New Sunday Times Feature - Diary of a Private Investor

[galway_blow_in]

@galway_blow_in Sounds great. The trick is to get a good average return on your entire savings over a long period, not just on a small proportion of them over a relatively short period. I've taken this to the extreme. All my savings, including ARF, AMRF, non-exempt savings, are in "risky" investments. I don't have any back-up in the form of a DB entitlement and I don't have a cent in so-called "safe" assets (other than enough cash to cover outgo over the next month or so), not even a single prize bond or savings certificate. I'm not sure that many financial advisers would agree with that investment strategy!

I've only 50 k in the equity markets for the past year as we hope to move house inside two years so I'm sitting on nearly 100 k in cash, on paper it's silly but I can't risk putting more in with a two year horizon

 

[Duke of Marmalade]

This month's diary update tells a cautionary tale of placing too much faith in Cristiano Ronaldo to rescue the situation – not on the football pitch but on the stock market.

I couldn't post the article normally: I was told that it contained banned words!!! Sorry to disappoint , but the banned words were the name of a leading luxury brand!
In order to get round the ban, I've attached it as a pdf file.

Colm, that’s a sad case

 

[redartbmud]

Colm, I have been caught on the naughty step a few times in the past, hence my title - please read it backwards
I agree with your philosophy. Having carried out due diligence, and seeing rising momentum in the share price, the trend is your friend - until the story changes.
We can only rely on the accuracy of published data and, if lucky, the chance to look at the whites of the eyes of the executive directors in open forums, such as AGM's, where you can assess their competence by raising questions and viewing performance in the flesh.
Having taken an initial position, it is not unreasonable to increase the size of holding, by degree, particularly when momentum is on your side.
Sadly the old card trick of 'adjusting the pack' has been played in this case.
It is now common the quote both adjusted and reported figure. Which to believe? The factual number, arrived at on the reporting date or the one dressed up to make the reader believe that all is right with the company and to just ignore the adjustments, because they will just go away.
Hmmm... You are absolutely correct to look at the cash position. That does not lie, it is either in the bank, or it isn't.
It has become all too easy to hide indiscretions and problems under the heading of adjustments, and to make believe that they are non-recurring. In most cases, they are there for good reason. The numbers quoted are subjective. The auditors will have looked at the arguments put forward, to justify the numbers. The final outcome will usually only be known, somewhere down the track, when the problem has been addressed, and the money spent. Again, it is easy to window dress spending to flatter the outcome, losing attributable costs within normal operating expenses.
It is then a value judgement to let go of the holding. If it subsequently bounces, you kick yourself for jumping too soon, but how many times do you see a share re-rated downwards, and then continue to fall even further.
Once the story changes, for the worse, caution is the by-word. Better to lose 6,7 or 8% than 60,70 or 80% plus!!
By preserving the remaining capital, you have a better start point for the next train that comes along.
Good hunting

 

[Colm Fagan]

The numbers quoted are subjective. The auditors will have looked at the arguments put forward, to justify the numbers.

I'm not an accountant, so I don't know if the auditors have any input to what goes into (and more importantly, what's excluded from) "adjusted net income". When the term is used, it's always qualified with "not an IFRS measure", which leads me to think the auditors don't have an input to the calculation. Do you or any of the other experts on the forum know the answer?

 

[redartbmud]

The report of the auditor, within the annual report and accounts requires them to comment that the report gives " a true and fair value of the state of affairs of the company" at the relevant date.
In so doing, they will have reviewed, in detail, any reported adjustments, and assessed their materiality in relation to the overall results.
The detail within their audit report should comment on such work undertaken and to give an assessment of the risk of material misstatement.
They should set out the parameters that have been applied when arriving at their conclusions.

A bit wordy, but I hope that I have answered the question.

 

[Colm Fagan]

Hi unpronounceable name. I don't think it's that straightforward. The auditors' certificate (for Samsonite, probably the same for other companies) confirms that they have audited the consolidated financial statements (which don't include the "adjusted net income: it was mentioned in the CEO's report) and that they (i.e. the consolidated financial statements) "present fairly .... the consolidated financial position of the Group ...in accordance with IFRS"
As far as I can see, they're running a mile from making any comment on the truth and fairness of "adjusted net income", but I recognise that I'm in foreign (i.e. accounting) territory - probably the first actuary in history to realise that I can't tell accountants their business!

