New Sunday Times Feature - Diary of a Private Investor

[Colm Fagan]

For my February paper, I tested it for the US and UK markets for the 32 years from 1986 to 2017 inclusive (that was the longest I had monthly data for). There were only two months with negative returns and both of those were less than 0.1%.
Having a modest fixed income element would make it even smoother, but at a cost of lower return, as set out in my August diary update. It’s just not worth it if the smoothing works well. Smoothing is even better for auto enrollment: works from cradle to grave.

 

[Sarenco]

For my February paper, I tested it for the US and UK markets for the 32 years from 1986 to 2017 inclusive (that was the longest I had monthly data for).

I was really thinking of a bear market that lasted a decade or more (US post-1929; Japan post-1990, etc.).

Having a modest fixed income element would make it even smoother, but at a cost of lower return...

You would certainly expect the fixed-income element to be a drag on performance over the long-term. However, there have been periods of 30 years or more in all developed economies where domestic long-term bonds outperformed domestic stocks.

I think it's interesting that the Norwegian and New Zealand sovereign wealth funds (which essentially have an infinite time horizon for their investments) both have a fixed-income allocation within their portfolios. The same is true of the big university endowments in the US.

 

[Colm Fagan]

Yes. I looked at Japan from 1989 to 2005 for the February presentation - ropey!
I argued that (a) Japan in that period was quite unique for all sorts of reasons (as set out on a couple of slides); (b) the world learned a lesson from the Japanese experience that was applied to get the Western World out of the 2007-09 crisis; (c) there should be an extra overlay onto the investment strategy to avoid excessive exposure to any specific geography, industry sector, technology, investment theme or economic outlook. Also, because of the low weighting given to current market value and the extremely long investment horizon, I reckon that up to 20% could be in unquoted assets such as real estate, forestry, infrastructure, etc.
My bottom line was that every single investment- without exception- should be expected to deliver the target return of risk free plus (say) 3% to 6% over the chosen investment horizon. In theory therefore there is no room for bonds. Obviously there has to be room for bonds or cash for tactical reasons. The problem with that is that one can always argue that a major recession is round the corner so we must hold on to our shekels. “Time in the market is more important than timing the market”.

 

[Colm Fagan]

By coincidence I’ve just read an interesting article on this topic - of whether equity risk reduces for longer holding periods - in this week’s Economist. It reruns an argument that Brian Woods (whom some in this parish will know) and I explored in a paper presented over 40 years ago. That paper was dismissed at the time but belatedly recognized as “ground breaking” nearly 20 years later! Based on that precedent, I probably I won’t be around when the latest proposals are recognized!

 

[joe sod]

Renishaw, a specialist engineering company with its headquarters in Gloucestershire, is my longest-standing and largest single holding. I bought my first shares in the company in 1998, at £4.05 a share. It’s my one and only “ten-bagger”, defined as a share worth ten times what was paid for it originally. It now accounts for more than 25% of my total portfolio.

Results for the year to 30 June were published on 26 July. The market liked what it heard and the share price, which had been rising steadily for weeks, reached a closing high of £56.60 the following day. I took advantage of the price rise and sold just over 10% of my holding at an average of £56.20 a share.

Then the price started falling. I wasn’t worried as I still considered it a sound investment. In fact, when the price fell, I couldn’t resist the temptation and bought back around a third of what I’d sold, at an average price of £51.13 a share.

Then, for no apparent reason, the price kept falling. It was down to £47.40 by the end of September and there was no respite as we moved into October. By 5th October it was at £45.56 and by Thursday last (11th) it had dipped below £40 a share - a fall of almost 30% from the July high. No wonder I was left reeling. On its own, the fall in Renishaw’s share price caused a 7.5% fall in the value of my total portfolio in just two months.

I dont want to rub salt in the wounds but I saw Renishaw had another big fall today, i dont know what the reason is but I was interested in your post and your honesty in talking about your investments. On a positive note you have been investing in this share since 1998 and should still be in substantial profits. Maybe the reason why you have not sold much of your holding is that you would crystallize a large capital gain and have to pay alot of capital gains tax. You have not really discussed this aspect of the investment. Maybe if you were resident in the UK where they have a very generous capital gains tax allowance of around £11,000 you might have been selling off more of your investment and re investing somewhere else. Maybe i am not correct in my assumption but I think the onerous capital gains tax situation in Ireland has stopped people from selling off investments with big capital gains, this partly explained why many irish investors did not sell their bank shares in 2008 when trouble hit. I know you are far more sophisticated than most people investing in ireland

 

[cremeegg]

I just did some basic research on Renishaw. It is a fine company with an enviable record. However that was fully recognized by the market from early 2016.

