Good Growth and Why the London Plan is Strategically Flawed

NHS in crisis (queues in A&E, operations postponed and delays getting to see your GP), road network suffering from worse congestion, overcrowded trains and underground in London, air pollution still a problem, not enough schools to accommodate growing numbers of children and simply not enough houses to meet the demand for homes. These are simply symptoms of too many people and not enough infrastructure.

For those concerned about the future of one of the major financial capitals of the world, namely, London, here’s an editorial I wrote for the Alliance of British Drivers on the subject of the “London Plan” – on which there is a recently launched public consultation:

The population of the UK has been growing rapidly and particularly in London and the South-East. The latest figures from TfL show that the number of trips by London residents grew by 1.3% in 2016, up by 19.7% from the year 2000. The population of London grew by 21.4% in that period.

Forecasts for the future are for it to grow from the level of 8.8 million people in 2016 to 10.8 million in 2041 according to the Mayor’s London Plan, i.e. another 22%.

More people means more housing demand, more businesses in which they can work, more shops (or more internet shopping deliveries) to supply them, more transport to move them around and more demand on local authorities to supply services to them.

In addition more people means more air pollution – it’s not just transport that generates air pollution and even if every vehicle in London was a zero emission one we would still have major emissions from office and domestic heating, from construction activities, and from many other sources.

The London Plan and Mayor Sadiq Khan talk about “good growth” but unfortunately the exact opposite is likely to be the case. It will be “bad” growth as the infrastructure fails to keep up with population growth even if we could afford to build it.

In London we have not kept up with the pace of population growth for many years and the future will surely be no different.

London residents have suffered from the problems of past policies which condoned if not actually promoted the growth of London’s population. Indeed Mayor Khan insists London should remain “open” which no doubt means in other language that he is opposed to halting immigration – for example he opposes Brexit and any restrictions on EU residents moving to London which has been one source of growth in the population in recent years.

There are of course several policies that wise politicians might adopt to tackle these problems. Restrictions on immigration and the promotion of birth control are two of them that would limit population growth. China is a great example of how a public policy to discourage children has resulted in dynamic economic growth whereas previously China suffered from population growth that outpaced the provision of resources to support them – result: abject poverty for much of the population; that is now receding into history.

The other answer is to redistribute the population to less crowded parts of the country. It is easier and cheaper to build new infrastructure and homes in less populous parts of the country than London. Back in the 1940s and 1950s there was a national policy to encourage businesses and people to move out of London into “New Towns” such as Bracknell, Basildon, Harlow, Stevenage, Milton Keynes and even further afield.

Government departments that were based in central London were moved to places such as Cardiff or the North of England. The population of London fell as a result.

One way to solve the problems of traffic congestion and demand for housing in London would be to encourage redistribution. This could be encouraged by suitable planning policies, but there is nothing in the proposed London Plan to support such measures. In the past, businesses and people were only too happy to move to a better environment. Businesses got low cost factories and offices. People got new, better quality homes and there were well planned schools and medical facilities.

Despite the attitude of many non-residents to the New Towns, most of those who actually live in them thought they were a massive improvement and continue to do so. It just requires political leadership and wise financial policies to encourage such change.

These are towns with few traffic congestion or air pollution problems even though some of them are now the size of cities – for example Milton Keynes now has a population of 230,000.

It is worth pointing out that past policies for New Towns and redistribution of London’s population were supported by both Labour and Conservative Governments. But we have more recently had left-wing Mayors in London (Ken Livingstone and Sadiq Khan) who adopted policies that seemed to encourage the growth in the population of London for their own political purposes, thus ignoring the results of their own policies on the living standards of Londoners. So we get lots of young people living in poor quality flats, unable to buy a home while social housing provision cannot cope with the demand.

The Mayor’s London Plan is an example of how not to respond wisely to the forecast growth in the population of London. His only solution to the inadequate road network and inadequate capacity on the London Underground or surface rail is to encourage people to walk, cycle or catch a bus. But usage of buses has been declining as they get delayed by traffic congestion and provide a very poor quality experience for the users.

The London Plan should tackle this issue of inappropriate population growth. The rapid population growth that is forecast is bound to be “Bad Growth”, not “Good Growth” as the London Plan suggests. Population growth and its control should underpin every policy that needs to be adopted in the spatial development strategy of London.

