Invinity Open Offer, Ideagen, and AJ Bell Results

I have recently taken a strong interest in those shares that are involved in electrification of the world. It’s not just the UK Prime Minister who wants to save the world from global warming and air pollution with Joe Biden likely to be much more environmentally conscious than Donald Trump. Those companies or trusts that are involved in alternative energy sources such as wind and solar, and systems to manage the fluctuations they impose on the grid, are of particular interest.

One such company is Invinity Energy Systems (IES) who announced a placing and open offer this morning. This was a company that was mentioned at a recent investor discussion group I attended and I did some research into it and bought a very few shares.

It produces vanadium flow batteries which are typically large batteries used in large energy storage projects. They are alternatives to lithium-ion batteries which have limitations and lithium is a relatively rare element that we might run out of or it might become very expensive. Vanadium is the 20th most abundant element in the earth’s crust and is mainly used in steel making at present. Vanadium flow batteries have advantages in that they can be cycled many times, have a 25-year lifetime, with no risk of thermal runaway and are cost competitive. They have been around for many years but not in high volume production mainly because they are bulky and hence only suitable for certain applications – Invinity plan to change that. It’s still a relatively early stage business but it seemed worthy of a punt as their sales prospects, of which details are provided, look promising.

Their placing is at a discount of 8% to the pre-placing market price and dilution is only 16% so I consider that acceptable and the other good aspect is that they are including an “open offer” so existing private shareholders can participate.

For those interested in the environmental sector the following shares may be of interest (Note: I hold some of these): Gore Street Energy Storage Fund (GSF), Greencoat UK Wind (UKW, Gresham House Energy Storage Fund (GRID), Impax Environmental Markets, (IEM), Octopus Renewables Infrastructure Trust (ORIT) and The Renewables Infrastructure Group (TRIG). Some of these are effectively private equity trusts that invest in storage systems, windfarms and solar power installations. Much of their revenue comes from guaranteed prices for power supply and their assets are valued on a discounted cash flow basis. This enables them to pay high dividends with some capital growth but they are currently typically trading at a high premium to net asset value as they have grown in popularity as good reliable dividend payers have disappeared from the market. Whether the assets are fairly valued is anyone’s guess and clearly it depends on what discount rate is used – never an easy thing to determine in DCF calculations.

There is a lot of enthusiasm for these companies in the market at present so readers need to decide whether it is a bandwagon that will fade or grow stronger.

Last night I attended a webinar on Ideagen (IDEA) run by ShareSoc. I have held this company since 2012 and it has been highly profitable but one aspect I am unhappy with is that they regularly do placings, typically to fund acquisitions, but never include open offers, so I have been diluted. As Chairman David Hornsby said last night, they do at least only do placings at near the market price, but I am not convinced that is a good excuse. Market cap of Ideagen is £500 million while that of Invinity is £138 million so if Invinity can include an open offer why cannot Ideagen?

From David’s other comments it seems they are planning a placing to enable them to do more acquisitions to meet their growth plans. That might be why the share price has been drifting down of late as expectations of this have become known.

AJ Bell (AJB) announced their final results this morning (they run the YouInvest platform). Revenue was up 21% and pre-tax profit was up 29% but on a forecast p/e of 48 according to Stockopedia for next year the price is clearly discounting more growth but there must be limits on how much market share they can grab.

One interesting item mentioned in the AJ Bell announcement was that the FCA has delayed implementation of the “Making Transfers Simpler” rules due to the Covid-19 epidemic. The new rules were designed to make transfers between platforms easier so as to encourage a more price-competitive platform market. Let us hope these changes are not abandoned although AJ Bell mention they feel the new rules could be improved and have made alternative suggestions.

As anyone who has moved an ISA or SIPP between platform operators knows, it takes way too long and is too expensive. The FCA’s new rules may have helped in some regards but are not a total solution.

At least AJ Bell have substantially reduced their exit charges in their new price list effective from January. They have made a number of other changes to their prices which overall do not seem unreasonable and they will remain competitive.