Like so many investments which are successful over a period based on sound fundamental reasons, success becomes the reason for further success.

Momentum, even fashion, takes over driving the price above any real value. People buying not because it’s a good company at a reasonable price but because all the previous buyers made money.

We all know how long the market can stay irrational.

The next phase may be the market over compensating on the other side.

The interesting thing to me is why you didn’t realize your gains when there was a step change upward in the price.

A belief that you can’t time the market ?

CGT issues ?

Delight that the market had finally seen the value in Renishaw which you had spotted earlier. And an emotional attachment to your perspicacity that you couldn’t walk away from. A case of loving your shares.

Renishaw is simply not worth €3bn.

 

[Jim2007]

I don’t follow Renishaw, but a few quick ‘back of a cigarette pack’ calculations suggest you’re right. How if I held the stock, I’d say it is not so over valued as to warrant a disposal just yet.

 

[Colm Fagan]

@joe sod @cremeegg @Jim2007
Thank you for your comments. I don't have any major disagreements with what you've written, just modifications/ amplifications.

I don't take a conventional approach to valuing companies. My main criterion is whether I think it will deliver my target return of (say) 6% to 7% a year over the next n years. Like Warren Buffett, my ideal holding period is forever, i.e. n approaches infinity. I recognise that I've erred in not giving enough consideration to the reality of having to sell at some future date, and the uncertainties around what price I'll be able to sell at. I'll come back to this point later.

Looking at Renishaw as a stock to be held forever, the analysis is straightforward. Over long periods, it has consistently delivered double digit growth in earnings and a slightly lower rate of growth in dividends (the lower rate of growth in dividends means that it's now reinvesting a higher proportion of profits back into the business). I only have records for the last 13 years. Over that period, EPS has grown by 13.7% a year on average and dividend per share by an average 8.9%. The period over which that 13.7% average growth rate was achieved spans 2009, when EPS fell 79%, to just 21% of the 2008 figure, but it bounced back the following year and hasn't looked back since.

Unlike most fast-growing companies, growth is almost entirely organic rather than by acquisition. Total share capital now is exactly the same as when I bought my first shares in 1998: no new shares were issued in the meantime, and none bought back. The company has no borrowings; it owns a high proportion of the properties it occupies all over the world, and has over £100 million cash in the bank, so growth wasn't achieved by leveraging up the balance sheet and taking on extra risk - another common, and risky, formula for fast growth.

The formula for growth is, and always has been, to invest around 15% of revenues in R&D each year. The vast bulk of this "investment" is expensed through the P&L account. Thus, a massive asset is being created (in the form of patents, know-how, new products in the pipeline) that is almost completely unrecognised in the balance sheet. Companies sometimes acquire such know-how by buying other companies. They can then recognise the value of acquired R&D in the balance sheet. It's a peculiar quirk of accounting. Renishaw keeps it all hidden away - and is happy to keep it that way.

Because of the durability of the growth formula, I am confident that EPS will continue to grow in future (providing they keep investing 15% of revenue in R&D). I've factored a 9% average EPS growth rate into my calculations. Assuming dividends stay at a constant percentage of profits, I can also expect dividends to grow by 9% a year on average. My desired return is "only" 7% a year, so I'm prepared to pay a good price for that sort of payback.

Of course, the share price will gyrate all over the place, but those gyrations don't affect the above reality. The share price is only relevant if I want to sell (or buy, but I'm now very much a seller). The plan is to sell my shares gradually over the years, taking advantage of elevated share prices to sell, and holding on when it's depressed. I did sell some shares when the price was at £56, but I admit that, while I thought £56 was a bit rich, I didn't think it was mad, so I only sold a small proportion of my holding. Also, as I wrote in my last diary update, I bought back around a third of what I sold when the price dipped below £52. Now that the price is down to £37.82, I'm sorry that I didn't sell more at the higher price, but I'm not going to die of depression over it: I'm still convinced that the growth formula is intact for the longer term. Yes, it will be squeaky bum time if we get a repeat of 2009, because of the problems in China (a major market for Renishaw) but Renishaw is better placed to ride out a severe recession than most other companies (the cash position was boosted by another £15 million since 30 June, to £115 million by the end of September). I hope that I too will be able to ride out a recession - if one comes. Nevertheless, I recognise that, as I get older, I should be giving more consideration than I've given hitherto to the price at which I may have to offload stock. One lesson learned - painfully.

