Cash Held by Brokers, and Low Traffic Neighbourhoods

The Daily Telegraph ran an interesting article today on the amount of client cash held by stockbrokers and what they earn from it. Most brokers pay no interest on cash held in broking accounts, but get significant interest on it that they retain for themselves. They singled out Hargreaves Lansdown who apparently received £91 million in the last 12 months (to June) for some criticism. They obtained a margin of 0.75% on the cash held.

Many investors moved out of the stock market during the March epidemic rout but left the cash in their broking accounts rather than move it out, mainly because it’s takes effort and can be tricky to do so with ISAs and even more so with SIPPs.

But you can take cash out of an ISA and put it back in later, just so long as you put it back in within the same tax year. In fact I took quite a lot of cash out of our ISAs and with the market recovering strongly I am moving some back in. I did not expect the recovery to take place until much later in the calendar year. It’s quite difficult to understand why the market is recovering so quickly. Perhaps investors are looking further ahead than the short term poor economic numbers, or are betting on a vaccine working and soon (the FT reported on Russia going into production with one). But I never try to figure out the rationality of the market – I just follow the market trend but selectively about which shares I am buying and selling.

There is a great deal of irrationality in the world at present. A good example was a webinar I attended this morning run by Landor Links on Low Traffic Neighbourhoods (LTNs). These are being promoted by the Government and frequently consist of road closures using the euphemistically named “modal filters” Several of the speakers promoted the wonders of such schemes typically using slides showing the joy of cycling in sunny weather. They failed to cover how the residents of boroughs such as Waltham Forest got to vote on the proposals, before or after implementation. I know there is a very large amount of opposition in Waltham Forest, in Lewisham in the Oval area, in Islington and several other parts of London. But the Covid-19 epidemic is being used to justify emergency measures without any public consultation.

It’s all quite disgraceful as democracy is being undermined and the road network is being destroyed. Traffic congestion in Lewisham for example has been made a lot worse to my personal knowledge and that’s even before the schools return. Labour controlled Councils are frequently a particular problem as they tend to like to decide what is good for you rather than listening to their electorate or taking into account any rational arguments.

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

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Virtual AGMs and How Innovation Works

The Financial Times ran an article today headlined “What’s an AGM without a chat with directors over a prawn sandwich?”. It covered the lack of attractiveness of AGMs now that there are only virtual electronic ones, if any at all, that shareholders can attend. I added this comment to the article on their web site:

“It is most disappointing that many companies are failing to hold virtual AGMs while the epidemic is around. AGMs are a valuable opportunity to ask questions of directors, both formally and informally. But as most have been held in London that means physical attendance for many was not practical. The best solution is a hybrid AGM where people can attend in person or electronically.

The smaller the company, the more valuable the AGM becomes. If they don’t want to hold formal AGMs electronically they could at least provide a seminar for shareholders to attend. But the FCA should draw up some firm rules that stop companies avoiding doing anything.

I am one of those people who regularly attends AGMs and I find them essential to learn more about companies and their management”.

There were a number of other good comments posted, but it is most unfortunate that the FT’s article writer talked about the free lunches and other goodies. Personally I could not care less about the lunches and frequently avoid them. The offered buffets I have found to be a good source of an upset tummy.

Anyway it was good to see today that Polar Capital Technology (PCT) are going to hold a virtual AGM on the 2ndof September. This will not just provide on-line access to the meeting but also support on-line voting using the Lumi Global web site or App (see  https://www.lumiglobal.com/ ). They also support hybrid AGMs which may be useful when the epidemic is over. I am a firm supporter of hybrid AGMs when normality returns as not many people can spare the time to attend meetings in person, particularly if they live remotely from the venue. But physical attendance is still the best if you want to chat informally to the directors, or fellow shareholders, so I would not want to see conventional AGMs abandoned in place of solely virtual meetings.

Polar Capital Technology are of course one of the big investors in innovative technology companies. I am just finishing reading a recently published book by Matt Ridley entitled “How Innovation Works”. I can certainly recommend it for summer holiday reading.