For more background on the London Plan, see: https://abdlondon.wordpress.com/2018/01/07/london-plan-abd-submits-comments/

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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The Art of Execution – Essential Reading For Investors

I am an avid reader of newsletters and the national press on investment matters and noticed a couple of writers recently mentioned very positively the book “The Art of Execution” by Lee Freeman-Shor. I have now read it myself and it’s definitely a book every stock market investor should read. Here’s why:

There are thousands of books available on investment, aimed at both neophyte and experienced investors. They tend to fall into two main groups: those teaching you how to pick out good investments and those explaining how successful past investors have operated. Incidentally reading the latter ones simply tells you that there are many different styles that can be successfully used. But the main problem with the former approach alone, as the author points out, is that even with the most expert fund managers (and the most highly paid), only 49% of their “best ideas” made money when he analysed their performance.

Mr Freeman-Shor managed investors in his role as a fund manager at Old Mutual Global Investors and studied all the deals they did over seven years. Some investors made money for him overall but others did not, and the main differentiator was how they reacted to various circumstances, not their skills in initial stock selection.

Every investor faces decisions. When your favourite stock, where you have a big holding, drops 20% do you cut your losses and sell, or buy more? When another stock rises by 20%, 30% or more do you sell it to realise profits in fear of it falling back? Or do you buy more? Or perhaps you sell some and keep the rest (“top slicing” as it is called)? Do you worry when your portfolio ends up with 40% or 50% in one or two holdings?

Many investment gurus tell you to use a “stop-loss” to avoid big mistakes, but Freeman-Shor explains that many successful managers actually bought more if they believed in the fundamentals of a company. Clearly there is more to this subject of successful execution than the simple rules advocated by many. What really differentiated the successful investors is not how good they were at picking out winners, but how they managed their holdings later. He identifies a few distinct styles which differentiate the winners from the losers.

One of the handicaps of professional investors the author identifies is their unwillingness to take risks in case they get fired for short term underperformance. So they tend to over-diversify and take profits too early. These are bad habits that private investors can avoid.

There is much in this book that I have learned myself from 30 years of investing. But the author identifies the key habits and investment styles than can be successful. Essential reading for any new investor and highly recommended. And also interesting for those already experienced.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Hargreaves Lansdown and Fund Charges

There was a good article published yesterday by Phil Oakley of Sharescope on Hargreaves Lansdown (HL). Why are they so profitable a business when, as Terry Smith said, they seem to be in essence a “distributor” operating in a highly competitive field with few barriers to entry? The answer, apart from their high-quality customer service, is the level of charges they make on investment in funds (unit trusts and OEICS, not investment trusts which are treated as shares).

Investors in SIPPs via HL might be paying several thousands of pounds per year on larger portfolios (e.g. £3,000 on £1m and more on larger amounts), when investors would only pay £200 for a similar portfolio in shares. Other platforms also charge more for funds, but are substantially cheaper even so.

Why do they charge so much more for funds than shares? Phil questioned whether there is any more administration as a result.

But you can see why HL and other platforms promote funds so aggressively rather than direct investment in shares or in investment trusts (and bear in mind that there are usually equivalent investment trusts for most OEICs, often even managed by the same managers).

HL seems to be a company that it is better to be an investor in than a customer. Customers are suffering from the syndrome of buying something that they are sold that is in the seller’s interests, rather than standing back and deciding what they want, who they wish to buy it from and what price they wish to pay. In other words, investors are not “shopping around” for the best deal.

For that reason when HL adopted their new platform charges, I closed my account and moved my SIPP portfolio elsewhere. But it’s not a thing to be done lightly as it takes a lot of time and hassle to do so as disgruntled customers of Barclays are finding out. An example of the FCA not ensuring there is a competitive market by guaranteeing rapid transfers as they should be doing.

Now many readers might say, but I don’t have a large portfolio – just a few tens of thousands in value. And I get the same high-quality service for relatively little money. Firstly you need to bear in mind that overall portfolio charges are a significant drag on investment returns. As your portfolio grows, the bigger the drag.

