New Sunday Times Feature - Diary of a Private Investor

I am not sure how useful this percentage game is. Of course the best chance of getting more than 4% p.a. is equities. The best chance of getting more than 20% p.a. is 80% geared emerging markets. The best chance of getting more than 0% p.a. is cash.

This is really a utility play. At its very simplest we might be comparing an annuity guaranteeing 20K p.a., a cash dominated ARF guaranteeing 10K p.a. but with flexibility and inheritance potential or an equity dominated ARF with expectation of 20K p.a., same flexibility but chance of bomb out or reduction to peniary at some stage.

The utility function will be driven by many personal considerations and of course if the fund is 5 times bigger than implied in the above example the same utility calculus will lead to a different strategy.
 
Hi Duke
Thanks for bringing the discussion back to sanity. To expand on your post, different people can take wildly differing approaches if available assets are more than sufficient. At one extreme, someone with a good DB pension and a low risk appetite will invest their additional savings carefully, to ensure there will always be something in reserve. I'm at the other extreme. I have a high risk appetite. For me, any additional savings over and above those required to provide a reasonable income for me and the other half allow me to take a higher risk approach with my entire pool (including the ARF). OK, if things go belly up, I'll lose the excess, but I still hope to have enough in the ARF, by changing to a more conservative investment strategy. This explains my personal (very personal) decision to invest more than 100% of my entire funds in equities - and to take some short positions.
 
Here is my latest diary update, which tells a tale of woe!

Diary of a Private Investor Update #3 8 May 2018

Stock pickers love regaling us with stories of their coups, of the shares they bought that are now worth many times what they paid for them originally. They seldom tell us of their clangers, of the shares that have fallen in value since purchase. I now understand their reticence to admit mistakes. It is painful to recall one’s failures for posterity.

I bought shares in WPP, the advertising group, in March 2017, at £17 a share. They seemed good value at the time. The yearly dividend was 56.6p, so the dividend yield was 3.3%. Diluted earnings per share were twice that, at 113.2p a share, and had increased by an average of more than 14% a year for the previous seven years. The company planned to continue paying half its earnings in dividends in future.

My aim is to get a 7% per annum return on my investments. A dividend yield of 3.3% meant that earnings only had to grow by 3.7% a year for the return on my WPP investment to exceed my target, assuming I held the shares forever. I had no intention of holding the shares forever. The sums get complicated when we allow for sale at some future date, but the basic principle is that I would earn more than 7% a year if the dividend yield at time of sale was less than 3.3% and less than 7% pa if the dividend yield at time of sale was more than 3.3% – all on the assumption that earnings (and dividends) grew by an average 3.3% per annum during the holding period.

There were a lot of “if’s” in this. The first was the assumption that earnings would grow by 3.3% pa on average. Like other advertising agencies, WPP faced challenges on several fronts. Facebook and Google were grabbing a bigger share of advertisers’ spend, sometimes bypassing the agencies entirely; major advertisers such as Proctor & Gamble (makers of Gillette, Crest, etc.) and Unilever (Ben & Jerry, Dove, etc.) were making big cuts in their advertising budgets, largely at the behest of activist investors. I was aware of those threats, but the prospects for global growth were good and I believed that the big agencies could keep growing, albeit at a slower pace than previously.

By June 2017, the share price had fallen to £15.49 a share. I still believed in my original investment thesis, so I topped up my holding by about 50%. WPP was now my sixth largest exposure in a highly concentrated portfolio (my two largest holdings each account for well over 20% of my equity exposure).

The price kept falling through the summer and I started to go cold on WPP. On top of the challenges outlined above, consulting firms such as Accenture and Deloitte were muscling in on areas that were formerly the preserve of the established agencies and were taking business from them. I sold a small portion of my holding in August at £14.23 a share and resolved to sell the rest on any sign of a rebound in the price.

There was no rebound. I kept revising downwards the price at which I was prepared to sell, but the price kept falling faster than my lowered expectations.

Results for 2017 were released on 1 March 2018. Growth in Diluted Earnings per share was 6.4%, ahead of my 5% target, as was the dividend increase of 6%, but the management statement accompanying the results was downbeat and the shares fell 8.2%, to £12.60. Then, on 3 April, came a bolt from the blue. The Board announced that Sir Martin Sorrell, WPP’s chief executive and guiding light ever since he founded the business 33 years ago, was being investigated for alleged “personal misconduct”, adding that the amounts involved were not material to WPP. I couldn't believe it. This was the same man who had been pilloried by shareholders and press a couple of years previously for his exorbitant pay packet of £70 million. Was he trousering more of the company’s money to top up his pay packet? Maybe the competitor who famously called him an odious little This post will be deleted if not edited to remove bad language some years ago had the measure of the man known in some quarters as the Napoleon of the ad industry, presumably because of his stature and his ambitions for global domination. Sorrell resigned shortly afterwards, and the Board dropped its investigation, much to the chagrin of some shareholders, myself included.