He dispels the myth of the lone inventor or genius creating leap forwards in products by covering many of the histories of past inventions such as the steam engine, the light bulb, the computer, the airplane and the adoption of farming – in other words a very wide period of history. The research that has gone into this book must have been very extensive indeed as so many examples are covered.

What conclusions are drawn? That innovation is typically a collaborative process of many minds and it is frequently difficult to pin down the first inventor. They often all learn from each other. He also looks at what environments encourage innovation and what discourage them. A wealthy and free society helps, while Government direction and monopolies are disadvantages. Few innovations come directly from scientific research financed by Governments or others.

The author emphasizes that innovation is often a gradual process with no great leaps forward in reality – it often just appears so in hindsight. For those investing in technology companies it’s well worth reading to understand why some companies are successful and others not. It certainly matches my experience of working in the software industry.

Now it’s the height of summer, and our windows are open, the flies are swarming into our houses. I recently purchased a great product which I consider a major step forward in fly killing. It’s a typical innovation in other words. It’s like a tennis racket but has wires connected to a battery in the handle that enable you to swat the flies and they instantly get fried when they touch the wires. No more swatting flies with newspapers and leaving squashed flies. Who invented this product? I have not been able to find out. But it is clearly a development of large mains powered fly killers that one saw on the walls of shops in the past. A photograph is below.

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

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FCA Seminar and Property Funds Rule Change

The Financial Conduct Authority (FCA) is consulting on a rule change for open-ended property funds. The problem of such funds holding illiquid investments in direct property are well known. If investors want to sell when property goes out of favour, the funds simply cannot sell their underlying holdings fast enough. It can take months to do so when investors in the funds expect their cash immediately. Or as the FCA puts in, there is a mismatch between the liquidity offered to investors in the funds, and the liquidity of the fund’s holdings.

This problem has resulted in the funds having to be “suspended” or “gated” to stop redemptions, and many still are after the March crash this year.

The FCA’s solution is to require investors to give notice before they can get their cash – potentially up to 180 days. But this would probably mean that investors would not be able to hold such funds in ISAs, unless their rules are changed. Needless to say, investors who currently do so are not going to be best pleased as they would have to sell them.

This is a very simplistic solution to a long-standing problem, and to my mind may not solve the problem as disposing of property can take longer than 180 days if you want to obtain a fair value for it. Permitting illiquid investments of any kind to be held in open-ended funds is simply wrong.

Such funds should be wound up, or converted to investment trusts which is surely not impossible. Meanwhile I won’t personally be responding to this consultation as I am not so daft to hold such funds, only property investment trusts.

See the FCA press release here for details: https://www.fca.org.uk/news/press-releases/fca-consults-new-rules-improve-open-ended-property-fund-structures  and for how to respond to the consultation.

Yesterday the FCA presented at a seminar hosted by ShareSoc and UKSA as a webinar. Mark Seward was the speaker from the FCA but he did not cover the above issue at all (he is responsible for “Enforcement and Market Oversight”).

He did cover the outcome of the Redcentric case where grossly misleading accounts were published. He said the investors had “purchased a lemon”. They did not fine the company, but the company is compensating the shareholders affected and 3 former executives are awaiting trial. He explained the reasons for the FCA’s actions which seemed reasonable to me (I never held the shares though – those more familiar with the case might have a different view). He also mentioned the Burford case and the legal decision re disclosure of trading data and made some uncalled for derogatory remarks about the comments made on it by some ShareSoc members.

He covered the emergency measures introduced by the FCA for the Covid-19 epidemic which he said enabled the UK markets to raise 3 times more capital than any other European market in the first half of the year. But Mark Northway raised the issue of the problems of private investors participating in these fund raisings. I would also have liked to see the issue raised of companies not providing access to AGMs nor any other means for shareholders to talk to the directors while the epidemic rages.  

