The nerves were tested last week. Back in Q4 last year the 17% fall in the FTSE 100 was one of those typical draw-downs that happen towards the top of a bull market. It is necessary to have sucked in all the “buy the dip” money before the market can reset finally when the mood turns to “sell the rally”.
Two things happened last week:
First was the inversion of the yield curve. This is supposed to be a sure-fire indicator of recession. But with low interest rates globally I am not sure this will be quite the savage recession that some of us have known in our youth. Last week Jyske bank launched the world’s first negative interest rate mortgage. You don’t actually get cash in your hand but each month the mortgage decreases by more than the amount of the mortgage payment. This is confusing. The FAQ’s on the website are full of questions such as “How is that possible?” and “Did I read that right?”. Last week the cry “inverted yield curve” seems to have caused contagion from debt markets to equity markets. Yield curves have been predicting downwards rates, implying a recession for a while, but equities have been ignoring this flashing warning indicator.
Second was the IPO documents for WeWork were produced causing a stampede of commentators to call out the most ludicrous IPO in history. To be clear this is a company in need of financing and if it doesn’t get funding from the IPO I am told it could be out of business this year.
This company pledges to donate $1bn to charitable causes over the next 10 years, the founder has pledged his shares to banks against a $500m loan facility. The company acquired the rights to the name “WeCompany” from the founder for $5.9m when the company name was changed from WeWork to WeCompany. The founder, by increasing the voting rights of “b” and “c” shares in the IPO will maintain majority control post IPO. It aims to “elevate the consciousness of the world”. The financials don’t look too pretty but at least the prospectus assures us that the cash burn will be “efficient”. I find this worrying as an indicator of the cleansing needed in markets.
Nothing New
Market behaviour is in line with previous occurrences so perhaps history has some lessons to teach us here. We have had a credit crunch like 2009 before. Which brought on similar subsequent lunacy in markets. In 1672 Charles II defaulted on royal loans causing a banking collapse. 5 London Goldsmith went bust, 9 others were in drastic difficulty and 10,000 wealthy family were “financially embarrassed”. As part of the remedy credit rules were relaxed and there followed the 1680’s containing some wild speculations in wreck salvaging companies and other new technologies. There was the listing for the “Company for the Sucking Worm Engine” which aimed to produce a fire engine. The “Night Engine Company” which was to provide a deterrent for burglars sounds an interesting one while my favourite is perhaps a company which listed in order to “drain the red sea to recover the gold abandoned by the Egyptians after the crossing of the Jews”.
This was all very exciting until the unfortunate incident of a 9-year war with France started in 1688 which ended the speculation.
There seem to be some parallels today. We have market listings that are extreme, we have high debt and we are beginning to see some financial innovation. And we still have some differences in Europe. I am inclined to think this may be a modest correction to sort out the stupidity as we can see the financial innovation that will ensure money is invested or spent on account of negative rates. This is a cycle and no one knows for sure where we are on the chart below although I am sure many will have a view:
Source: Forbes
Behaviour is now important
Personally, I am sensing we may be at the “Anxiety” point above. Which may mean that in the short term this will undoubtedly be a time to hold our nerve and not get frightened out of investments at the wrong moment. It is a time to know why we hold every stock and stick to the reason we hold it. Rarely will that reason change just because the share price changes. But it will play with our minds. We need to stay focussed and know that what happened 350 years ago will be similar this time. And hold tight while picking opportunities as we find them. We need to know our temperament and not let the investment demons frighten us in the dark. I find I can relate to investing in terms of agricultural personalities:
The Trader This investor is an emotionless being. They looks at shares as pebbles to be picked up and skimmed or to be thrown away. They are generally jovial and treat it all as a game. The rules of gaming apply. A losing streak can take the trader down. But he will still be smiling.
The Farmer This is a more reflective being who follows the circle of life. Investing in young companies and harvesting when they are ripe. They like growth and are patient with growing pains. But they can get emotional when blight ruins a crop.
The Hunter This species are seeking out the big winner. The hunt is long and thorough and when they have tracked it and chased it down will seize their opportunity. Their weakness is when they find their elephant turns out to be an antelope, they may lose interest and go hunting again.
The Landowner A very rare species this one. He just forgets about the stock and goes home. He isn’t driven by profits but seems to accumulate them. It needs a level of patience that few possess. Usually restricted to the ultra-high net worth breed.