HL may be vulnerable to losing their larger customers, who are clearly the most profitable ones, to competitors who could cream off the big hitters by various marketing tactics. Having a number of different stockbroking accounts, in general I find the administration is fine and they seem to compete on price to a large extent rather than facilities or service. Their focus is on attracting new investors who wish to start investing rather than converting existing investors from other platforms. Perhaps it’s the difficulty of persuading clients to move their accounts that inhibits them and reduces the competitiveness of the market for stockbroking services.

HL might therefore be vulnerable to regulatory change if the FCA tacked this issue vigorously and other platforms got their marketing act together.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Audit Quality and the Caparo Judgement

There was a very good letter from Guy Jubb and Mark Solomon on the subject of the Caparo legal judgement in the Financial Times yesterday (6/2/2018). It was headlined “It is time the curse of Caparo was broken”. Here is some of what it said:

….the joint inquiry into Carillion by the parliamentary Work and Pensions Committee, and Business, Energy and Industrial Strategy Committee, must examine closely the little-known consequences of the Caparo judgment (Caparo Industries plc v Dickman [1990] 2 AC 605), which, in summary, ruled that auditors do not owe a duty of care to any one shareholder but rather to the body of shareholders as a whole, represented by the board of directors. The court decided that it would not be fair to visit what was viewed as indeterminate liability to investors for purely financial loss upon auditors and their firms. This all means that, as a practical matter, the auditors of listed companies are, in the normal course, immunised from the risk of being sued by investors for audit failure. It just never happens.”

The Caparo judgement overturned the previously assumed responsibility of auditors to the shareholders of a company and the general public to ensure that the accounts of a company could be depended upon. The judgement seemed to rely on the fact that shareholders have no contractual relationship with the auditors but only with the company who appoints them.

This judgement made it exceedingly difficult for shareholders to pursue auditors, and although there are possible “derivative” actions there are other obstacles that have been introduced over the years that reduce the potential liability of auditors. One is that they are now mostly not simple partnerships with the partners being individually and personally liable, but Limited Liability Partnerships. Secondly auditors write their contracts with companies and these now limit the scope of liability substantially – they frequently exclude liability for omissions that one would expect auditors to identify.

With the declining quality of audits, and the lack of competition between the big four audit firms, it is surely time to revisit the whole legal framework under which auditors operate. With companies often more interested in reducing audit costs than ensuring the accounts can be relied upon, one can see why and how the standard has been reduced over the years.

It’s not just Carillion that has shown how dubious are current audit standards but the problems in the banking crisis faced by RBS and HBOS were a direct result of lax audit reports. It also extends to numerous smaller companies – indeed too many to mention.

How to fix these problems? These are my suggestions:

  1. Auditors should have a statutory responsibility to the owners (i.e. the shareholders) in a company.
  2. Auditors should personally be liable for failings and not be able to hide behind LLP structures.
  3. Contracts between auditors and companies should be based on “model” contracts as laid down by the Financial Conduct Authority or the Financial Reporting Council, and drawn up based on the advice of investors.

I shall write to my Member of Parliament on this subject as this is something the Government needs to take in hand. I suggest readers do the same. How do you contact your M.P.? Simply go here for contact information: https://www.parliament.uk/mps-lords-and-offices/mps/

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Good News – Shares Are Getting Cheaper!

Yes the markets are plummeting, but that’s surely good news. It means you can buy the profits and cash flow that companies generate at lower prices! But the irrationality of investors and their tendency to follow the herd means they often do not pay attention to this good news.

The market turmoil at present is simply one of those sell-offs where investors think that sentiment has turned and it might be a good time to realise some profits. But the projections for the earnings of companies have not changed, nor for the dividends they might be paying in future.

The stocks that have been badly hit are those where the earnings are non-existent and the cash flow negative. In other words, those where growth in revenue is expected sooner or later to generate some profits. Or where speculators are playing a game of “pass the parcel” where they hope to sell to a bigger fool.

So here’s a few companies that suffered today of that ilk: Blue Prism (down 6%), Purplebricks (down 7%), LoopUp (down 7%), FairFX (down 7%), Wey Education (down 14%). These are not necessarily bargains yet as confidence in their future is everything when evaluating such businesses and confidence is fast evaporating from investor sentiment.