Another issue discussed was the outright refusal of the FCA to provide any information on the progress of an investigation. This is exceedingly frustrating for investors as it means after a complaint is made, there is no apparent action for many months if not years. When many of the facts are reasonably well known and in the public domain already (as in the Redcentric case, or in other cases such as those of Globo or Patisserie) this can appear quite unreasonable.

Mark Seward suggested that no regulatory body (for example, the Police) discloses anything about their investigations, partly because the evidence might disappear if they did. But this is simply not true. The Police often inform victims of crimes about the progress of a case, sometimes albeit on a confidential basis. Victims and the police are also entitled to follow the “Code of Practice for Victims of Crime” published by the Government which the police have to adhere to (but not the FCA who are specifically excluded for no good reason).

The seminar was not altogether a waste of time, but could have had a much sharper agenda.

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

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On the Wealth of Nations

The stock market’s in the doldrums and August is coming up when everyone goes on holiday. But I would guess many of my readers will not be going far, or not at all. You may need some lightweight tome to read on your sofa or on the beach though, so here is a book I have just finished and can recommend.  

It’s called “On the Wealth of Nations” by P.J. O’Rourke. First published in 2007 and claiming to be a New York Times Bestseller, it’s a digest and analysis of that venerable book of the same title by Adam Smith which was published in 1776. I tried reading that book many years ago but found it heavy going. It’s long and in a somewhat archaic style but it was the foundation of much subsequent thought in economics. For anyone interested in the worlds of business and finance, it provides a primer on the division of labour, productivity, and free markets.

P.J. O’Rourke is a very unlikely person to take a stab at popularising Adam Smith’s book but he makes a very fine job of it. He is a comic writer and wit whose reporting on the war in Iraq and in motoring stories in such books as “Give War a Chance” and Holidays in Hell” are also worth reading.

O’Rourke relates much of Smith’s adages, aphorisms, epigrams, insights, observations, maxims, axioms, judicious perceptions and prejudiced opinions (which Smith produced in large numbers) to the modern world. Here’s one example: “The freedom of the market, though of uncertain fairness, is better than the shackles of government, where unfairness is perfectly certain”.

Smith lived before the rise of modern capitalism and the importance of the joint stock company. But he wisely had this to say (as O’Rourke quotes) that as the result of an immense capital divided among an immense number of proprietors [shareholders]:  “It was naturally to be expected therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs”. That’s still true of many companies is it not?

O’Rourke relates two very amusing anecdotes about Smith and his absentmindedness. He is supposed to have gone out into the garden in his dressing gown and, lost in thought, wandered into the road. He walked to Dunfermline, fifteen miles away, before steeple bells broke his reverie and he realised he was wearing his robe and slippers in the midst of a crowd going to church.

At another time, deeply involved in conversation over breakfast, he put bread and butter and boiling water into a teapot and then pronounced it was the worst cup of tea he had ever had.

Some of the issues that Smith discussed in his book such as whether to support free trade or not, what are good taxes or bad taxes, and what level they should be at, are still the subject of topical debate.

In summary O’Rourke’s book is easy reading but still prompts much thought on the world of business, economics and politics.

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

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Tech Stocks Bubble Bursting? And Is Stockpicking a Waste of Time?

The bubble in technology stocks seems to be bursting. There were a couple of interesting articles published in Shares Magazine and in the Financial Times this week. The first was headlined “Tech Stock Mania”. It suggested investors had been piling into technology stocks in volumes not seen since the dotcom bubble of 1993/2000 which I well remember. That was an age when the market valuations of such companies became totally detached from reality and the fundamentals on which you value companies. The mantra was that growth was everything to capture market share in the brave new computer software and internet world. Is it different now?

Technology stocks have been attractive of late because revenue growth is still there and the avoidance of personal contact has driven the need for more digitization and for new software products. Shopping has moved decisively to the internet and video tools and social media have become more widely used. Zoom’s share price has risen by 260% since the start of 2020 and electric car maker Tesla almost as much making the company the most valuable car producer in the world, even though they produce relatively few cars. There was a general rise in all the big technology shares this year until a sell-off in mid-July. It appeared that the increase in valuations was being driven by momentum as investors bought in response to share price rises, which is a great merry-go-round if you can jump on and off at the right point. Just looking at the vertiginous charts of some of these companies can spook you. It’s not that I am a great follower of charts, but when I see a rise in the share price faster than any growth in sales or profits, then this tells me that the market is getting over-excited.