@joe sod: you're right about CGT being a constraint on selling. I'm not going to rail against it; I accept tax as a fact of life, just like the weather. The government would probably get more revenue from this tax if they reduced it: people would buy and sell more, and it would also be better for the economy. Anyway, I'll try not stray into politics. Some of my shares are in the ARF/ AMRF, so I don't have to worry about CGT on those; I also hold some in the spread bet account, which is exempt from CGT, but I repeat what my spread bet providers are obliged to tell me every time they write to me: 78% of their retail clients (79% for another provider) lose money on spread bets, so be warned!!!

 

[Colm Fagan]

The great thing about writing the "Diary of a Private Investor" column is that I keep learning from others!

Following up on what I wrote yesterday (#410 above) in response to comments/ questions from @joe sod, @cremeegg , and @Jim2007, I did a few "back of a fag packet" calculations to work out what the sale price would have to be for different holding periods to earn my target return of 7% (or 6%) a year, on the (woefully artificial) assumption that earnings grow steadily at 9% pa. In practice, of course, earnings growth will be volatile around the long-term average, as will the PE ratio, but I can only deal with one uncertainty at a time!

Let's take the simplest situation first: if the PE multiple at exit is the same as at time of purchase, the annual return will be 9% plus the dividend yield, irrespective of whether the P/E multiple at both dates is 10 or 50. All that varies is the return from dividends, expressed as a percentage of the original investment.

We therefore know that the exit P/E multiple has to be less than the starting multiple to earn my target return of 7% (or 6%) a year, but how much less?

Take starting figures as follows: Price: £37.82 (as at Friday's close); Earnings per share (EPS): £1.705 for 2018; Dividend per share: £0.60.
Thus, the starting P/E ratio is 22.2.

If I sell the stock after 10 years, I'll earn a 7% return if the P/E ratio has fallen to 15.5 by then (from 22.2 now); I'll earn 6% a year between now and then if the exit P/E ratio has fallen to 13.9. If I sell after 20 years, I'll earn 7% a year if the exit P/E ratio is 9.9; 6% if it's 7.7.

On a twenty-year investment horizon, there's no way (IMHO!) that the P/E ratio will have fallen below 10; therefore, I'm confident that I'll earn more than my target return over that time horizon.

As I get older, however, my investment horizon is getting shorter, so I do have to give more thought to what the exit P/E ratio might be. Remembering too that earnings are volatile, and may now be close to a cyclical high (for a company in a very cyclical industry), I'm starting to agree with the critics that I have too much tied up in this particular stock. (A bit late, I hear you say!). The only reason I agree with them however is because my investment horizon is short; if I were younger, and had a longer investment horizon, I wouldn't be concerned.

 

[cremeegg]

the (woefully artificial) assumption that earnings grow steadily at 9% pa. In practice, of course, earnings growth will be volatile around the long-term average, as will the PE ratio, but I can only deal with one uncertainty at a time!

Small engineering companies are ten a penny, often badly managed, everything with them is price, the competition is fierce.

Huge engineering companies Siemens, GE, ABB and a few others are formidable operators with enormous advantages over any new competitor.

It is very possible that Renishaw are in a sweet spot, and have been for many years. They may be better managed than the tiddlers and so were able to grow out of that group, they may be able to continue as they are for many years, but growing to the next level may be beyond them.

Past performance at growing by 9% may not be a guide to future performance. Indeed the very things that made them successful in the past may work against them in the future. For example, is their management very concentrated ?

For a company in a mature industry to outgrow the economy is difficult, to continue to do so requires it to change its DNA regularly.

 

[Colm Fagan]

@cremeegg Thanks for your comments.