What should one do when the market is falling? One thing to bear in mind is that you can never know how far the market will fall, or when it might start to recover. Don’t try is my answer. Just follow the trend – the trend is your friend as the old saying goes (author unknown). In other words, you should not be buying when everyone else is selling because trends can persist for an unexpectedly long time. You need to wait until the market, and the individual stocks you are looking to buy, really, really do look very cheap on fundamentals. We are surely a long way from that point at present.

I shall wait to see if any bargains appear.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Revenue Recognition, Patisserie Valerie, Utilitywise and Cryptocurrencies

Revenue recognition is a hot topic at present as folks have come to realise that this is a frequent cause of company accounts misrepresenting the true state of the business. Quindell and Blancco are two examples and I cover Utilitywise below. But first let me report on the Annual General Meeting of Patisserie Valerie (TIDM:CAKE) which I attended this morning (as a shareholder of course).

The company operates a chain of cake+coffee shops under the company name but they also have several other brands. However they seem to be concentrating on the Patisserie Valerie one in terms of new openings. This is a typical “retail roll-out” story where they just open more outlets – fixed costs do not increase in proportion so profits grow rapidly. They plan to open about another 20 stores per year at present. The company is run by Executive Chairman Luke Johnson who owns 38% of the company.

Having read the Annual Report I asked a question on revenue recognition because on page 16 it says “revenue recognition has been identified by the audit team as a significant risk”. Perhaps the auditors are now hedging their bets by putting that in all company reports but I found it rather surprising bearing in mind that I expected most customers would be paying cash in the cafes. Indeed the CFO indicated 80% of revenue is in cash. They do issue promotional vouchers but these are not recognised as revenue until used. However they do have some wholesale customers and franchise deals with companies such as Sainsbury where payments are delayed. This explains why they have significant trade accounts receivable at £12.3 million on revenue of £114 million. So I don’t think revenue recognition is likely to be an issue in this company.

Otherwise the AGM was fairly routine and we did get some cake at the end. There were about a dozen shareholders present in the City at one of their outlets. Luke Johnson is not a greatly impressive figure physically (first time I had met him) but answered questions openly. He noted profits were up 19% at £16.4 million. He said they opened 20 new stores and all were immediately profitable. Net cash was £25 million at the year end so they are well positioned for acquisitions if they arise, he noted. A couple of interesting questions from shareholders were:

  1. Is there any difficulty in attracting staff, particularly in London and the South-East. Answer: probably as hard as it has ever been, but they expect a lot of foreign staff to stay in the UK after Brexit and many are non-EU citizens anyway.
  2. Media have reported a possible acquisition of Gails, a similar chain (and partly owned by Luke Johnson I believe). Answer: cannot comment.

In summary, Patisserie Valerie is riding on the popularity of cake and coffee of late, but they are differentiated slightly from common coffee shops. They are also vertically integrated which keeps costs of the cakes low and as a result have good profit margins. Defending that position could be tricky but the business seems to be well managed.

Utilitywise (UTW), a reseller of utility power contracts, has had its shares suspended after failing to file accounts within the timescale required by the AIM market rules. To quote from the company’s announcement: “This delay is due to the volume of work still required to be completed by the Company and its auditor to cater for the proposed change in the Company’s revenue recognition policy, as announced on 17 January 2018. This work includes amendments to the Company’s financial reporting systems in order to analyse energy contract data in accordance with that new policy, alongside associated work by the Company’s auditor, for the audit of its results for FY17 to be completed.”

Now I don’t currently hold this company’s shares but I did briefly from December 2013 to July 2014. The more I learned about the way revenue and profits from contracts entered into that covered future periods were recognised, the more concerned I became. Revenue was still reportedly growing rapidly in 2014 but I sold at about 260p. The share price recently was near 40p.

In my book, revenue and the associated profits from long-term contracts should not be recognised until the cash comes in. But that’s not the way accountants like to handle matters at present. Part of the difficulty lies in costs expended in the short term to obtain or develop the contracts so matching costs with revenue, a basic accounting principle, is a problem.

Lastly I think it is worth mentioning cryptocurrencies, initial coin offerings, bitcoin and blockchain technology. These are all hot subjects that I do not think I have covered before which is probably a gross omission.