I am of course a great believer in the merit of technology companies where growth can be achieved but past technology giants did not always grow for ever – IBM, Hewlett-Packard and Oracle are good examples. Management errors in not keeping up with technology and market changes are usually the cause, i.e. they collapse like empires from their own internal weaknesses.

I have to admit to recently selling a few shares in the large investment trusts that invest in technology companies – you can guess which they are. The private investors and institutions who buy the shares in such trusts may have even less real view of what is happening in the real world and hence their share price discounts have shrunk to zero or are even negative.

The mega-cap technology stocks such as Apple, Microsoft, Amazon, Alphabet and Facebook now represent more than a fifth of the US stock market according to an article in the FT. That is surely a dangerous level of concentration. Investors seem to think that such companies are not just defensive because of their near-monopoly control of certain markets, but that they still have growth opportunities. They may be right but there is a limit to how much you should pay for any business when the valuation is founded on future growth. Sometimes the growth disappears as markets become saturated and the valuation then crashes as valuations are a discounted calculation of future earnings.

The big winners from the technology boom have been stock-pickers. But Chris Dillow wrote an article for Investors Chronicle a week ago that was headlined “The Impossibility of Long-Term Stockpicking”. It argued that because few listed stocks survive for many years on the market, you are wasting your time stock-picking. Also only 1.3% of shares accounted for all the rise in global markets between 1990 and 2018 according to academic research. The three companies that accounted for 6% of it were Apple, Microsoft and Amazon which were never sure bets if you look at their history.

Mr Dillow therefore argues that as you have no hope of picking the winners you might as well buy an index tracking fund, and you would have done better to hold cash than invest in small cap stocks on AIM.

The article is well worth reading but I am not convinced. My investment portfolio has done better than the FTSE-Allshare over the last 20 years. It might apply to unsophisticated investors that an index tracker may give a good return with minimal effort but you do have to take into account the management charges. You also need to consider what index to follow – global index tracker of large companies perhaps? If so you will have significant exposure to currency risk and the fact that large companies generally underperform. You still have to make some investment decisions and they won’t be any easier than studying individual companies.

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

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Capital Gains Tax Reform? Surely Long Overdue

Last week the Office of Tax Simplification (OTS) announced a review of Capital Gains Tax. They have invited evidence and there is a simple on-line survey you can complete on the subject (see link below). As someone who occasionally pays capital gains tax, I give you my views on the subject below.

It is of course a horribly complex tax with several different rates and numerous exemptions. I need to employ an accountant to work out my self-assessment tax returns when I don’t consider my affairs particularly complex – I am mainly invested in listed shares, although I do have a few EIS and VCT investments. My accountants use specialist software to do the calculations, not generally available to retail investors and even that seems to be prone to complex misunderstandings.

This also puts a great burden on HMRC in terms of administration when it brings in less than 1% of tax revenues. Plus there is an enormous amount of effort put in by investors and their advisors to avoid paying the tax (there are lots of ways to do so). Indeed one could argue that the current Capital Gains tax regime was invented by accountants as a “make work” project due to the complexity of the rules.

Should the tax be scrapped altogether as some people have suggested? I don’t think so for the following reason: It is very easy to convert income into capital gains, or vice versa. I recall this was done many years ago by the Beatles when instead of receiving royalties they sold the revenue stream from music royalties as an asset. But even private investors can do this – for example by investing in investment trusts that roll up the income and don’t pay it out in dividends. Another example is that of Venture Capital Trusts which are often effectively converting capital gains into tax free dividends. Or of course investors can simply avoid trading in individual shares and invest in trusts or funds which are not taxed on their individual holdings and realisations thereof.