The price dipped briefly below £11 a share. Like a rabbit caught in headlights, I didn’t know whether to stay or run, eventually doing a bit of both: I sold about 30% of my holding on Friday 27 April, at £11.48 a share, only to regret it almost immediately: the share price rebounded strongly to £12.45 on the Monday, when results for the first quarter of 2018 were announced. My only consolation was that I hadn’t sold the lot at the lower price.

This morning (8 May), the price had risen further, to £12.82 a share. The prospective dividend for the current year is 60p, implying a dividend yield of 4.7%. Despite the attractive yield, I have lost faith in the company. I sold the rest of my holding at this price, bringing the curtain down on my short but costly relationship with WPP.
 
Very interesting Colm.

You bought at £17 and sold at $12.82 - it's only a 25% fall, reduced by dividends. So it's hardly a tale of woe.

Colm Fagan said:
The yearly dividend was 56.6p, so the dividend yield was 3.3%. Diluted earnings per share were twice that, at 113.2p a share,
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I don't understand that. I don't do fundamental analysis, but I thought that the diluted EPS meant what the EBS would be if more shares were issued through stock options etc. Should the diluted EPS not be lower than the undiluted EPS?

Brendan
 
Brendan
I've only got a minute, so a very quick reply. I was talking about dividends and earnings, not diluted v undiluted earnings. You're right about undiluted v diluted EPS. I hope to come back later with a fuller reply, as there are a few wrinkles in it.
Colm
 
Brendan Burgess said:
You bought at £17 and sold at $12.82 - it's only a 25% fall, reduced by dividends. So it's hardly a tale of woe.
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It's bad when you're going through it. A significant proportion of my investing is on a leveraged basis, so I avoid really high risk shares. That was my worst experience in a long while.
Brendan Burgess said:
but I thought that the diluted EPS meant what the EBS would be if more shares were issued through stock options
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Yes, you're right. They also bring in a concept that they call "headline diluted EPS". I think the word "headline" is meant to be the "real" figure, which removes as many of the distortions as possible. I was happy to use it as the headline diluted EPS (120.4p) was lower than the diluted (basic) EPS (142.4p). Also, as you surmised, the diluted basic EPS (142.4p) was lower than the (undiluted) basic EPS (144p). All these figures are for 2017. The figures you quoted for 2016 were the dividend (56.6p) and the diluted headline EPS (113.2p).
ThirstyLizard said:
May I ask what your criteria is when deciding to invest while aiming for the 7% return goal?

Is it a mixture of dividends (what's your min divy return?), capital gain, trading?
Click to expand...
I don't buy into the "value" versus "growth" school. I just buy shares that I think will deliver my target rate of return in the long-term. I don't give a damn how that return is obtained, from dividends or capital gains or a combination of the two. For tax reasons, the high dividend payers are more likely to be in my ARF and the low dividend payers in the non-exempt account. For example, Ryanair is one of the shares in my portfolio. They don't (normally) pay a dividend, but they use their spare cash to reduce the number of shares in circulation. I complete a variation of the WPP type calculation of expected return when I'm analysing companies like Ryanair that rely heavily on share buybacks.
The 7% figure was just pulled out of the air (not where David Drumm pulled his figures from!). Actually, that's not true. There is some logic in how I derived it. I'm a firm believer in the equity risk premium. I believe it's about 5% a year. Add 5% to a reasonable long-term risk-free return of 2% and we get 7%. One corollary of this is that I don't have any bonds in my portfolio, as they can't deliver 7%. If I included bonds, I'd have to look for more than 7% from some of my other holdings. Some shares don't deliver, but for every WPP there's another that has delivered more than the 7% over a long period. I'm not complaining. Of course, if there's an Armageddon, I'm sunk!
And finally, in answer to your "trading?" question, I am a firm believer in a buy and hold strategy for my long positions. I plan to do a piece sometime on my turnover rate. It's miniscule. Short positions are a different kettle of fish.
 
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Diary of a Private Investor Update #4 11 June 2018
Man overboard but shipwreck averted


May: what a month!

In brief, excellent results for two of my long-time favourites, Renishaw and Apple, were almost undone by a near disaster on another of my holdings, Samsonite.

