘Building gains for the future’, 21 May 2014).
It is clear to me that the housing boom in the regions has some way to go as the ripple effect from the London market gathers pace and the combination of rising employment levels, constrained planning decisions, government backed mortgage schemes for home buyers and ultra easy monetary policy are all creating a favourable tailwind for house prices. The London market is a law onto itself, and current prices are rich to say the least, but given both Taylor Wimpey and Barratt sell more property outside the capital then the regions are more important for both in terms of their forward sales.
Indeed, when Taylor Wimpey released a pre-close trading update this week ahead of half-year results on Wednesday, 20 July, the company revealed that the ‘Help to Buy’ equity government loan is proving incredibly popular with its customers, predominately first time buyers. In fact, the scheme accounted for 42 per cent of the company’s 4,755 private home sales in the period at an average selling price of £207,000. Taylor Wimpey is currently working with a further 2,000 households to access the scheme.
It’s hardly a surprise that higher selling prices and a ramp up in completions are driving up margins. That’s good news for profits. In the case of Barratt, analysts at Charles Stanley expect the company to double EPS to 29p in the financial year to end June 2014, rising to 40.5p in the current fiscal year. On this basis, expect dividends of 9.43p and 13.37p, respectively, implying a prospective yield of 3.6 per cent.
Analysts at the broking house predict Taylor Wimpey will lift EPS by over half to 10.2p in calendar 2014, and by a further third to 13.4p next year to underpin a ramp up in the payout from 3.44p in 2014, to 7.55p in 2015. These chunky dividends are very supportive of the investment case. In addition, Barratt is the lowest rated UK-quoted housebuilder on just 1.1 times book value and, although Taylor Wimpey is higher rated on 1.7 times, that valuation looks justified by a higher payout ratio.
In the circumstances, I would be using the derating of both shares since the spring as an opportunity to add to your holdings as I feel the sector bull-run has some way to go.
How Simon Thompson's 2014 Bargain share portfolio has fared
|Company||TIDM||Magazine offer price||Opening offer price on 7 Feb, 2014||Bid price on 7 July 2014||Change on magazine price (%)||Change on opening offer price (%)|
|Naibu Global International||NBU||58||62||63||8.6%||1.6%|
|PV Crystalox Solar||PVCS||19||19.35||17.25||-9.2%||-10.9%|
Note: Latest share prices taken at close of trading on Monday, 7 July 2014
Value play to deliver
Pawn broking may not be for everyone, but I still feel there is money to be made in the shares of Aim-traded pawnbroker H&T (HAT: 179p). Reassuringly, the company has just announced in a pre-close trading update ahead of interim results on Tuesday, 19 August that trading is in line with analysts’ full-year predictions.
Currently, analyst Andrew Watson at brokerage N+1 Singer predicts H&T will report a 6 per cent decline in revenues to £93m this year to produce pre-tax profits of £5.5m and EPS of 11.6p, in advance of a recovery in 2015 when pre-tax profits of £7.1m and EPS of 14.9p are predicted. However, if the gold price continues its recovery - the yellow metal has risen almost 10 per cent since the start of the year - then there is a fair chance these estimates will be exceeded and the recovery I am banking on could take hold sooner than investors expect. Last year, the company reported pre-tax profits of £6.7m and produced EPS of 13.4p, so I am under no illusion that when H&T reports its interim results that profits will be under pressure.
More important are the dynamics driving the business and on this front there is some positive news to report. The debt reduction programme is on course and net borrowings at the end of June were £13.5m, down from £20.7m at the start of 2014 and £28.5m a year ago. This means net debt only equates to 15 per cent of shareholders funds of £88m and H&T is trading well within its £50m four-year credit facility. So with finances strong, there is every reason to expect the dividend to be at least maintained at last year’s level of 4.8p, implying a yield of 2.7 per cent.
The company is also delivering on its promise to boost retail sales. These increased by almost half year-on-year in the first half this year. This is a sensible strategic move given the gold price is down by almost a third from its record high three years ago and H&T’s retail business earns very decent margins. Furthermore, expanding retail sales offers a better avenue for disposing of unclaimed pledges from customers who pawned their valuables. Thirty six of the company’s stores are now trading under a new brand, Discount Secondhand Jewellery, to boost the focus on retail. It’s also worth considering the hidden value in H&T’s balance sheet. That’s because inventories of £20.7m understate the true worth of the assets held as the majority of stocks were accumulated at much lower gold prices.