For myself I feel that I am in the camp of being a farmer. That’s why I like small companies. I like ones that can grow large. Every few years the growth pauses as they need to invest in the next layer of infrastructure before moving back to growth again. And that is why I am interested by recovery situations and companies that are well invested with strong balance sheets and dedicated management. I want those companies approaching spring-time and I want to sell them when everyone wants them in summer.
Companies
It is no coincidence that I have previously covered a number of these stocks under various different themes (below). Tatton and Gresham are perhaps in the late spring while H&T and Ramsden are yet to show any of the benefits of recent investment so may better be thought of as early spring.
Company/Date of comment and links below:
Tatton Investment Management – 24 June 2019 Click here
I sense it may be useful to add a couple of others that perhaps should go on watch lists. With markets having sold off close to 9% I am tempted to go a little further up the risk curve. Market sell offs tend to create value opportunities. I am intrigued by the extreme valuations of these two stocks which I have been tracking looking for an opportunity. They are coming to the end of a difficult period with strong balance sheets and profitable models. Archetypal Benjamin Graham stocks. Cheap on earnings basis, dividend basis and book value basis. And if spring-time is near…
Plus 500 – It has been a harsh winter
Share Price 724p
Mkt Cap £820m
Source: SharePad
The 5-year chart shows the seasons this stock has already been through and the regular phases of investment followed by harvesting.
Company
This spread-betting company has a number of negatives that invites cynicism. It is an Israeli company with Israeli management which has been prone to upsets. Given that 80% of spread-betting customers lose money which will bar it from investors portfolios. It is also this factor that arouses the interest of the regulator who is tasked to protect the customer.
On the other hand, it is unique as essentially being a technology company operating with a large technology team harvesting online customers far more efficiently than the competition and as a result it makes far higher operating margins than any of the competition such as IG Group and CMC Markets. It also has more cash relative to its market cap than its comparators (see below).
Source: SharePad
Regulation
In July 2018 ESMA, the pan European regulator for Plus 500’s products announced it was going to bring in new rules which had the following effect:
Prohibiting the sale of binary options to retail investors (at the time reported to be c5% of Plus500 business)
Lower leverage limits on Contracts for difference trades. At the time traders were betting on the most popular product of currencies and equity indices at leverage of 200:1
Protection for customers against having negative account balances
New tighter close out rules
Standardised risk warnings and disclosures
It was largely the lower leverage limits that had the biggest impact on these firms. One of the attractions was that customers had significant upside so perhaps this is one of the difficult areas where investment meets gaming. Its OK to pay for gaming but this is regulated by a regulator who is used to protecting investors. The result is that inevitably revenues were going to fall. The problem for investors was that no one knew by how much. The share price graph above tells the story that when the effects became known in February 2019 it was worse than feared.
Results March 2019
The results themselves were stellar with turnover up 65% to $720m and a 70% operating margin delivering profit of $379m. A dividend was paid out that equates to a 22% yield at today’s share price. Except the outlook statement said the effect of the ESMA proposals was worse than they had anticipated. Allied to this the company intended to maintain its marketing spend in order to benefit the company over the medium term meant a material downgrade to estimates.
Estimates
The analysts trying to estimate the effect of the new market can be seen clearly on the SharePad chart below. It looks a bit like the random walk of a drunk to me which may well be the reality of the analysts insight into this new world they were operating in.
Today forecasts look like this:
Source: SharePad
So, this makes me wonder when the market will deem it to be spring and this company is once again deemed to be a growth business again. It could be when these rather dismal year-end December 2019 results are announced or it could be ahead of that. Importantly we had a H1 pre close update issued on 2 July stating that competitors had also reduced marketing spend and as a result they were acquiring more customers at a reduced cost. The shares responded mutely.
Valuation
On these earnings estimates which analysts appear to believe are trough year earnings the shares trade on a PER of 7.1X. There is also a yield of 8.5%. Even at this low valuation the company still trades at a premium to its asset value because the ROE is so high.
Conclusion
This is not a stock for everyone as there are risks. Further regulation is a significant one of these risks. But it does have all the hallmarks of recovery with a strong foundation. I sense there could be a very good return to be had here but I will make a personal note to remember to sell this one when it is more accepted because it is a risky one. In farming terms this is a bit like a weaner to “bring on and get to market”.
IPF – Is it Springtime yet?