I'm always conscious of Brendan's (the boss's!!) request to avoid detailed discussion of individual shares. He's happy to give me space on this forum to explain what I've bought/sold and my reasoning for my decisions. I've tried to adhere to his instructions, so I don't plan to respond to your detailed comments, other than make the general point that a winning formula for consistent long-term growth is hard to find. Some work for limited periods, e.g. consolidators (funeral homes is an example that comes to mind), increased borrowing, going on the acquisition trail, but many of these so-called winning formulae can come to sticky ends.

When I was lucky enough to own a significant portion of a business, and to have a major say in its direction, I liked to think that one of the reasons for our success was because we always tried to learn new things and to be at the forefront of new thinking, rather than just turning the handle on something that had made money for us in the past. I like to invest in companies with similar mindsets.

Small engineering companies are ten a penny

Small engineering companies may indeed be ten a penny, but companies (in any sector) with the mindset I've described are extremely rare and should be cherished. If you know of any others that meet the criteria I've described, I would be delighted to hear from you (you can send me a private message on AAM).

 

[Colm Fagan]

Just as it Says on the Tin

Update 9 of “Diary of a Private Investor” 3 December 2018


It’s been a traumatic few months for my portfolio. Its value fell by 15.8% in October, making it the worst monthly result ever, or at least the worst since I started keeping detailed monthly records from the start of 2013. October’s fall came on the back of an 8% fall in September and was followed by a further 2% fall in November. Do the math. I’m a lot poorer now than I was a few short months ago.

Renishaw, which regular readers will be familiar with, was the main culprit. It fell from a high of £56.60 in mid-July to a low of £36.70 on 23 October, down 35%. It has made a partial recovery since, to last Friday’s £42.82.

Renishaw wasn’t my only faller, not by a long shot. Samsonite, the luggage company (see Update 4 of 11 June), was another major casualty. It fell 25% between end August and end November.

Those two stocks are at opposite ends of the world – Renishaw in the UK, Samsonite in Hong Kong – and operate in very different markets– Renishaw in precision engineering and Samsonite in luxury travel goods – but they have one thing in common: China is a major market for both. Stocks with significant exposure to China are suffering at present due to the country’s economic problems. I fear that there’s more bad news to come from China, so I’ve reduced my exposure to both stocks. Even after the sales, Renishaw is still my largest single holding.

The overall result could have been even worse, except for two recent decisions that worked out well – more by accident than design.

Apple is one of my longest standing and best-performing stocks (first discussed in my Sunday Times column of 6 December 2015: https://www.askaboutmoney.com/threads/colm-fagans-diary-of-a-private-investor.207496/ ). In June 2017, I increased my holding by 50%, buying at $144.26 a share. I bought more again in January 2018 at $169.85 a share. Feelings of vertigo started in May, and I sold a small portion of my holding at $187.43. I sold further tranches at $191.95 in June, at $218.18 in August, and at $220.69 in October, ending up with slightly more than I had before the May 2017 purchases. Each sale at a higher price than the last one made me feel annoyed with myself for selling too soon. No longer. At the current price of $178.60, my decision to offload a significant portion of my holding is looking good.

I had a similar lucky escape with Tesla. As discussed in Update 2 (1 April), I opened a short position in Tesla earlier in the year, i.e. I gambled on the share price falling. At the end of September, I was sitting on a nice profit and in early October I closed 60% of my position at $266.08 a share, at an average profit of $36.44 a share. Then came a bolt from the blue. The results for Quarter 3, which were published after the markets closed on 24 October, were well ahead of forecasts, and the price was expected to jump when US markets reopened. I decided that discretion was the better part of valour and closed out most of my remaining position at $320 a share, before the market officially opened on the following day. At the current $350 a share, that decision is looking good.

I still find it hard to believe Tesla’s excellent result for the third quarter. My suspicions are heightened by the fact that the chief accounting officer resigned shortly before quarter end, having been with the company for less than a month. That doesn’t sound good. If the rest of my portfolio were doing well, I would back my belief with money, but my current more cautious self is not prepared to make the call. I’ve decided not to close out my remaining short position in the stock for the time being, though.

