Magic Hat portfolio: RB out, WIN in

It’s time to fiddle with my Magic Hat portfolio
( The exit candidates are BSY, RB, SMWH. I chose to eject RB (Reckitt Benckiser) because it had a PE of 19.2 and an earnings yield of 5.98%. It’s also fairly stodgy.

There’s not going to be much analysis on my buy. I’m basically going to rank the Greenblatt stocks in descending earnings yield, weed out the bad ones, and first past the post wins.

Here’s some that were rejected:

INM has an EY of 83%. That seems to be distorted by exceptional income, though.

CTEK Chinese company. Instant rejection.

RMG Looks like another data anomaly due to exceptional income.

QPP gets a dishonourable mention. Paul Scott has written negatively about it for quite some time. The M-Score puts it as an earnings manipulator. The number of shares in issue has more than doubled over a short timeframe. Revenues were £14m for 2011, and are expected to rise to £1022m for 2014. Seems too good to be true. Receivables are 86% of revenues, which seems suspiciously high. There’s a very distinct whiff of fish about this stock. I see that Stockopedia has an article pointing out that Fidelity has doubled its stake, though. So what would I know?

I’ve decided to put WIN in the portfolio. WIN (Wincanton) is a logistics group. It’s a tricky decision, because Paul Scott has described it as univestable, on account of its balance sheet. However, it did negotiate a new and improved financing agreement on 19 June. It does have a Piotroski score of 8, and a stock rank of 99. It also makes it into the screen of screens. So. Man versus robot. Let’s see who will win.

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$TSCO.L Tesco and the Buffett Test

I found this interesting PDF ( about Buffett’s purchase of Coca Cola from The Odd Lot blog (

The idea is disarmingly simple: you want at least a 10% earnings yield (not actually defined by Buffett, but the reasonable presumption is EBIT/EV), AND you want to convince yourself that that the “coupon” will grow. The sustainability of the coupon will likely depend on a few key factors, and it’s your job to identify and resolve them.

So let’s look at TSCO. According to Stockopedia, it has an EV of £30.75b, based on a share price of around 291p. Its Operating Profit reported on 16 April 2014 was 2631m. Taking that to be EBIT (and we can get into all sorts of arguments about how it needs to be adjusted), we get an earnings yield of 2631/30750 = 8.6%. This is below 10%. Could this be why Buffett was offloading some of it in late 2013?

TSCO’s mean operating income over the last 5 years was 3314m. That would give it an EY of 3314/30750 = 10.8%. So, arguably, it could be considered a purchase – although that depends on your view as to whether declines in profitability over the last two years is a permanent shift. Is it a price war that is only expected to be temporary, or are the likes of Aldi and Lidl changing the
landscape forever? Answers on a postcard, please.

Buffett increased his holding in TSCO on 13 Jan 2012, a day after TSCO announced its results, causing the share price to drop 19%. I’m not going to dig into filings, so let’s say that Buffett bought at 320p – probably close enough.

I’m being a bit broad-brushy, but let’s suppose Buffett was working with the latest available full year results at the time. So that would be annual fiscal data as of Feb 22 2014, with operating income of 3917m, net debt of 6790m and 8046m shares in issue. That gives me an EV = 6790 + 3.2*8046 = £32537m. Thus the EY is 3917/32537 = 12.0%.

So perhaps we should not have been surprised at Buffett topping up on TSCO at the time he did. His crystal ball seems to have gotten a bit hazier since then.

Happy investing to you all.

Update 04-Jul-2014 I have been reading around, and it seems that Buffett wants 10% in pre-tax earnings. So we want to look at things from an equity basis, rather than a firm basis. This actually makes our calculations easier. The latest reported income before tax was 2259m. The market cap is 23050m, based on a share price of 290.85p. So the pretax earnings yield is 2259/23050 = 9.8%. This is below a buy threshold, although only just.

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This is what 6 months of regular drawing can do for you


To the left is one of my first drawings. To the right is my latest drawing. It took long enough to draw, mind.

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REDD – shares up 5.3% on pre-close trading statement

Specialty finance (vehicles) company REDD (Redde) issued a pre-close trading statement, the gist of which is: results likely to exceed upper end of market expectations and net cash is up.

The company also announced the appointment of N+1 Singer as joint stockbroker. REDD (formerly HHR) had a £60m placing Dec 2013 “to fund strategic growth”. In Feb 2014 it announced an acquisition of New Law for £24.5m in cash and £10.5m in shares. They still have a lot of cash left, so REDD could be looking into another acquisition.

New Law had profit before tax of £7m, and net debt of £8.2m. So the total cost is about £43.2m (24.5+10.5+8.2) – which seems OK as an acquisition.

Looking on Stockopedia, REDD has a PE of 10.0, a PEG of 0.69, an EV/EBITDA of 3.79, a stock rank of 93, and is in the Screen of Screens. Is this going to turn out like shooting fish in a barrel?


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June 2014 artwork

June 2014 artwork

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DTG (Dart Group) valuation: 350p, share price 207p

Awhile ago I said that I was putting together an “Aswath” collection of utilities on github to value companies using methods suggested by Prof Damodaran. Work is still ongoing, very scrappy, and mostly indecipherable to an outsiders. One part of it is his much simpler model for 3M. Whilst still not complete, I had written a Fortran program that computes part of it. Although the model is designed for using firm valuations, I thought it would make a good first approximation for equity. The 3M model is much simpler than his model for high-growth companies that might have different phases for revenues growth, losses, and so forth.

