Some stock screens

It's coming up to ISA seasons so I've been looking for new ideas.  I typically use stock screens to help me whittle down the approximately 10,000 investable companies out there.  Here's a few of my favourites:

Dividend Screen
P/E less than 10x
EV/EBITA less than 8x
Divi Yield more than 8%
Sorted by insider buying

Quality Screen
10 year average RoE more than 10%
3 year average RoE more than 8%
P/Tan. Book less than 1.4x
5 year growth at least 0%
Sorted by insider buying

Interesting how many Hong Kong and Singapore names are in these lists, and how few US names.  This chimes with what anecdotally I've been seeing for a while.  Some ideas to followup on at least.

Current market valuations

I try to avoid thinking too hard about market valuations as I firmly believe you can make good money by simply judging what you see in front of you.  There is no reason for me to care that Vodafone looks overvalued if the company’s I’m looking at appears attractive.  However, even the most undervalued portfolio will show a degree of correlation with the market as a whole, so I think you should always be aware of how attractive current markets are and how they are likely to do over an extended period – say 10 years - as there is little to prevent your own portfolio becoming even more undervalued. 

Which is why the following charts worry me.  Below is the Cyclically Adjusted Price to earnings (CAPE) for the US.  It shows that current valuations are around 50% higher than their long-term average of 15. 

 Another way of looking at the same problems is using Tobin's Q.  This compares the replacement value of a company's assets compared to the price it fetches in the market:

Again the story is similar, with valuations around 40% above the long-term average. 

As a relative novice to the investment game, I was surprised by these results.  Valuations don't look stretched on a P/E basis, with the market as a whole on around 14x at the moment.  So why do both CAPE and q suggest equities are so overvalued? 

The answer lies in profit margins, which are extremely elevated relative to historical norms.  The chart below illustrates this clearly: 

The absolute levels are higher than operating margins because depreciation is excluded from the results, but the trend is clear.  Margins are around 7% higher than normal, and this is a relatively recent phenomenon.  Note that on this chart a 7% increase on 30% margins implies companies are only earning 25% more than 'normal', but if we include depreciation the increase is probably closer to 50%. 

The upshot of all this is that future returns on the S&P are likely to be mediocre.  Hussman (link on the right) projects just a few percent per year over the next decade. 

I'll address why margins are high, and why I think they will eventually come down, in a subsequent post.  But for now, I'll be especially careful not to get too enthused by low P/Es if they are supported by supernormal profit margins (resource stocks anyone?). 

Performance

I've been monitoring roughly how my portfolio has been doing for a few years, but as the amount of money I've got has become more meaningful I've decided to try and track it more accurately, properly accounting for dividends etc. starting from the beginning of 2012.  Choosing a benchmark is always difficult but I've opted for the FTSE 100, for ease of measurement more than anything else.

My goal is to outperform by 5%+ a year.  The FTSE is a relatively unvolatile index compared to most country indices and AIM shares (of which I own a lot) generally move in and out of favour in dramatic fashion.  As such I expect to underperform markedly when markets fall, but hopefully outperform by a greater amount when they rise.

I've umm'ed and err'ed on whether to include cash in my return figures.  I generally view holding cash as an investment decision rather than being constrained by liquidity requirements for daily living, so really it should be included in my results.  The argument in favour of leaving it out is that I'd probably have to hold cash anyway if I was invested in an index fund.  I think the arguments in favour are stronger, so I'll be including the cash weighting in my performance figures.

Anyway, here's the performance through to the end of February.  As you can see, I've had a reasonably nice run, helped by an immediate gain of 20% on my United Carpets position.  Game Group has all but gone into administration but I've already felt the pain from that one.  But then again, markets have generally risen since the start of the year so perhaps all I've got is some leveraged beta...

United Carpets

One of the benefits of keeping some cash on hand is that you're able to take advantage of opportunities to buy businesses that have seen their share price depressed by irrational selling.  United Carpets looks like one of those opportunities. 

United Carpets is a company that popped up on a few screens I've been doing over the past year.  It has a healthy dividend yield, net cash, not obvisouly distressed trading, yet its P/E multiple was around 6-7x trailing earnings.  This is cheap, but in the darkest corners of the AIM market not ridiculously so for a small cap, so I added it to my watchlist rather than buy it outright.  Since then, I've watched it fall from 8p to 5p over the course of a few months, but on Tuesday it fell from 5p to 3.1p on heavy volume.  Normally this means something like a set of bad results, but there was no published news either from the company or from Bloomberg.  It's main listed competitor, Carpetright, has also not published any negative news.  Getting interesting...

UC only owns a few retail outlets outright, most of its revenue is derrived from franchise fees.  A quick browse of the web suggests this amounts to 10% of sales plus a fixed fee for advertising.  In other words, its not dependent on the profits of its franchises, and this has helped it maintain profitability throughtout the downturn, unlike larger rival Carpetright.  There are a couple of downsides to this arrangement.  First, it's not as exposed to any pick up in the housing market (and we're surely closer to the bottom than the top).  Second, its continued profitability is partly down to its franchises, who might be loss making themselves ( anyone who's look at the Coke bottlers or McDonald's in any detail will understand the importance of system-wide profitability).  However, according to the interim report it appears as though only one of UC's 82 stores closed in the last 12 months, so clearly the owners aren't struggling so much they are forced to close.

Valuation
Trailing 12m profits are around 580k, but as results in the 1H of this year were weaker we could be looking at full year profits of 500k.  The market cap at the price I managed to buy was £2.9m, implying a P/E around 6x earnings.  Current trading is said to be a little better (SSS up 4.4% in past 11 weeks) so its likely full year profits will be higher than this.  600k doesn't feel unreasonable, still below the 800k achieved last year.  This would put the business on 4.8x earnings.

This is cheap, but the strength of the balance sheet suggests we should also be willing to strip out the cash from the market cap.  Current assets are higher than current liabilities even excluding £1.7m of cash, bringing down the price we are paying for the 'earnings side' of the business to just 1.2m.  Now the P/E looks a fairly ridiculous 2x! 

I'm normally happy to strip the cash out of a business when you've got a sensible management team in place who are aligned with shareholders, and the high insider ownership gives me some comfort with this.  Up till this year UC were paying a 0.75p dividend (a 21% yield!) and I expect they will be keen to resume this once trading picks up a little.


Summary
This looked too good an opportunity to pass up and I purchased £2900 worth of shares, a fairly comical 70,000.   This makes it a fairly large percentage of the portfolio, but then again you don't often get a chance to buy a solid business on 2x! 

UV

New start

Hello all,

This is my second attempt at an investment blog, unfortunately life got in the way last time.  I'm intending this largely as a way to try and clarify my own ideas, as I often find that once something is written down they become clearer (and hopefully learn from my mistakes). 

Anyway, here's my current portfolio:

Best,

UV