 

[redartbmud]

Hi Colm,
My personal experience goes back a very long way now but, in my day, we used to pay particular attention to extraordinary and exceptional items reported in accounts:
1. Justification.
2. Relevance.
3. Significance to the results.
4. Underlying assumptions. - basis on how the provision had been calculated.
5. Quantification of the figure. ie. make up of the number.
In the following year, the useage of the provision was audited, to ensure that any remaining provision should be carried forward, written back to profit, or increased, if the problem remained ongoing. (Not necessarily relevant to a write down of goodwill.)

Yesterday, I just happened to be looking at the Audit Report on the annual accounts of De LaRue, which stretches over 7 'dusty' pages.
Their Adjusted operating profit was £87.3m and the Reported operating profit £123.3m.
The auditors report against key sections of the accounts, stating their view on the risk of material error in the reported figures, and the steps taken to review and assess the compliance to statutory reporting requirements and the subsequent impact and probability of material misstatement of the numbers.
I would therefore contend that they have in fact audited the numbers for adjustments.

My bone of contention is that modern techniques rely far too heavily on statistical analysis of probability and risk. As long as something falls within an accepted tolerance, then it is perhaps 'too readily accepted'. Their whole statement is very meaty and difficult for the layman to digest.

That is my humble defence, which I lay before you.

redartbmud

 

[RedOnion]

The report of the auditor, within the annual report and accounts requires them to comment that the report gives " a true and fair value of the state of affairs of the company" at the relevant date.
In so doing, they will have reviewed, in detail, any reported adjustments, and assessed their materiality in relation to the overall results.
The detail within their audit report should comment on such work undertaken and to give an assessment of the risk of material misstatement.
They should set out the parameters that have been applied when arriving at their conclusions.

A bit wordy, but I hope that I have answered the question.

Not in Hong Kong where Samsonite are listed. The audit rules are very old there, and if you look at the Samsonite annual report, the audit report is only a single page.

Compare to something like Bayer, where adjusted numbers are specifically addressed.

 

[redartbmud]

Colm,
Maybe it will be wise to avoid future investments that rely on a footballer, such as Christiano Ronaldo, to front an advertising campaign.
You know from his image that he is more a LV kinda guy, more so than Samsonite
(The full LV name appears to be a banned word)

Just sayin'

red

 

[redartbmud]

Colm,

Ah the dreaded International Boundaries and Universal Audit Standards.
That should be addressed. The domicile, for governance and reporting standards for International Companies should be exactly the same the world over, and not be left to chance, where possibly lower standards are applied in certain countries
That is Utopia, I know, and maybe it is for good reason that many of the European Nations have joined together to form The EC.
I do not wish to get drawn into the political debate over Brexit, but society is now global, like it or not, and there must be continuing moves to raise standards, across the globe, in all aspects of life.

 

[Colm Fagan]

It's great, at this age, to be still learning. Thanks, guys/ gals. Interesting. The "Control F" function is very handy. I used it to search for the word "true" in the Samsonite results. Not once (unless you allow "true-up"). More interesting still, I looked at the latest accounts for a recent addition to my portfolio (which hasn't yet appeared in the diary). It's a UK company, so everything should be shipshape (until Jeremy, John and their commie buddies take over, or alternatively Boris and his F*** business colleagues, but I digress). I searched for the phrase "true and fair" in its accounts. Not once. My understanding (speaking again as a non-accountant) is that auditors have managed to weasel their way out of certifying that accounts give a true and fair view. Apologies to my auditing friends. No more invitations to breakfast briefings or even the occasional dinner at their expense.

 

[RedOnion]

auditors have managed to weasel their way out of certifying that accounts give a true and fair view

No, the requirements are set out in company law in the UK. They may describe it as "free from material misstatement", but by providing an opinion they say they represent a true and fair view.
A simple language version of UK auditor responsibility:
www.frc.org.uk/auditorsresponsibilities

You'll find a lot of UK reports include a link to the above.

Edit: I'm an accountant, but not an auditor.

 

[Colm Fagan]

@RedOnion Thanks! I don't have time now (I'm under pressure to get back to sunning myself!!), but I'll look at it later. One quick question though: why don't the words "true and fair" appear in the UK company's accounts?

 

[Sunny]

Whether you look at adjusted net income is up to the investor. It can often include some useful information around fluctuations in reported income but as also mentioned, can be a useful place to be 'creative'. The issue as stated is that it is not an IFRS measure so it is not standardised. This makes comparison a bit more complicated if you are using adjusted figures as you can bet that two companies are probably doing different things (without breaking any rules I should add!). Cash Flow Statement is still king to me but that's probably because I come from a fixed income background.

 

[RedOnion]

One quick question though: why don't the words "true and fair" appear in the UK company's accounts?