The necessary programs are available on github, but I’ll save you the trouble of hunting it down, and present the fortran program that does the calculations:

implicit none

!real, parameter:: rf = 0.0295, beta = 0.2114, erp = 0.0791
real :: rf , erp 
real :: beta 

real :: roe, dcov
real :: eps0 
!real, parameter :: roe = 0.1968, dcov = 2.1, eps0 = 8.98

!real omega, rho
!real a0, theta1, g1, h1

! sensible defaults
!real, parameter:: n = 5.0
integer :: n 
character :: dummy

! intermediate calculations
real :: theta1, g1
real :: gt, r
integer :: i
real ct

real p1, pt0, p0

real :: h1
real :: divs(1:100) ! dividends
read (*,*) dummy
read (*,*) roe
read (*,*) dcov
read (*,*) beta
read (*,*) rf
read (*,*) erp
read (*,*) eps0
read (*,*) n

theta1 = 1-1/dcov
g1 = roe *theta1

! set these intitial values
!beta = 0.2114
!beta = 1.2
h1 = rf + beta * erp

print *, 'g1', g1
r = (1+g1)/(1+h1)
print *, 'r', r, 1/r
do i = 1, n
 divs(i) = eps0 * r ** real(i) * (1-theta1)
 print *, divs(i)
end do
print *, 'p1: sum of divs 1:n', sum(divs(1:5)) ! should equal p1
p1 = eps0 *(1-theta1)*r * (1-r**n)/(1-r)

gt = rf
ct = rf + erp
pt0 = eps0 * r**n * (1+gt)/ct

! calculate pt0 the hard way
!div(n) = div(n-1) / (1-theta1) * (1-gt/ct)
!for i = int(n)+1, 100
! divs(i) = divs(i-1) * 

p0 = p1+pt0
print *, 'p1', p1, 'pt0', pt0, 'p0', p0

!data rf, beta, erp / 0.0295, 0.2114, 0.0791/

!data omega, rho / 2.1, 0.01968/

!data n / 5.0/
!a0, theta1, g1, h1, 
end program 

It is a simple two-phase growth model. Admittedly, the program is very scrappy at the moment, so I hope you can follow it. It is standard Fortran (90?), and ought to compile on any standard compiler. It has compiled using the free GFortran compiler. Linux and Cygwin users should have no trouble getting it working.

Here’s the input file, which you can redirect to the executable you create:

0.14   ROE
8.9    DCOV
1.0    BETA
0.0295 RF
0.0496 ERP
21.4   EPS0
5      N
dated 30-jun-2014

Run that, and you get a valuation of 355.52 – the last number that pops out of the program. A note about the numbers:

  • N is the number of years that the growth phase will continue, before reverting to market returns. Using the value 5 is a very good default
  • ROE is return on equity during the growth phase. Stockopedia is reporting its ROE at 23.8% at the moment, but I’ve used a decade mean of 14%
  • DCOV is the dividend cover. I’m using 8.9, which is around about both the current and decade mean.
  • BETA is the beta of the stock. Quite tricky, because Aswath is publishing betas of 0.94 for air transport, Digital Look has a beta for DTG at 0.83. So maybe you’ll want to re-run the program using a lower beta. I’ve used a beta of 1, nice and simple
  • RF is the risk-free rate, which I’ve used from Jan 2014
  • ERP is the equity risk premium, which I’ve obtained by fiddling with Damodaran’s figures. They are computed or Jan 2014, as per RF
  • EPS0 is the current earnings per share, which I have taken from Stockopedia.

There are a number of other assumptions, like retention rates in the terminal phase, which don’t need to be specified. I’m writing some documentation, which should eventually appear on my github repo, and this will explain how these kinds of numbers can be obtained, and exactly how the DCF valuation model works.

I’m actually becoming quite a bit more keen on Damodaran’s work, because it allows you come up with an actual valuation, and incorporate growth assumptions, which I think is something value investors will  have a hard time doing ordinarily.

Anyway, DTG is taking a hit today, which is inconvenient for me, as I am a holder. Stockopedia has a stock rank of 97, which is obviously very good. Checking another site, I see that valuation ranks are consistent, which is nice to see. It’s also rebounding from being oversold. So hopefully this augers well. Incidentally, I’ve been doing some superficial scanning around on stocks that are cheap and oversold, and I think that it could make for a very interesting article. Just to give you a for-instance, if you had bought PIC (Pace) on 31 May 2011 after the massive sell-off, the RSI dipped to 21.4, and you could have bought at a price of around 94p. You would have needed nerves of steel, because the share price did dip to about 45p. Still, if you had kept the faith, you would had a return of about 55% pa for 3 years (that’s compounded, not arithmetically, and I am talking approximate). So doing some valuation work, looking for good value, and buying when the shares are way oversold can bring exceptional returns. All that is for another article, though.

Share price 207p, Valuation 355p.

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Four sketches of the same subject

Four sketches of the same subject

I thought it would be interesting to see if my sketches improved if I drew the same pricture over and over again. I have shown the sketches in chronological order. Although there is something to dislike in every drawing, it is gratifying to realise that they do get better.

The second one introduces charcoal and white acrylic. It is the least satsifying one.

Picture 3 was drawn from memory, and I feel it looks much more “artistic” than its predecessors.

Pitcure 4 uses pencil, charcoal and pen, and I’m pleased to say that it is the best of the bunch. The way he is coloured is much better.

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