It is therefore irrational to have different rates for capital gains and income which is currently the arrangement.  That’s clearly one simplification that could be made, although investors will be furious if they have to pay more tax as a result.

But one big problem is the lack of indexation of capital gains which was scrapped some years ago by Gordon Brown and replaced by allowances. This means that you pay tax not on the real change in the value of a share, but on that created simply by inflation when the shares are worth no more in reality. This may not seem a major issue in a period of low inflation, but with money being printed like it is going out of fashion by Governments, high inflation might well return. Even a low rate of inflation over many years can result in a very large tax bill, and even worse, you may not have the option to retain the holding. A takeover bid for a company can effectively force a sale. Indexation should be reinstated as it was not difficult to take it into account in your tax returns.

Capital Gains Tax also distorts investment decisions. For example, you might hold on to a shareholding longer than you otherwise would because you know a large tax bill will result. So your portfolio may end up containing a lot of companies with poor prospects and their market share prices might remain higher than they otherwise would be, i.e. the market in the shares is distorted.

It also causes sales of shares to take place when they might not be best timed, simply to use up capital gains tax allowances in the current tax year. Or even to anticipate changes to tax rates and allowances by decisions from new Chancellors or new Governments.

The existing arrangements encourage the use of investment trusts and funds rather than personal investors holding individual shares. This has had a negative impact on the stock market as investment decisions are now made by fund managers rather than real owners. It has also meant that much of the profits generated by public companies end up in the hands of the fund manager rather than the end investor who rake off 1%, 2% or more per annum which can often be a very high proportion of the real return generated by companies. It also has a negative influence on corporate governance as fund managers have little interest in controlling the pay of directors for example. In effect we have a lot of absentee owners.

These defects might be considered an argument for scrapping CGT altogether but that is unlikely. However, an alternative proposal would be to reform it so that a rollover of investments did not incur tax. In other words, if you reinvested the proceeds from a sale of shares or other assets into new assets within a period of time then no tax would be payable. If no net profit is actually realised, why should investors pay tax?

Do people even care about paying tax on their profits when they die? Capital gains tax liability currently disappears on death and that might need to be changed if rollover was permitted but there is also interaction with Inheritance Tax here which would also need to be reconsidered.

Property is taxed at different rates, although the property you live in is exempt. This has of course encouraged people to invest in a home as an asset for their retirement. This has powered the house price bonanza in recent years and encouraged people to occupy bigger houses than they need. Although encouraging home ownership is meritorious, it is not clear why gains from owning a home should be tax free. Reforming this could be a political hot potato although a “roll-over” provision and other exemptions could mitigate the adverse consequences.

Capital Gains Tax has always had a negative impact on business creators although there are allowances that reduce their liability when a business is sold. Much tax planning activity is prompted by such outcomes which typically undermines the tax take. Another related issue is that high capital gains tax rates encourage wealthy entrepreneurs to move to countries where capital gains taxes are lower or even zero. We lose their expertise and also they spend their money in other countries as a result.

In summary Capital Gains Tax is ineffective, generates relatively little in tax from very few individuals and is a disincentive to entrepreneurial activity. It can result in tax being paid on purely inflated share prices and when no actual cash is realised as the profits are soon reinvested. It does of course discourage therefore new investment and distorts the stock market.

In my opinion, capital gains tax needs a complete overhaul. If you agree, or disagree, please add some comments to this article. I’ll ponder those before making a full submission to the OTS review.

OTS Capital Gains Tax Review: https://www.gov.uk/government/consultations/ots-capital-gains-tax-review-call-for-evidence-and-survey

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

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Coronavirus News, AstraZeneca Vaccine, Bowling Alleys and Boeing 747s Retired

The UK death count from the Covid-19 virus is now 45,233. At least that’s the latest figure available because daily reports of deaths have now been suspended because the statistic is now known to be unreliable. Anyone who was identified as a Covid-19 infected person but later died from any cause is identified as a Covid-19 death. The result is that someone who was at death’s door from cancer before infection is counted as a Covid-19 death. Even someone who is run over by a bus is likewise included. This is truly bizarre and the Government has ordered an investigation.