Platform operators have generally been edging up their prices as the interest they receive on client cash has disappeared as interest rates have shrunk while regulatory costs have increased. This has also undermined the few “free dealing” platforms that wanted to conquer the UK market like Robinhood have done in the USA with commission free trading. Operators such as Freetrade were potentially a threat to AJ Bell but with the former offering only a limited service that threat seems to be receding.

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

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Epidemic Over? Unable to Trade and Chrysalis VCT Wind-Up

The news that the Pfizer vaccine for Covid-19 appears to work (at least 90% of the time) and has no negative side effects gave stock markets a good dose of euphoria yesterday. It suggests that we might be able to return to a normal life in future, but exactly when is far from clear. Actually producing and distributing the vaccine is going to be a mammoth task and it is very clear that it will only be given to certain people in the short term – the elderly and medically vulnerable. Some people might not accept the vaccine and transmission of the virus may still take place. It is clearly going to be many months before we can cease social distancing and wearing face masks – at least that is the situation if people follow sensible guidance which they may not. Some countries may not be able to afford to immunize everybody so how this good news translates into reality is not clear. In summary, the epidemic is not over.

But the good news did propel big changes in some stocks such as airlines, aerospace industry companies and the hospitality sector which have been severely damaged by the epidemic. Rolls-Royce (RR.) share price was up 44% yesterday for example, although I wouldn’t be buying it until it can show it can make a profit which it has not done for years. In the opposite direction went all the highly rated Covid-19 diagnostic stocks such as Novacyt (NCYT) which I hold. There have probably been way too extreme movements both up and down in the affected stocks as sentiment was only one way.

The big problem faced by many investors though was that platforms such as Hargreaves Lansdown and AJ Bell Youinvest actually ceased to function. It is reported that their customers were unable to log in and trade. But this is not a new problem. See this report in December 2019 when there was a previous bout of euphoria that affected the same two brokers: https://roliscon.blog/2019/12/16/euphoria-all-around-but-platforms-not-keeping-up/ .

They clearly did not learn their lesson and should have done better “load testing”. Perhaps the moral is don’t put all your eggs in one basket by relying on one broker (I use 5 different ones and spread my holdings over them).

For those with an interest in Venture Capital Trusts (VCTs) it has been pointed out to me that Chrysalis VCT (CYS) is putting proposals to wind up the company to its shareholders. I used to hold the company, but sold out in 2018 at prices ranging from 62p to 66p – the current share price is 35p. I had big concerns then about the shrinking size of the company (NAV now only £14.9 million) as cash was returned to investors. The other major concern was the holdings in the company, particularly that in media company Coolabi and the valuation thereof (last filed accounts were to March 2019 and showed a loss of over £7 million).

VCTs that shrink too much, even if they are good at returning cash to shareholders, can get themselves into an unviable position as costs of running the VCTs sooner or later get out of proportion. As the announcement by the company makes clear, in such a situation a VCT has the following options: a) merge with another VCT; b) change the manager and raise new funds; c) sell the company or its portfolio; or d) wind it up.

But raising new funds under the tougher VCT rules that now apply might not be easy, while mergers with another company might be difficult. Who would want to acquire a portfolio where 29% of the current valuation is that of Coolabi – even if you believe that valuation!

The directors give numerous reasons why a wind-up is the best option after they got themselves into this difficult situation. They correctly point out that some investors will be prejudiced by this move as some original investors will have claimed capital gains roll-over relief. They will get their tax liability rolled back in after the wind-up and the ultimate cash cost might be more than what they obtain from the wind-up. Ouch is the word for that. But the directors are going to ignore those investors on the basis that a wind-up “best serves shareholders as a whole”.

The other problem is that a wind-up of a company with holdings of private equity stakes takes a long time and there is no certainty that the value they are held at in the accounts can actually be obtained. Investors in Woodford funds will have become well aware of that issue! Who would actually want to buy Coolabi for example, or some of the other holdings?

Another VCT I held in the past that got into the situation of returning cash to shareholders while finding no good new investments and not raising funds was Rensburg AIM VCT. They managed to escape from it after a lot of pushing from me by merging with Unicorn AIM VCT. But I fear Chrysalis VCT have left it too late and hence the choice of the worst option.