Share Price 96p
Mkt Cap £214m
Source: SharePad
Sector
This was the overseas home credit division of Provident Financial which was demerged from Provident Financial in 1997 and listed separately. I accept that many find this high cost credit to be unethical but that is not a view I share. All the home credit companies were originally retailers. Provident was once called the Provident Clothing and Supply company, S&U stands for “Sports and Utilities” which was originally the retailer that formed NSF’s home credit business while MorsesClub was once a department store. It is no coincidence that IPF is headquartered in Bradford where there is a high immigrant population.
Having been to a hardware store last winter I queued behind an old aged pensioner who was emptying her change onto the counter to pay for her bag of coal and the shop keeper giving her two bags of coal “for next time” I felt I was witnessing the social benefit these companies can provide, and in fact how these retailers turned into lenders. This social benefit was acknowledged by the FCA in their recent review of high cost credit providers. The collectors for these companies visit people’s home and form personal relationships with their customers. Unlike pay day lenders.
It is no coincidence that the peaks in their loan books are at Christmas and the beginning of the school year when uniforms must be bought. However, regulators take a keen interest in the sector.
Issues
IPF has most of its business in Europe, largely Poland and Romania where interest rate caps have been imposed by regulators with some presence in Mexico. The current issue is in Poland where the charge cap is proposed to be reduced from25% to 10% of the loan value which risks making IPF’s Polish credit business unviable. To counter these regulatory issues the company has been developing digital on line loans and moving to larger and longer term loans with lower rates to more credit worthy customers while the shares have fallen 85% from their high in 2013.
Financial Model
The financial model is actually a very simple one. The companies lend £100 and expect to collect back perhaps 85p out of £100 over 6 months. They will charge around £50 interest on this which cover the bad debts of £15 and the cost of collecting and financing etc will absorb perhaps £20 leaving the rest as profit.
Valuation
The shares now trade on a PE of 3.6X and yield 13% on this year’s forecast dividend. The tangible assets on the balance sheet are £371m at the most recent year end which is 73% higher than the current market cap.
Investment Case
The problem we have is that the new lower rate cap in Poland is not yet introduced which makes an investment when we don’t know the likely outcome of the regulatory changes nothing more than a gamble. The draft proposals need to be ratified by the EU and are currently proceeding through the polish parliament. Both parliaments may change the proposals and the process may take some time. In the meantime, the online business and Mexico are growing. In H1 the profit split is below.
Conclusion
The business derives nearly all its profit from Europe where the outlook remains uncertain. But both the digital business and Mexico have the potential to be larger than Europe at once there is a cross over point these shares will be highly rated which means there are enormous rewards available. But I suspect the capitulation moment may not yet have been reached. If and when the Polish regulations have been clarified the company promises it will update investors on the financial impact of the regulations. That may well be the point of maximum gloom. I will keep it on my watchlist with a view to banging the drum on the downgrades. I suspect it gets worse before it gets better. It’s the lifecycle.
Summary
In these more difficult markets, it is important for investors to understand why they hold every stock in their portfolio and be swayed by the self-doubt that difficult markets can induce. This requires an understanding of our own psychology and motivation. I find viewing investing as a farming process helps and difficult markets can present some useful opportunities for the focussed investor. It may be too early for IPF but Plus 500 may be through its difficult winter. Back to take some more bravery pills now.
Weekly Commentary: 19/08/19
Agricultural Investing
The nerves were tested last week. Back in Q4 last year the 17% fall in the FTSE 100 was one of those typical draw-downs that happen towards the top of a bull market. It is necessary to have sucked in all the “buy the dip” money before the market can reset finally when the mood turns to “sell the rally”.
Two things happened last week:
This company pledges to donate $1bn to charitable causes over the next 10 years, the founder has pledged his shares to banks against a $500m loan facility. The company acquired the rights to the name “WeCompany” from the founder for $5.9m when the company name was changed from WeWork to WeCompany. The founder, by increasing the voting rights of “b” and “c” shares in the IPO will maintain majority control post IPO. It aims to “elevate the consciousness of the world”. The financials don’t look too pretty but at least the prospectus assures us that the cash burn will be “efficient”. I find this worrying as an indicator of the cleansing needed in markets.
Nothing New
Market behaviour is in line with previous occurrences so perhaps history has some lessons to teach us here. We have had a credit crunch like 2009 before. Which brought on similar subsequent lunacy in markets. In 1672 Charles II defaulted on royal loans causing a banking collapse. 5 London Goldsmith went bust, 9 others were in drastic difficulty and 10,000 wealthy family were “financially embarrassed”. As part of the remedy credit rules were relaxed and there followed the 1680’s containing some wild speculations in wreck salvaging companies and other new technologies. There was the listing for the “Company for the Sucking Worm Engine” which aimed to produce a fire engine. The “Night Engine Company” which was to provide a deterrent for burglars sounds an interesting one while my favourite is perhaps a company which listed in order to “drain the red sea to recover the gold abandoned by the Egyptians after the crossing of the Jews”.