Blockchain technology is interesting. It’s basically an “open ledger” which might have many applications, although whether it is really any good for really high volume transaction processing seems to be in doubt. Many banks and other financial institutions seem to be looking at it but it is not altogether clear why they need it (are not existing systems and software adequate enough? Perhaps they are just a bit archaic?). It may be lower cost and simplify development but it potentially has great weaknesses.

For example, Coincheck, the “Leading Bitcoin and Cryptocurrency Exchange in Asia” as they style themselves, recently suffered a hack that meant $500 million has disappeared into the hands of the perpetrators. They have promised to reimburse affected customers but it seems highly unlikely that they have the financial backing to do so.

This is not the first such time this has happened. Another case was that of MtGox which became bankrupt after a similar fraud. So it seems bitcoin systems are not as secure as one might have hoped.

One reason internet fraudsters like payments in Bitcoins is allegedly because they cannot be traced. So does that mean there is no audit trail so one cannot trace where the funds come from and where they go to? This is a major defect in any transaction system which suggests to me that Bitcoins and other similar currencies based on blockchain technology should be promptly regulated by all countries as soon as possible. There may be a need to have a “virtual” currency not controlled by any one Government, but unless it is secure with proper audit trails on its movement, it is not fit for purpose.

The Financial Conduct Authority (FCA) should be looking at this area and pronto before the wide boys of the financial world exploit gullible folks and fraudsters take advantage of its defects.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Government To Review Share Buy-Backs

The BEIS Department of the Government has announced a review of share buy-backs. That’s where the company buys its own shares in the market, a practice that used to be illegal but is now very widespread.

Business Secretary Greg Clark said: “…there are concerns that some companies may be trying to artificially inflate executive pay by buying back their own shares. This review will examine how share buyback schemes are used and whether any action is required to prevent them from being abused.”

If a company buys back its shares, then it will increase the earnings per shares (EPS) because the same profits will be spread over fewer shares. But EPS is often an element in the calculation of performance related bonuses, e.g. in LTIPs. So effectively management can earn bonuses by simply deciding to buy back shares rather than really improving the underlying performance of the business.

Obviously cash has to be used to buy back the shares, and another concern is that this is money that should be used to develop new products, services or markets. In other words, it contributes to the lack of investment in the UK economy. In extremis companies can borrow money (i.e. gear up) to provide the funds to cover the buy-back which increases the risk profile of the company.

There is also the suspicion that some companies undertake large scale buy-backs to support their share price, often encouraged by institutional investors who wish to exit. The directors always deny this, but one can see the sub-conscious motive to “clear-up a share over-hang” that may be present. In practice, share buy-backs may benefit shareholders who are departing more than they benefit shareholders who remain.

In theory, if a company cannot find a good use for surplus cash, i.e. cannot reinvest it in the business profitably, then buying in shares where the per share intrinsic value of the company is more than the market share price should make sense. But determining what is the “intrinsic value” is not at all easy.

There are also tax issues to consider. Some investors think it’s best to retain the cash in the business because paying it out in dividends might incur more tax, and sooner, than the capital value growth that might otherwise be obtained.

You can see there are many complex issues around this topic that could fill a book, or at least a pamphlet. But here are some comments on the approach I take:

  1. I always vote against share buy-backs unless there are very good justifications given by management (and that’s about 1 in 20 votes in practice).
  2. The only general exception I make is investment companies (e.g. investment trusts) where it does make logical sense and can be used to control wide discounts.
  3. I prefer management to reinvest in growing the business if they have surplus cash (and as I rarely invest in no-growth businesses, you can see why the above rules are easy to apply).

If the advisors to the Government determine that share buy-backs are being undertaken for the wrong motives, what could they advise the BEIS to do about it? Reading the minds of directors about their motives for share buy-backs will not be very practical. If they simply wish to stop the abuses related to incentive schemes they could insist that all such schemes (including all share options) should be adjusted for the buy-back – they often are not at present. But would it not be simpler just to revert to the old regime and outlaw them except for investment companies? I do not recall it created any major practical problems.

If a company’s shares consistently trade below “intrinsic value” then someone will buy them sooner or later – after all many people believe in the perfect market hypothesis and it’s probably true to a large extent – particularly with large cap companies where share buy-backs are the most common. So simply banning share buy-backs should not create significant problems.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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