So, I was incorrect above. UK company law explicitly requires auditor to provide an opinion as to "true and fair". The material misstatement is used more in detail, but the opinion requires true and fair language.

Taking Diageo as an example;
"In our opinion:
• Diageo plc’s group financial statements and company financial
statements (the ‘financial statements’) give a true and fair view
of the state of the group’s and of the company’s affairs as at
30 June 2018 and of the group’s profit and cash flows for the
year then ended;"

 

[redartbmud]

I think that the "True and Fair" debate can now be safely put to bed

Mr Fagan, please ensure that you do not get too much of the sun.
It can create much confusion, in the area of the body where the "little grey cells" function. Hercule Poirot.

Red Onion. Thanks.

Cheers

 

[Colm Fagan]

I think that the "True and Fair" debate can now be safely put to bed

Agreed, and thanks to all for your input (although I've still some homework to do, to read up the link suggested by @RedOnion
I'm also reassured by @Sunny 's comment that:

Cash Flow Statement is still king to me

Yes, I too ended up looking at the cash flow statement when I got confused by the adjustments made to arrive at "adjusted net income". As an aside, it seems that analysts have now reached similar conclusions to those I arrived at last week. The Samsonite share price is now HK$22.35, compared to an average €24.63 when I made my final disposal.

 

[redartbmud]

Off at a tangent:
UK audits focus on the Balance Sheet, more than the P&L A/c. and in the USA the bias is towards the P&L A/c, rather than the Balance Sheet.

I can remember, back in the day, I had an American client whose year end was 31 December. We used to audit the stock on 30 September, then roll the figure forward to the year end by sampling transactions over the 3 months. It was the only option- they almost wanted the audited results before the year end - very tight timetable

 

[Colm Fagan]

"Shareholders Have Feelings Too"
is the title of my latest diary update (number 14). The "speed-read" is as follows:

"A Lord venting his frustration helped propel me to a 25% profit on an investment. I then dumped the shares at the scent of possible trouble ahead"

The full update is as follows:

Company bosses should treat shareholders as their friends. No, closer even than friends. How many of your friends would be prepared to hand you money on the vague promise that you would see them right if things went well, but they could wave goodbye to their hard-earned cash if things went badly? The Chairman’s and Chief Executive’s statements accompanying Annual Reports can inform shareholders, sometimes unintentionally, what companies really think of them. In April, I dumped shares that I had bought only six weeks previously, partly because I concluded after reading the Chairman’s and Chief Executive’s statements that the company didn’t value its shareholders and didn’t care much about their feelings.

Charles Taylor plc is a UK small cap company, meaning that it is listed on the main London stock exchange but is outside the top 350 quoted companies. It provides support services to the insurance industry.

In March, I decided to invest in Charles Taylor at £1.94 a share, mainly because Lord John Lee, a successful investor and a former Conservative MP who writes an occasional personal finance column in the Financial Times, thought they were good value a year ago at £3 a share. The company hadn’t told the stock exchange of any material adverse developments in the meantime, so I reckoned its shares must be even better value now, more than a third lower. I was also reassured by the dividend of 11p a share, implying a dividend yield of close to 6%. Companies generally set dividends at a level they think can be maintained in normal circumstances, so even if the price were to fall, I would still earn a good running yield. I decided to invest only a small amount, in keeping with my recent resolution to start with a small stake in a company and to increase it only when I got comfortable with the company’s strategy, its financials and its people (see diary update 11: “The Virtues of a Small Harem”).

Charles Taylor’s results for 2018 were published on 13 March, the morning after I bought the shares. I put the results aside to study later, but I was happy with the proposed 5% dividend increase. It signalled that the Board and management had confidence in the company’s prospects.

The price hardly moved after the announcement, indicating that the results and prospects were broadly as the market expected. I took this as another encouraging sign. Then something strange happened. After staying almost unchanged for three weeks, the share price suddenly jumped 8% on 3rd April, to £2.16, for no apparent reason. It jumped again to £2.37 on Monday 8th April and kept rising over the next couple of weeks, hitting £2.52 by Friday 19th April. It was now up 30% on when I bought just five weeks previously. Naturally, I was happy with this turn of events but asked myself: why did the market wait three weeks before reacting so positively to the results?

I discovered that the price jump on 3rd April came immediately after an article by columnist Lord John Lee appeared in the online edition of the Financial Times. Referring to his holding in Charles Taylor, Lord Lee wrote: “I had expected that the results would deliver a modest bounce in the share price, but hardly a movement.” He was right: the share price hardly moved before his article was published. It soon made up for lost time. The price jump of 3rd April was followed by a further boost when the article appeared in the following weekend’s print edition of the paper.