This was all very exciting until the unfortunate incident of a 9-year war with France started in 1688 which ended the speculation.
There seem to be some parallels today. We have market listings that are extreme, we have high debt and we are beginning to see some financial innovation. And we still have some differences in Europe. I am inclined to think this may be a modest correction to sort out the stupidity as we can see the financial innovation that will ensure money is invested or spent on account of negative rates. This is a cycle and no one knows for sure where we are on the chart below although I am sure many will have a view:
Source: Forbes
Behaviour is now important
Personally, I am sensing we may be at the “Anxiety” point above. Which may mean that in the short term this will undoubtedly be a time to hold our nerve and not get frightened out of investments at the wrong moment. It is a time to know why we hold every stock and stick to the reason we hold it. Rarely will that reason change just because the share price changes. But it will play with our minds. We need to stay focussed and know that what happened 350 years ago will be similar this time. And hold tight while picking opportunities as we find them. We need to know our temperament and not let the investment demons frighten us in the dark. I find I can relate to investing in terms of agricultural personalities:
For myself I feel that I am in the camp of being a farmer. That’s why I like small companies. I like ones that can grow large. Every few years the growth pauses as they need to invest in the next layer of infrastructure before moving back to growth again. And that is why I am interested by recovery situations and companies that are well invested with strong balance sheets and dedicated management. I want those companies approaching spring-time and I want to sell them when everyone wants them in summer.
Companies
It is no coincidence that I have previously covered a number of these stocks under various different themes (below). Tatton and Gresham are perhaps in the late spring while H&T and Ramsden are yet to show any of the benefits of recent investment so may better be thought of as early spring.
Company/Date of comment and links below:
Tatton Investment Management – 24 June 2019 Click here
Gresham House – 24 June 2019 Click here
H&T – 17 June 2019 Click here
Ramsden – 17 June 2019 Click here
I sense it may be useful to add a couple of others that perhaps should go on watch lists. With markets having sold off close to 9% I am tempted to go a little further up the risk curve. Market sell offs tend to create value opportunities. I am intrigued by the extreme valuations of these two stocks which I have been tracking looking for an opportunity. They are coming to the end of a difficult period with strong balance sheets and profitable models. Archetypal Benjamin Graham stocks. Cheap on earnings basis, dividend basis and book value basis. And if spring-time is near…
Plus 500 – It has been a harsh winter
Share Price 724p
Mkt Cap £820m
Source: SharePad
The 5-year chart shows the seasons this stock has already been through and the regular phases of investment followed by harvesting.
Company
This spread-betting company has a number of negatives that invites cynicism. It is an Israeli company with Israeli management which has been prone to upsets. Given that 80% of spread-betting customers lose money which will bar it from investors portfolios. It is also this factor that arouses the interest of the regulator who is tasked to protect the customer.
On the other hand, it is unique as essentially being a technology company operating with a large technology team harvesting online customers far more efficiently than the competition and as a result it makes far higher operating margins than any of the competition such as IG Group and CMC Markets. It also has more cash relative to its market cap than its comparators (see below).
Regulation
In July 2018 ESMA, the pan European regulator for Plus 500’s products announced it was going to bring in new rules which had the following effect:
It was largely the lower leverage limits that had the biggest impact on these firms. One of the attractions was that customers had significant upside so perhaps this is one of the difficult areas where investment meets gaming. Its OK to pay for gaming but this is regulated by a regulator who is used to protecting investors. The result is that inevitably revenues were going to fall. The problem for investors was that no one knew by how much. The share price graph above tells the story that when the effects became known in February 2019 it was worse than feared.
Results March 2019
The results themselves were stellar with turnover up 65% to $720m and a 70% operating margin delivering profit of $379m. A dividend was paid out that equates to a 22% yield at today’s share price. Except the outlook statement said the effect of the ESMA proposals was worse than they had anticipated. Allied to this the company intended to maintain its marketing spend in order to benefit the company over the medium term meant a material downgrade to estimates.