Renishaw is my only ten-bagger. My first investment in the company was 20 years ago, at £4 a share. The price is now more than ten times that – with the bonus of regular dividend income landing in my bank account every half-year in the intervening period. Over the 20-year period, I’ve used temporary price dips to increase my holding, to the stage where Renishaw now represents more than 25% of my gross portfolio before borrowings, a significantly higher percentage of the portfolio’s value net of borrowings.

Every year, in May, the company hosts an Investor Day, at which it showcases its latest inventions. I enjoy attending these events, which are normally held at the company’s Head Office in rural Gloucestershire, to meet with the Board and management and with other long-term investors. Unfortunately, other commitments meant that I was unable to attend this year’s event.

A stockbroker’s report landed on my desk a week before this year's Investor Day, with a “sell” recommendation on Renishaw. After reading the report, I concluded that the analyst had underestimated the company’s prospects in key growth areas, particularly in additive (3D) manufacturing, so I decided not to act on his recommendation. My faith in the company was rewarded: the market liked what it heard on Investor Day and the share price increased by almost 15% in the month, to £53.80 by month end. Renishaw’s performance alone caused an increase of almost 6% in the value of my total (net) portfolio in the month.

Apple Corporation is another of my long-time favourites. I took my first bite in December 2012 at $73 a share (the actual share price at the time was $511 but a share split gave me seven times as many shares). It now represents close to 9% of my gross portfolio. The share price increased 13% in May, to almost $187 by month end, contributing another 2.3% to overall portfolio performance.

With Renishaw and Apple performing so well, and others of my top holdings not doing badly either, May was heading to be one of my best months ever, with total growth of more than 9%. Then disaster struck.

The first inkling of trouble came before European markets opened on the morning of 24 May, as I was preparing to head off to the US on holidays that day. I received a notification that Samsonite’s share price had fallen more than 10% in overnight trading in Hong Kong, with the additional bad news that trading had been suspended mid-morning, but that it would reopen the following morning. I discovered later that a short-seller had accused the Board and management of questionable accounting practices and poor corporate governance and claimed that the company was only worth HK$17.59 a share, almost 50% less than the prevailing valuation. I had a sizeable long position in Samsonite and a 50% price fall could cause the total value of my portfolio to fall by more than 7%, wiping out most of the gains in the month on my other holdings. I was worried as I headed through US Immigration Control at Dublin Airport.

On the other hand, why should I believe a short-seller who was out to make money by causing a sharp fall in the share price?

I pondered my options as the plane passed over Greenland. I purchased some in-flight Wi-Fi, looked again at the latest set of accounts, and eventually decided to part with just 11% of my holding, and to hang on to the other 89%, in the hope of eventual recovery. The partial sale went through the following morning (Hong Kong time) at $27.06 a share. Then, at the end of the day, trading in Samsonite was suspended again – at HK$26.51 – and remained suspended for the rest of the month.

Days went by with no meaningful response from the company to the short-seller’s allegations. The longer the delay, the more I regretted not offloading my entire shareholding when I had the chance. May 31 came and went; still no reply. At what price should I include the remaining Samsonite shares in my end of month portfolio valuation? If the company didn’t come up with a satisfactory response, the true value could be considerably less than the HK$26.51 at which they last traded. Lacking any better information, I decided to include them at this price in my valuation. This resulted in an overall portfolio gain for the month of 5.2% – a great result in the circumstances, if I managed to avoid a meltdown in the value of my Samsonite holding.

Finally, the company issued a statement on the morning of June 1, the day before I was due to come home from my vacation in Charlottesville and Washington. The market decided that the responses to the short-seller’s allegations were satisfactory and the share price jumped more than 10%, but not quite back to its level before the report was issued. I was relieved that my decision to hang on to the bulk of my holding had been vindicated.

As far as I can gather, the only serious casualty from the entire affair was the Chief Executive, who had apparently claimed on occasion, or had allowed others to believe, that he had a doctorate when he hadn’t. He wasn’t the first and definitely won’t be the last senior executive in an organisation to embellish their CV. He resigned as CEO and from the Board, to be replaced by the Chief Financial Officer.

For me, the close shave has caused me to reconsider aspects of my approach to investment. More will be revealed in due course on the outcome from those deliberations.
 
Gordon Gekko said:
Does it not illustrate the perils of your concentrated approach?
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Samsonite illustrate the perils of a concentrated approach; Renishaw and Apple demonstrate the advantages of a concentrated approach. Long-term return, not reduced volatility of short-term returns, is the objective. On that measure, I'm well ahead.
 