But if I still held the shares, I might vote against the wind-up and encourage the directors to take another path. It is possible to run VCTs on a shoestring if a big focus on costs in taken. In addition, the directors say that they did have some discussions about fund raising, possible mergers or the acquisition of the company but have rejected those for various reasons. But I think they need to look again, after a more realistic view of the values of the existing portfolio holdings has been obtained.

One change that should certainly be made if the company chooses not to wind-up is a change in the directors and fund managers who allowed the company to get itself into this unenviable situation. Regrettably there often appears to be a tendency for directors and fund managers to want to keep their jobs and their salaries long past when tough decisions should have been made.

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

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Portfolios for Ageing Brains and Value Hell

There were a couple of good articles in last week’s Investors Chronicle – one of which I totally agreed with and one which I did not.

The first was by Chris Dillow who reported on academic studies of aged Americans. It was suggested that investment skill declines with age and those who were unaware of their cognitive decline were substantially poorer than others who were aware of it who hadn’t suffered such a decline. Now as someone who is about to reach the age of 75, this is not solely an academic issue.

The article suggested that older people might have acquired some wisdom over the years, and tend to acquire better rules of thumb, but their stock picking ability does decline. Mr Dillow suggests that one answer to this problem is to delegate our wealth management to others. But he does point out that this leaves you still with the problem of picking a good fund manager when your ability to do that might also decline. His other solution is to simplify your portfolio so you just hold equity and bond trackers plus cash.

I am not convinced by this at all. Clearly some people suffer sharp mental degradation with age and should delegate portfolio management to others, or buy managed funds of various kinds. But others do not.

Has the performance of Warren Buffett (Aged 90), or his partner Charlie Munger (Aged 96) or George Soros (Aged 90) declined in recent years? It’s not obvious at all.  My own portfolio performance last calendar year was double that of the FTSE All-Share and almost double that of the MSCI WMA Balanced Private Investor Index. So I don’t think I’ll give up managing my own portfolio just yet.

The other interesting IC article was entitled “Welcome to Value Hell” by Algy Hall. It reported on the performance of a “Value” based screen over the last year and said “the performance over the last 12 months has been extraordinarily bad”. The top 50 picks did worse than the FTSE All-share and the top 5 were a disastrous -69%. Even over the last three years, it returned minus 19.3% total return compared with plus 10.7% from the FTSE.

Looking down the list of shares recommended last year, they are a very mixed bunch but gaming companies did well (Plus500, Flutter, William Hill, IG Group and GVC). The “Zeus” screen used is based on how much the earnings have diverged from historic means, i.e. it is based on the principle that they might “bounce back”.

I think the lesson is that looking at past profits tells you little about the future and that stocks that look cheap at a glance are to be avoided. They often need a re-rating which can be crystalised by specific events. But in the depression of a pandemic, that is unlikely to occur and even in the good times other companies will do better.

One can only conclude that these “cheap” stocks needed to be even cheaper than they were to make reasonable investments. In effect the market was not reflecting the bad news about the stocks and investors were holding them longer than they should in the hope of recovery.

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

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Market Musings

The stock market seems to be positively benign at present, if not almost somnambulant. While certain sections of the economy have gone to hell in a handcart, the enthusiasm for technology stocks has not abated. My very diversified portfolio is up today at the time of writing by 0.4% helped by good news from Dotdigital (DOTD) today and a sudden enthusiasm for GB Group (GBG). Optimism about a more general recovery in the economy seems to be still prevalent.

It’s probably a good time to consider overall market trends with a view to adjusting portfolios for the future. It is very clear for example that the UK at least, if not the world, is heading for a “net zero” world, i.e. a world where we are not emitting any carbon which implies a very high reliance on electricity generated from wind, solar and hydroelectric sources.

Whether that can be achieved in reality, and in my lifetime, remains to be seen. Whether it is even rational, or economically justified, is also questionable. But now that the religion of zero carbon has caught on, I do not think it is wise for any individual investor to buck the trend. As with any investment fashion it’s best to jump on the bandwagon and as early as possible. So I hold no oil companies and few interests in coal miners, except where they are part of diversified mining companies who are also mining copper (essential for the new electrification) and steel (not easily replaced). But I have recently invested in “renewable infrastructure” investment companies of which there are several, and in funds that provide battery support and load smoothing systems. Wind farms and solar panels tend to generate intermittent electricity so there is a big demand for emergency sources of power.