The good news is that a second vaccine candidate looks like it might be effective. This is the one produced by Oxford University and which AstraZeneca (AZN) is gearing up to manufacture and distribute in volume. The share price of the company perked up on Friday as a result based on press reports and rumours although the trial results are not due to be published in the Lancet until Monday. Whether they will really make any money from this product remains to be seen. I only hold a few shares in the company and will wait to see a clearer view before buying more.

The other good news is that bowling alleys and other similar entertainment venues such as casinos will be able to reopen on the 1st August. But there will be restrictions on bowling alleys with only alternate lanes open, players limited to groups of 6 and they will be offered gloves to wear. Also bowling shoes are out.

I always thought the provision of shoes was a bit odd now that everyone is wearing trainers or other rubber/plastic soled shoes as I thought the original purpose was to protect the wooden runway. It seems that bowling shoes also enable the players to slide along the surface but only professionals actually do that. Bowling shoes may now die out.

CFO of Hollywood Bowl Lawrence Keen was quoted by the BBC as saying: “At 50% capacity, the company will still be profitable, albeit just”. I own a few shares in both Hollywood Bowl (BOWL) and Ten Entertainment (TEG) but again I think it is best to wait and see whether the players return before buying more shares.

Other news was the announcement by BA that they are “retiring” their entire fleet of Boeing 747s. With 31 planes they are the largest operator of the planes in the world.

As airline passenger numbers are much reduced from the epidemic impact, BA clearly sees little chance of filling the planes in future, and you need to fill a 747 to make them economic operationally. Boeing 747s were first made operational in about 1970 and unbelievably are still being manufactured, albeit with a lot of updates such as improved engines. They are still in demand for cargo flights due to their large capacity. What’s the price of a good second-hand 747-400? About $12 million, although I suspect prices are falling rapidly.

Memories: I recall the original promotional videos for the plane which featured lots of space to walk around in “lounges” with a bar at one end. In reality they soon crammed in as many passengers as possible and were hence not particularly comfortable, particularly in economy class. Some planes were configured to use the “upper deck” which one reached via stairs and I do recall at least one trip in that location. But the large number of passengers always meant it took a long time to unload and load, with long queues at passport control resulting.  Certainly a plane to avoid for passengers in my opinion even if you were flying business or first class. There was a certain comfort in having four engines in case one or two failed, but aircraft engines improved in reliability over the years so the initial doubts about flying more fuel efficient twin-engined planes soon vanished.

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

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Economic Trends, Audit Quality and the Importance of Management

The news on the epidemic and its impact on financial news continues to be consistently bad. GDP rebounded in May to be up 1.8% but that’s a lot less than forecast. It fell 20.3% in April but as many businesses did not reopen until June perhaps the May figures are not that surprising.

Masks now have to be worn in shops. This will be enforced by the police with possible fines of £100. That will surely discourage some people from shopping on the High Streets.

The BBC ran a story today that said that scientists forecast a second wave of the virus in Winter with up to 120,000 deaths. But that is a “worse case” scenario. The claim is that the colder weather enables the virus to survive longer and with more people spending time indoors, it may spread more. I think this is being pessimistic but it’s certainly not having a positive effect on the stock market.

The London Evening Standard ran a lengthy and very negative article yesterday on the impact of the virus on London with a headline describing it as “an economic meltdown”. It suggested 50,000 jobs will go in the West End alone due to a decline in retail, tourism and hospitality sectors. Commuters are still reluctant to get on public transport – trains, underground or buses. In Canary Wharf only 7,000 of the 120,000 people who normally work there are at their desks it is reported. One problem apparently is that with numbers able to enter lifts being restricted it can take a very long time to get all the normal staff at work in high rise buildings. Hotels, clubs and casinos have been particularly hard hit with the extension of the Congestion Charge (a.k.a. tax) discouraging visits. 