Colm Fagan said:
Renishaw now represents more than 25% of my gross portfolio before borrowings, a significantly higher percentage of the portfolio’s value net of borrowings.
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Hi Colm

So are we saying something like this:

Gross portfolio: 100
Borrowings: 30
Net portfolio: 70
Renishaw: 25
= 36% of net portfolio

Even if Renishaw is a great company and very well managed, a great company can be overvalued.

upload_2018-6-11_20-3-12.png


Or, even worse, a great company, can be undervalued. A company that has tripled in price in two years can halve fairly easily. I am not saying that it will or that it should. It's just a risk.

Your portfolio would then be:

Gross portfolio: 100 down to 88
Borrowings: 30
Net portfolio: 70 down to 58

That would be a fall of 17%


There is a reasonably good chance of an overall market correction. No matter how good your shares are, your gross portfolio could fall by 30%, so your net portfolio would suffer even worse. I really don't think you should be borrowing to buy Renishaw shares, no matter how good it is.

Brendan
 
Now let me assume that your net worth is €2m.

That is plenty for your to live comfortably on for the rest of your life.

If your portfolio doubles over the next three years, what difference will it make to your life? Not one whit. You will get some great self-satisfaction from being proven right.

But if your portfolio halves, then you might have to cut back.

Of course, if your portfolio is €4m, then it doesn't matter what happens. Even if your portfolio crashes by 50%, you will still have plenty to live on. Unless your gearing is over 30%!

Whatever way you look at it, borrowing makes no sense at all. There is no reward and there is a huge downside.

Brendan
 
Brendan, you've hit the nail on the head. As another regular AAM contributor, well known to you and me, said: "it's an obvious utility play", making much the same point as yourself. I've learned the lesson and am taking steps to reduce my leverage (but not my concentration: I still believe firmly in the value of a concentrated - but unleveraged - portfolio).
 
Brendan, I'll qualify my response: I think a small amount of leverage is OK. I'm working on how small it should be.
 
Colm Fagan said:
Brendan, I'll qualify my response: I think a small amount of leverage is OK. I'm working on how small it should be.
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Hi Colm,

For someone like yourself who can handle the volatility, wouldn’t the right amount be whatever you can get that doesn’t mean you’re carried out in a rerun of 1929/2008, provided you were diversified?

Maybe 30% (i.e. 50% fall in equities leaves you down 65%)?

But you seem to run such concentrated positions, I’d be genuinely worried about anything more than (say) 10%.

It’s very interesting to be honest.

Gordon
 
I think you are both wrong, in logic, on the matter of leverage.

If you believe you can earn a return greater than the interest expense, then leverage is justified.

If the value of your portfolio falls, leverage magnifies the fall, if the value of your portfolio increases leverage magnifies the rise. This is true but a distraction from the proper question about leverage.

If you expect over time that your portfolio will out perform the interest cost of the borrowing then you should borrow.

Brendan raises a good question, what if your portfolio halves in value. But he then goes on to misaddress the question. The only question to be asked about borrowing (once you are happy that you can justify the cost) is can I meet the cashflow.

If you expect your portfolio to fall, then sell, if you expect it to rise, above the cost of the interest, then keep the leverage.
 
First may I say I am loving your contributions, and am only picking at them because you have me engaged.

Colm Fagan said:
I don't buy into the "value" versus "growth" school. I just buy shares that I think will deliver my target rate of return in the long-term. I don't give a damn how that return is obtained, from dividends or capital gains or a combination of the two.
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This is another example of letting an investing nostrum dictate your thinking without really analysing it. There is a lot of that about AAM at the moment.

A value share is one that is worth buying because of the intrinsic strengths of the company. Yes it may well be a high yielder, but that is not the essence of a value share.

A growth share is worth buying because of the superior growth prospects of the business.

In each case if you are going to pick the stock you must believe that the market has mispriced either the quality or the prospects of the company.

Colm Fagan said:
I don't buy into the "value" versus "growth" school. I just buy shares that I think will deliver my target rate of return in the long-term. I don't give a damn how that return is obtained, from dividends or capital gains or a combination of the two.
Click to expand...

I can see why you dont care how the return is obtained, but if you expect the company to deliver a large rate of return you must have some expectation as to how the company will do that. That comes down mostly to either growth or quality.
 
cremeegg said:
If you believe you can earn a return greater than the interest expense, then leverage is justified.
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It's nothing to do with "belief".

Colm may well believe that he can outperform the interest rate expense, but he may well be wrong. He has no way of knowing whether he can or not. So the belief is irrelevant. The risk is not worth taking.

Brendan
 
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