2018 reflections: inactivity pays dividends
It is the season for reflections and resolutions. My main takeaway from 2018 is that it really does pay to do nothing most of the time. While I wrote about a number of companies I only bought into AJ Bell (AJB). The investment platform appears to offer an attractive combination of quality and growth.
Warren Buffett used a baseball analogy to highlight the importance of patience:
“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!,’ ignore them.”
My investing resolution is to only buy into high quality companies – hopefully I will stick to it. Quality companies tend to create long-term value and require less monitoring. I may be able to hold AJ Bell, for example, for decades to come.
High-risk companies promise high rewards. The reality, though, is that they tend to go off track. To quote the great Scottish poet Robert Burns (To a Mouse – a great poem to read over Xmas):
“The best-laid plans of mice and men
Go often askew,
And leave us nothing but grief and pain,
For promised joy!”
High risk stocks often have slip ups
Where we invest matters. This includes the market a company is listed in (AIM or LSE), the sector and the level of business maturity.
The AIM All-Share index (generally immature companies) was launched in March 1996 at 1,000 and is currently trading at 848. The 15% decline over 22 years is unpleasant considering that AIM stocks don’t tend to pay a dividend.
The FTSE 250 index of premium-listed, mainly well-established companies has increased from 4,296 in March 1996 to 17,446 today. The 300% return doesn’t include the dividends that FTSE 250 companies tend to pay.
AIM All-Share since 1996: going nowhere
FTSE 250 index since 1996: quality companies deliver
Below is a summary of the quality companies covered so far. They are also discussed in a podcast (based on share price close on 24th December):
The investment platform AJ Bell (latest share price 233p, market cap £949 million) offered an opportunity to buy into a high quality IPO. The shares listed at 160p and are currently trading around 45% above this level.
This bucks the trend of recent IPOs – Aston Martin and Funding Circle – and highlights that it is worth focusing on quality. At the current share price the rolling 12-month P/E at 30X is in-line with Hargreaves Lansdown. I remain optimistic on AJ Bell’s long-term prospects.
AJ Bell forecast (year to September)
I covered Hargreaves Lansdown (latest share price 1800p, market cap £8,540 million) to better under stand the market backdrop for AJ Bell. Hargreaves Lansdown has been an impressive growth story with client numbers currently standing at around 1.12 million.
The Bristol headquartered business knows the UK DIY (Do it Yourself) investor inside out. While the 12-month rolling P/E at 30X may be too rich for some the group is the market leader and the return on equity is 66%. Hargreaves Lansdown was relatively unscathed by the 2007/2008 financial crisis.
Hargreaves Lansdown forecasts (year to June)
A recent IPO I covered is the IFA support services group Simplybiz (latest share price 146p, market cap £112 million). The shares listed at 170p in April 2018 and are currently 13% below that level.
The forecast P/E for Simplybiz in 2019 is 11.4X with it falling to 9.8X in 2020 and the group has a net cash position. The valuation appears to be inexpensive relative to the quality of the business… unless I am missing something.
Simplybiz forecasts (year to December)
Mortgage Advice Bureau (MAB) generated a 100% return on capital employed excluding goodwill in 2017. The founder run business has seen its share price decline from £7 to just over £5 and may offer an interesting opportunity.
MAB (current share price 515p, current market cap £260 million) has a strong track record and is continuing to take market share. The dividend yield is forecast to hit 5.2% in fiscal 2019. While mortgage demand is cyclical MAB’s valuation has become more attractive.
MAB forecasts (year to December)
Screening for quality companies sometimes throws up unexpected opportunities. Integrated Diagnostic Holdings (latest share price $4.1, current market cap US$614 million) is one such opportunity.
The company operates in volatile emerging markets but the group has a long track record. Healthcare demand is increasing around the world and IDHC hopes to expand across Africa and the Middle East. IDHC has the potential to be a long-term winner.
IDHC forecasts (year to December)
The five companies discussed fit the conventional definition of quality i.e. good profit margins, a return on capital over 15%, good cash flow conversion, resilient demand and strong market positions.
I also covered PPHE Hotel Group (PPHE, September 27), which benefits from a focus on central London. Management are experienced hoteliers and the shares trade at a large discount to the net asset value.
Somero Enterprises (SOM, 17 September) currently generates very strong financial returns but is a cyclical business. On the Beach (OTB, 1 December, 15 November) generates good returns but increasing competition remains a risk.
Domino’s Pizza master franchisees (2 November) were seen as high quality in the past but competition is becoming more intense. Competition also put me off the restaurant business Fulham Shore (FUL, 10 October).
Restaurants are a tough area to invest in
An important afterthought is that family and founder owned businesses tend to allocate capital wisely. Many of the companies discussed have family or founder ownership and in a number of cases the founder is still running the business.
When management don’t have skin in the game you often see risky acquisitions and/or poor operating results. Restaurant Group’s (RTN) is a case in point given the company’s weak trading results and the pricey takeover of Wagamama.
If you have any reflections or investment resolutions do share them in the comments section below. All the best for 2019!
At the time of publication, the author holds a long position in AJ Bell.