Audit Quality

The Financial Reporting Council (FRC) has confirmed what we probably already knew from the number of problems with company accounts – that audit quality has declined in the last year. Following reviews of audits by the major audit firms including PwC, Deloitte, EY, KPMG, BDO and Grant Thornton there were a number of criticisms made by the FRC. The firms PwC, KPMG and Grant Thornton were particularly singled out. The last firm was judged to require improvement in 45% of its audits.

We were promised a tougher stance from the FRC but it is clearly not having the required impact. Published accounts are still clearly not to be relied upon which is a great shame and undermines confidence in public companies.

There were a couple of interesting articles in last week’s Investors Chronicle (IC). One was on the investment approach of Harry Nimmo of Aberdeen Standard. He is quoted as saying: “We do measure prospective and future valuations – it’s not completely ignored. But it doesn’t lead our stock selection, and we don’t have price or valuation targets”. Perhaps he does not trust the accounts either? He does apparently screen for 13 factors though including some related to momentum and growth.

Management Competence

The other good article in IC was by Phil Oakley headlined “How important is management”. If you don’t trust the accounts of a company, it’s all the other factors that help you to judge the quality of a business and the prospects for long-term returns which are important. Phil says that “management does matter” but he thinks some investors overemphasise it’s importance.

How do you judge the quality of the management? One can of course look at the results in the financial numbers over past years but that can suffer from a major time lag. In addition management can change so past results may not be the result of work by the current CEO but their predecessor. This is what I said in one of my books: “Incompetent or inexperienced management can screw up a good business in no time at all, although the bigger the company, the less likely it is that one person will have an immediate impact. But Fred Goodwin allegedly managed to turn the Royal Bank of Scotland (RBS), at one time the largest bank in the world, into a basket case that required a major Government bail-out in just a few years”.

RBS was also a case where the company’s financial results were improved by increasing the risk profile of the business – the return on capital was improved but the capital base was eroded. Management can sometimes improve short term results to the disadvantage of the long-term health of the business.

Is it worth talking to management, say at AGMs or other opportunities? Some people think not because you can easily be misled by glib speakers. But I suggest it is so long as you ask the right questions and don’t let them talk solely about what they want to discuss. Even if you let them ramble, you can sometimes pick up useful tips on their approach to running the business. Are they concerned about their return on capital, or even know what it is, can be a good question for example. I recall one conversation with an AIM company CEO where he bragged about misleading the auditors of a previous company about the level of stock they held, or another case where a CEO disclosed he was suffering from a brain tumour which had not been disclosed to shareholders. Unfortunately in the current epidemic we only get Zoom conversations rather than private, off-the-record chats.

Talking to competitors of a business can tell you a lot, as is talking to former employees who frequently attend AGMs. Everything you learn can help to build up a picture of the personality and competence of the management, and the culture that they are building in the company. The articles being published on Wirecard and Boohoo in the last few days tell us a great deal about the problems in those companies but you could have figured them out earlier by some due diligence activity on the management.

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

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Boohoo – Should I Speculate in the Shares?

There has been a lot of media comment on fast fashion retailer Boohoo (BOO) after publicity on the working conditions in the clothing industry in Leicester where at least some of its products are produced. The suggestions are that people are paid less than the legal minimum wage and work long hours in poor conditions, even possibly breaching Covid-19 regulations. The company has launched an immediate review led by a QC into these allegations, although the company has other sources of supply overseas and it seems that those produced in Leicester may simply be repackaged there.

The company also came under attack from shorter Shadowfall who published a damaging dossier in May which you can find on the web. The share price has been as high as 400p this year, but fell to close at 224p last night. However it’s making a sharp recovery today.

I don’t currently hold the shares but I did hold them from 2014 to 2017/18 and made considerable profits as a result. Last night the share price was back to near where I sold. Should I buy back into the shares is a question I face and my answer is probably not. These are my reasons:

The company has obviously been on a roll in the last few years with revenue doubling in the last 3 years. They have exploited the growth in the use of the internet for clothes shopping in the same way as ASOS, thus leaving traditional retail stores in their wake. With low price clothes that appeal to the young to the extent that some of it is disposable after one use, they have established a new business model with associated marketing channels.