Estimates
The analysts trying to estimate the effect of the new market can be seen clearly on the SharePad chart below. It looks a bit like the random walk of a drunk to me which may well be the reality of the analysts insight into this new world they were operating in.
Today forecasts look like this:
Source: SharePad
So, this makes me wonder when the market will deem it to be spring and this company is once again deemed to be a growth business again. It could be when these rather dismal year-end December 2019 results are announced or it could be ahead of that. Importantly we had a H1 pre close update issued on 2 July stating that competitors had also reduced marketing spend and as a result they were acquiring more customers at a reduced cost. The shares responded mutely.
Valuation
On these earnings estimates which analysts appear to believe are trough year earnings the shares trade on a PER of 7.1X. There is also a yield of 8.5%. Even at this low valuation the company still trades at a premium to its asset value because the ROE is so high.
Conclusion
This is not a stock for everyone as there are risks. Further regulation is a significant one of these risks. But it does have all the hallmarks of recovery with a strong foundation. I sense there could be a very good return to be had here but I will make a personal note to remember to sell this one when it is more accepted because it is a risky one. In farming terms this is a bit like a weaner to “bring on and get to market”.
IPF – Is it Springtime yet?
Share Price 96p
Mkt Cap £214m
Source: SharePad
Sector
This was the overseas home credit division of Provident Financial which was demerged from Provident Financial in 1997 and listed separately. I accept that many find this high cost credit to be unethical but that is not a view I share. All the home credit companies were originally retailers. Provident was once called the Provident Clothing and Supply company, S&U stands for “Sports and Utilities” which was originally the retailer that formed NSF’s home credit business while MorsesClub was once a department store. It is no coincidence that IPF is headquartered in Bradford where there is a high immigrant population.
Having been to a hardware store last winter I queued behind an old aged pensioner who was emptying her change onto the counter to pay for her bag of coal and the shop keeper giving her two bags of coal “for next time” I felt I was witnessing the social benefit these companies can provide, and in fact how these retailers turned into lenders. This social benefit was acknowledged by the FCA in their recent review of high cost credit providers. The collectors for these companies visit people’s home and form personal relationships with their customers. Unlike pay day lenders.
It is no coincidence that the peaks in their loan books are at Christmas and the beginning of the school year when uniforms must be bought. However, regulators take a keen interest in the sector.
Issues
IPF has most of its business in Europe, largely Poland and Romania where interest rate caps have been imposed by regulators with some presence in Mexico. The current issue is in Poland where the charge cap is proposed to be reduced from25% to 10% of the loan value which risks making IPF’s Polish credit business unviable. To counter these regulatory issues the company has been developing digital on line loans and moving to larger and longer term loans with lower rates to more credit worthy customers while the shares have fallen 85% from their high in 2013.
Financial Model
The financial model is actually a very simple one. The companies lend £100 and expect to collect back perhaps 85p out of £100 over 6 months. They will charge around £50 interest on this which cover the bad debts of £15 and the cost of collecting and financing etc will absorb perhaps £20 leaving the rest as profit.
Valuation
The shares now trade on a PE of 3.6X and yield 13% on this year’s forecast dividend. The tangible assets on the balance sheet are £371m at the most recent year end which is 73% higher than the current market cap.
Investment Case
The problem we have is that the new lower rate cap in Poland is not yet introduced which makes an investment when we don’t know the likely outcome of the regulatory changes nothing more than a gamble. The draft proposals need to be ratified by the EU and are currently proceeding through the polish parliament. Both parliaments may change the proposals and the process may take some time. In the meantime, the online business and Mexico are growing. In H1 the profit split is below.
Conclusion
The business derives nearly all its profit from Europe where the outlook remains uncertain. But both the digital business and Mexico have the potential to be larger than Europe at once there is a cross over point these shares will be highly rated which means there are enormous rewards available. But I suspect the capitulation moment may not yet have been reached. If and when the Polish regulations have been clarified the company promises it will update investors on the financial impact of the regulations. That may well be the point of maximum gloom. I will keep it on my watchlist with a view to banging the drum on the downgrades. I suspect it gets worse before it gets better. It’s the lifecycle.
Summary
In these more difficult markets, it is important for investors to understand why they hold every stock in their portfolio and be swayed by the self-doubt that difficult markets can induce. This requires an understanding of our own psychology and motivation. I find viewing investing as a farming process helps and difficult markets can present some useful opportunities for the focussed investor. It may be too early for IPF but Plus 500 may be through its difficult winter. Back to take some more bravery pills now.
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