It was time to do my homework on Charles Taylor, to decide whether to cash my gains or to make a serious long-term investment in the company. As always, I started by reading the Chairman’s and Chief Executive’s statements in the Annual Report. They painted a picture of a business going through a lot of change. Three companies were acquired in 2018 and the business undertook a major reorganisation.

Acquisitions can be good news for a company. They can also cause problems, financially and culturally. Charles Taylor’s largest acquisition in 2018 was of a Latin American insurance technology business (“InsureTech” is the buzz word) called Inworx. It cost the equivalent of more than two years’ dividends. Earn-outs for management could add significantly to the cost – possibly close to another two years’ dividends. Charles Taylor asked shareholders to fund the acquisition. The new shares were placed at £2.60 each.

Anyone who subscribed to the share placing in May 2018 was nursing a loss of around £0.90 a share by March 2019, when the Chairman and Chief Executive were composing their statements. Yet neither showed any concern for shareholders’ feelings. On the contrary, they seemed pleased to have persuaded them to pay a high price for the new shares. In the Chairman’s words, the oversubscribed share placing “demonstrates our shareholders’ confidence in the Group’s long-term strategy”. The Chief Executive followed up with “we have managed proactively our financial leverage through a significantly oversubscribed share placing.” In plain English, he was trying to say that it was better to have got the money from shareholders, who wouldn’t have to be repaid, than from the banks, who would demand their pound of flesh. Yes, a new share issue was better for managers; shareholders might think differently.

The Inworx acquisition could cause cultural problems. Integrating an acquired business is difficult at the best of times; it is even harder in cases such as this. Charles Taylor’s Board and top management are predominantly British; Inworx’s base of operations is in Latin America and presumably most of its management team are there too. Only one of Charles Taylor’s eight-person board and just one of its eleven-strong Executive Committee have deep technology expertise. Will the company’s Board and Executive Committee be able to rise to the challenge of integrating successfully a technology business that has its headquarters thousands of miles away in Latin America, in a different time zone, whose executive speak a different language day-to-day and who operate in a very different cultural milieu? The high earn-out element in the purchase price exacerbates the integration challenges.

Charles Taylor’s finances are also a source of concern. The company lost £3.3 million in 2018, which was transformed into a profit of £22.3 million after adjusting for exceptional items. I’m always wary of such adjustments, especially when they improve the result significantly on a consistent basis. In each of the last four years, Charles Taylor’s adjusted profit was higher than its published profit. Worryingly, the amount of the adjustment increased each year, rising from £1.4 million in 2015 to £4.0 million in 2016, to £7.9 million in 2017 and to a whopping £25.6 million in 2018.

The financial, strategic and cultural risks were too high for my liking, so I bailed out on 23 April, at £2.49 a share. By deciding to cut and run, I was admitting to another failed attempt to add to my harem, i.e. my portfolio of long-term holdings. There was some consolation in the form of a tidy profit from the adventure, for which I thank Lord Lee.

 

[redartbmud]

Due diligence.
Charles Taylor is a small business in a niche sector that operates in 29 countries across the globe. The management must therefore have a reasonably good grasp of those markets and the key players involved.
My first alarm bell that rings, when I examine the acquisition of Inworks is Argentina, closely followed by technology.
We are all aware that Argentina has major structural and financial problems. Then there is the vexed question of technology that has been the death knell of many a good business.
You point out, very clearly, the obvious operating difficulties associated with a subsidiary based "thousands of miles away in Latin America, in a different time zone, whose executive speak a different language day-to-day".

Deeper inspection of the company accounts reveals some interesting statistics:
Revenue has increased from £122.76m in 2014 to £210.32m in 2017, but operating profit remained stubbornly flat - £10.98m (2014) and £10.27m (2017).
Over the period, EPS has been on a declining path and the dividend flat, as does the Operating margin and ROCE.
Turning to the Balance Sheet, Intangibles rose from £55.09m to £107.98m.
They are hardly stellar numbers for a growth business. The material rise in the intangibles denote significant investment, that shows little return by the way of profit.

Your further revelations on the treatment of exceptional items sets 'Big Ben' striking 12 bells, and that is without recourse to the forensic examination of free cash flow.

That having been said, the timing of purchase and quick sale, has generated a tidy profit. well done!!

My personal view is one of higher than the average risk for a small cap stock - Not for Widows and Orphans, and those following a quiet life of Retirement.
It is very easy to buy into the glossy hype of a well oiled machine, that has a strategy of growth through acquisition, but controlled and quality must rank highly on the sheet of objectives, when filtering for suitable businesses.

redartbmud