The planned closure of loss-making stores - H&T has closed four so far this year and opened one to take the estate to 191 stores - and a cost reduction programme make sense too given the overcapacity in the pawnbroking market. That said, H&T’s board notes that there are “early indications of a reduction in competition” as weaker rivals exit the market. In turn, this should offer H&T scope to acquire profitable, but cash strapped pawnbrokers to bolster its own pledge book at rock bottom prices. The company can certainly afford to given its low gearing. At the end of June, H&T’s pledge book was down £10m year-on-year to £38.4m, inline with management’s guidance, but importantly an increase in interest rates charged on pledges helped to offset the profit impact.
Ultimately, H&T shares will re-rate once the early signs of a stabilisation in the market turn into a recovery and investors start to buy into the profit recovery forecast by analysts next year. I can envisage a scenario where this process starts to unfold in the second half of this year which is why I think it is sensible to buy the shares in advance on a chunky 26 per cent discount to H&T's last reported net asset value of 243p. That modest valuation is likely to look overly harsh if indeed this proves to be the bottom of the cycle. Offered in the market at 179p, H&T shares continue to rate a buy.
Record a recovery income play
Benjamin Graham, whose investment style I base my Bargain Share portfolios on, always tried to build a ‘margin of safety’ into the price he was prepared to pay for a slice of a company’s equity. It is something I have tried to replicate over the years.
Windsor-based specialist currency manager Record (REC: 35p) is a good example. The company has an incredibly strong balance sheet with net cash accounting for £27m of net assets of £33m. Net funds are the equivalent of 12p a share, or over a third of the share price. This financial strength means that the board can easily maintain the payment of 1.5p a share in dividends even if cover is tight. Not that this was an issue in the financial year to end March 2014 when both reported revenues and pre-tax profits increased by 7 per cent to £19.9m and £6.5m, respectively, to deliver EPS of 2.48p.
However, a reduction on the fees charged on its dynamic hedging strategies, combined with previously announced mandate losses, means that analysts at Edison Investment Research now anticipate a fall in revenues to £18.4m in the financial year to end March 2015. On this basis, pre-tax profits are likely to decline to £5.4m to produce EPS of 1.9p. But the board still expect to maintain the dividend at this year’s level, so the 4.3 per cent yield remains supportive.
It’s worth noting though that the company has been winning new business as highlighted by a near 50 per cent rise in assets under management equivalent to $51.9bn (£30.3bn) in the latest 12-month trading period. The problem being that the competitive environment and a change in the business mix to lower-margin passive hedging mandates means that margins have come under pressure. US dollar weakness has proved a headwind too as the consensus at the start of this year was for the currency to appreciate as the US central bank tapered in quantitative easing programmes. That should have created more business for Record as a strong dollar acts as an incentive for US clients to hedge off their currency risk. In the event the US dollar index has flatlined this year, and has actually weakened since February, confounding currency experts.
That said there is now the real prospect of a major divergence in monetary policy between the major central banks with the Bank of England and US Federal Reserve pursuing more hawkish policies, in stark contrast to the dovish European Central Bank. This backdrop should contribute to renewed interest from clients in ‘currency for return strategies’.
It is also worth noting that analysts have not factored in any new mandate wins in the aforementioned earnings estimates. That is a very conservative assumption and means that profits could rise sharply back towards last year’s level on only modest new business given the geared impact this will have on the company’s earnings.
Moreover, it’s not as if Record’s shares are expensive. Strip out net cash from the current share price and, based on low-ball earnings estimates for fiscal 2015, the shares are trading on a modest 12 times cash adjusted forward earnings and underpinned by that 4.3 per cent historic dividend yield.
So if you are willing to take a medium-term view as I am, and bet on a US dollar recovery, the risk still looks skewed to the upside. On a bid-offer spread of 33p to 35p, Record shares continue to rate a buy.
Please note I have already updated the investment case of 1pm (OPM: 76p) (‘Award winning growth’, 5 June 2014), and maintain a fair value target price of 80p. Also,Bloomsbury Publishing (BMY: 177p) is scheduled to issue a trading update on Thursday, 10 July and I will update my view following that announcement.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'