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AB Dynamics and the importance of flexibility

Michael Taylor uses the example of AB Dynamics to explain why understanding valuation is an important part of a trader’s armoury
September 17, 2020

AB Dynamics (ABDP) is one of my favourite shares. Not because I have multibagged the stock profusely (I haven’t) but because it is one of those stocks that seems to continuously offer excellent risk/reward opportunities both long and short.

It is a suitably boring business that tests cars. Vehicle suspension and brakes, as well as safety system evaluation are all a part of the AB Dynamics business model, and it works with many car manufacturers. Peter Lynch commented in one of his books that boring stocks in boring industries are sometimes the most exciting stocks an investor can own. This is because they can be consistent and because they are so boring they are often ignored.

This is partly why exciting technology and junior oil & gas and resource stocks typically tend to attract a lot of private investor attention. However, as we saw with Sylvania Platinum (SLP) last week, being able to think long-term can be a source of competitive advantage. Many people think of a trader as someone who buys and sells constantly. And whilst that is true in many cases and indeed my own, I do hold companies for swing trades which can be for weeks or months.

One thing I have noticed is that those who call themselves investors have bought and sold stock in a company that I have been holding for a trade. Of course, everyone is entitled to change their opinion or to sell out if they find a better place to work their capital. But being a trader does not necessarily mean one is only focused on short-term profits. Some of my best trades have come from holds of several months.

AB listed at 88p in 2013 (according to SharePad) and touched 2,850p at the end of last year. It is unlikely many of those who were involved in the IPO were still holding (investors churn their portfolios an awful lot these days due to social media and noise) but that is a fantastic return. Hitting a thirty-bagger can certainly change your portfolio for the better.

Looking at Chart 1, I’ve marked an arrow where the stock gapped up and continued going. This was on the announcement of the company’s half-year report. I had been wondering whether AB Dynamics was becoming expensive as it had an incredibly lofty PE ratio at the time. But PE ratio only tells us the multiple the market is prepared to pay for a company’s earnings. It doesn’t give us any inclination of whether those earnings or not are worth paying for. For example, paying 20x earnings for a company that is only growing 10 percent a year may seem like one is overpaying. This is would hypothetically be the case all things being equal. But what if the company is projected to grow earnings per share 50 percent a year for the next three years?

This is why valuation is complex and why I favour the chart to tell me what to do. Plus, it’s a lot easier. Why sift through pages and pages of notes from an analyst who will dilute his or her message to protect his or her job and keep favour with the right people, when you can load up a price chart and see what the market is telling you? I don’t wish to sound completely dismissive of analysts as many of them are much cleverer than I am but it is important to highlight the pitfalls of research.

To come back to the company’s half-year report, the company reported that its profit before tax (excluding share option costs) increased by 95 percent to £6.4m. The company’s PE ratio at the time was around 40, and so it was clear that the company was growing far faster than the market was paying for its earnings multiple. Looking at the chart, we can see the share price re-rating from the opening bell and it continued over the following weeks. Management also took advantage of strong market demand to conduct a placing to raise capital and further the company’s growth.

I am a technical trader at heart. But being aware of what the market values a company at and what the current earnings are can sometimes be a great catalyst for a re-rating. A trader should use all the arrows in one’s quiver – I have never understood those who are vehemently in support of one particular method. My goal is a trader is to make money. And if something works – no matter how illogical or silly it may sound – I will do it. My own trading data shows that January is often a strong month for me. For that reason, I ask my wife if we can not go away in January unless I can trade the morning sessions.

Moving across to Chart 2 we can see that the stock has been consolidating in a range for several months. It has put in higher lows which indicates that buyers are slowly working through sells and picking up the loose stock. We can see a shallow cup and handle forming, and the stock is closing in on a breakout of the red resistance line that I’ve drawn on the chart. I hold a small position in AB Dynamics as I want to keep a close eye on it, and I will add to this position if the stock can break out of the range. I will put my stop under the recent low of 1,800p. If I am wrong, then I wish to be wrong quickly. There is not much point in holding onto a loser, no matter the company’s valuation or prospects.

 

  • Michael has released his UK Online Stock Trading Course sharing his knowledge and how he trades the stock market. Investors Chronicle readers can take advantage of an introductory offer (ending September) by visiting www.shiftingshares.com/online-stock-trading-course
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