Financially they have a very high rating as investor enthusiasm for the growth story means they are now on a historic p/e of 53. But there are a whole range of issues that are of concern, some of which are apparent from the Shadowfall report. I particularly focus below on the non-financial aspects because as I say in my book Business Perspective Investing, accounts cannot be relied upon and it’s best to look at other aspects of a business.

Are there any barriers to entry in this business is one key question? Are they doing something that cannot be copied by competitors? Will their profits and profit margins be eroded by lookalike competitors in the traditionally fierce rag trade?

A few years ago, it might not have been easy to set up an internet retailing operation, but now everyone knows how to do it and it does not cost much either. The traditional clothing retailers and supermarkets may be catching up fast even if Boohoo have built a big customer base. But I suspect their customers are fickle, being young and impulsive and might easily be poached by others with lower priced promotions.

Shadowfall points out that one of the company’s competitors is ISawItFirst.com who even appear to be selling apparently identical products. That company is majority owned by the brother of BOO’s Chairman. Another oddity is that BOO owns 66% of PrettyLittleThing with an option to buy the rest. That company is also a competitor and is run by the son of BOO’s Chairman.

The company also acknowledges in its latest announcement that the current board comprises 4 executive directors and 3 non-executive directors, i.e. there is no majority of non-execs as usually expected for larger companies – and BOO is large with a current market cap of about £3 billion.

In summary, this looks like a company for short term speculation rather than long-term investment to me. Not my ideal investment proposition without even looking at their financials and the questions raised on them.

There is also a big risk there will be more bad news about their operations revealed in due course. Once a company comes under a spotlight, any dirt that was previously swept under the carpet tends to be revealed.

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

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Chancellor’s Statement – Eat Out to Help Out

I just watched the statement by Chancellor Rishi Sunak. He made some good rhetorical points which I pick out here:

He said the Government is “doing what is right” and is focused on job protection and creation. We are in the “second phase of our economic response to the virus”. The economy has contracted by 25% and we face significant job losses. But with the furlough scheme winding down to October, the measures are:

  1. A job retention bonus of £1,000 for each person who comes back from furlough (if all 9 million return, a cost of £9 billion).
  2. A new “Kickstart” scheme will pay employers for 16-24 year old staff for 6 months.
  3. Funding for new apprenticeship and trainee schemes
  4. £1 billion for the DWP to provide more support.

The Government is also investing in infrastructure to create jobs including £2 billion in green investment – for example in grants to improve the energy efficiency of homes. To improve confidence in the housing market, stamp duty is being cut temporarily as from today.

As our economy relies on “social consumption” (cafes, restaurants, etc.), there will be a cut in VAT from 20% to 5% on that sector for the next 6 months – at a cost of £4 billion. In addition, for August you will be able to eat out at a discount of 50% on Mondays to Wednesdays, funded by the Government. The Chancellor concluded with the phrase “Eat out to help out”.

There was a weak response from Shadow Chancellor, Anneliese Dodds who focused on the medical responses to the epidemic rather than the Chancellor’s statement.

Comment: It looks like the Chancellor wants us to put on even more weight by eating out. Encouraging folks to eat out may improve their “feel good” factor but this is a very temporary gesture. As regards the job protection and creation measures, these may help some people but will they really boost the economy?  

The hospitality sector, and companies in it, will clearly benefit from these measures, and it might encourage people to eat out. But I fear that many people like me will be reluctant to take the risk until it is clear that the epidemic has really disappeared.

The encouragement for people to return to work and the clear intention not to extend the furlough scheme is surely a sound policy as otherwise it would be too expensive while people would get out of the habit of working.

In summary I would suggest these policies may assist, but what really matters to improve the economy and employment is more confidence that the epidemic is fading away, and that will take time.

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

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