Now that the dust of battle on the stock market has settled – for the time being at least – it’s time to take stock. The heavy losses I suffered over the last few months caused me briefly to consider giving up on my strategy of investing 100% (or more) in growth stocks, and of pursuing a more conventional strategy, as recommended by the experts for someone of my advancing years. Then I did some sums and discovered that my strategy is delivering exactly what it says on the tin: significantly higher volatility but much higher returns than a more conventional mixed portfolio. Even after the recent falls, the average return on my portfolio from the start of 2013 (the date from which I have kept detailed records of cash inflows and – increasingly – outflows) has been more than 10% a year, which is probably 8% a year more than I would have earned on a bond-based portfolio. The bad news is that the portfolio could fall in value by another 24% before breaching my long-term target of a 7% annual return. A messy Brexit –even more messy than the one we’re already almost guaranteed – could leave me close to those levels. Not a happy thought.

 

[joe sod]

It’s been a traumatic few months for my portfolio. Its value fell by 15.8% in October, making it the worst monthly result ever, or at least the worst since I started keeping detailed monthly records from the start of 2013. October’s fall came on the back of an 8% fall in September and was followed by a further 2% fall in November. Do the math. I’m a lot poorer now than I was a few short months ago.

Sorry for your troubles colm, you never get used to losses no matter how much experience you have. I think most people are down significantly in the last few months anyway. For what its worth my worst period was late 2015, early 2016 due to the investments I had then but it recovered fairly quickly in 2016. I actually did not get hit too badly in 2008, but 2015/16 was my worst period in investing. Although if Brexit goes badly I could be hit fairly hard again but then that is the time to continue to load up on UK stocks which are the best value they have been in a long time.

 

[opexlong]

Mr. Fagan,

The heavy losses I suffered over the last few months caused me briefly to consider giving up on my strategy of investing 100% (or more) in growth stocks, and of pursuing a more conventional strategy, as recommended by the experts for someone of my advancing years. Then I did some sums and discovered that my strategy is delivering exactly what it says on the tin: significantly higher volatility but much higher returns than a more conventional mixed portfolio.

The sums don't tell the full story though. Here's a hypothetical scenario: suppose your portfolio returns for the next five years are -20% in 2019, -25% in 2020, -10% in 2021, -3% in 2022, +1% in 2023 and +0.8% in 2024.

Now what's your average gain for the period 2013 to 2024? Do those sums.

Your basket of correlated stocks will outperform a mixed portfolio in a bull market and underperform it in a bear market. So your strategy will do well and deliver exactly what it's supposed to until it doesn't.

 

[opexlong]

I had a similar lucky escape with Tesla. As discussed in Update 2 (1 April), I opened a short position in Tesla earlier in the year, i.e. I gambled on the share price falling [..] Then came a bolt from the blue.

How can you call it a bolt from the blue though? That's the ninth time this year that this stock has spiked after a large drop. In fact that's been its consistent pattern for the last five years.

 

[Colm Fagan]

you never get used to losses no matter how much experience you have.

Hi Joe. I agree, but the message I would like to get across is that high volatility, including the occasional experience such as I've had over the last few months, is a small price to pay for significantly higher long-term returns than can be earned from bonds or cash. Even after my recent disasters, I've still earned over 10% a year for the last six years compared to around 2% or so if I'd been in so-called "safe" investments. I am reasonably confident that the same will be true in future - and I hope to be around for another decade or two.

 

[Colm Fagan]

The sums don't tell the full story though. Here's a hypothetical scenario:

I'm not sure what your point is. I'm dealing with real scenarios, not hypothetical ones.

 

[Colm Fagan]

How can you call it a bolt from the blue though?

The bolt from the blue was the unexpected profit, not the price hike. To quote from the FT of the following day (recognising the FT's copyright, etc.):
"In a quarter when most analysts still expected red ink, the electric car maker came up with a $312m net profit, its first since the heavy spending began two years ago to launch and ramp up production of the all-important Model 3"
I agree that there have been lots of price hikes - and price falls. They are "normal" for Tesla. Making a profit is definitely not "normal".

 

[DeeKie]

I love reading your posts Colm. I’m curious as to whether you got to ask the questions that you wanted answered at the Reinshaw AGM? Did they impress in person?

 

[WhiteCoat]

Hi Colm,

I was very struck by David Attenborough's speech in Poland yesterday. I'm just wondering to what extent ethical considerations inform your investment considerations. Personally, in view of climate change challenges and especially given your very concentrated portfolio, I would not be comfortable shorting Tesla or holding Ryanair.