There was a very good article by Bearbull in last weeks Investors Chronicle headlined “The Net Zero Perversion” on this subject. He commences by saying “It is surely the new paradigm – that economic recovery from the damage caused by the response to Covid-19 can only be achieved by a fundamental shift towards a zero-emissions future. This is stated as fact – that reducing greenhouse gas emissions to ‘net zero’ by 2035 will be the powerhouse of economic growth – when, of course, it’s just a contention; much like the complementary one that investing in companies that are wonderfully compliant in meeting their economic, social and governance (ESG) commitments will bring excess investment returns”.

He goes on to say, after some other comments that must have enraged the uneducated environmental enthusiasts: “Yet there is plenty of evidence that the pursuit of net zero is brimming with unintended consequences, which is what you might expect from a movement driven by a weird mixture of idealism and greed”. He points out that rewiring our homes and expanding the grid to cope with the new electricity demand might cost £450 billion, i.e. £17,000 per household. Similarly the banning of the sale of new internal combustion powered vehicles from 2035 just causes the pollution generated from the manufacture of electric vehicle power systems and associated mining activities to happen elsewhere in the world. But overall emissions might not fall.

This fog of irrationality and attacks on personal mobility via vehicles using the Covid-19 epidemic as an excuse is now happening in several London boroughs, encouraged by central Government “guidance” and funding. Roads are being closed. In the Borough of Lewisham, adjacent to where I live, road closures have caused increased traffic congestion, more air pollution and gridlock on a regular basis. There is enormous opposition as the elderly and disabled rely on vehicles to a great degree while in the last 75 years we have become totally dependent on vehicles for the provision of services (latterly for our internet deliveries). Councillors in Lewisham think they are saving the world from global warming and air pollution that is dangerous to health when they won’t have any impact on overall CO2 emissions and there is scant evidence of any danger to health – people are living longer and there is no correlation between local borough air pollution and longevity in London. Air pollution from transport has been rapidly falling while other sources (many natural ones) are ignored. Lewisham and other boroughs have partially backed down after a popular revolt but local councillors still believe in their dogma. There is a Parliamentary E-Petition on this subject which is worth signing for those who think that the policy is misguided: https://petition.parliament.uk/petitions/552306

The Bearbull article concludes with this comment which matches my opinion: “All of which means investors should preserve their scepticism. But they should also recall their purpose in investing – to make money, not to go to war with the climate change movement, however ridiculous they may see some of its follies. Sure, as consumers they should see much of the pursuit of net zero for what it is – another charge on their net income. But as investors they should see it as an opportunity to join the momentum and, at the very least, to park some of their capital in a fashionable part of the market”.

When it comes to investment, markets can be irrational for a very long time. That is surely the situation we are currently seeing with stock markets kept buoyant by a flood of cheap money and there being nowhere else to stash it. With traditional industries and businesses in decline, most of the money is going into technology growth stocks or internet shopping driven businesses such as warehousing. That trend surely cannot continue forever. But in the meantime, following market trends is my approach as ever.

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

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FRC Report on AGMs and Defensive Tech Stocks

 The Financial Report Council (FRC) have recently published a report on AGMs with a subtitle of “An opportunity for change”. The report covers how Annual General Meetings have functioned during the Covid-19 epidemic.  With restrictions on physical meetings, companies have adopted different approaches. Some have provided only the legal minimal which means ordinary shareholders have not been able to attend or ask questions. Other companies have provided virtual AGMs, with questions needed to be asked in advance, while others have provided a more comprehensive solution with questions capable of being asked and answered on the day, and votes capable of being submitted on the day.

I have commented on these different approaches and on the general issue of how to operate hybrid AGMs in future on this blog – just use the search function to search for “AGM” to see the articles.

The FRC report is a very good analysis in general of this subject (see below). It’s not too long or tedious for the casual reader but there are a few points worth noting:

They suggest that all shareholders be encouraged to use electronic communication and that they should provide an email address when purchasing shares.  It would certainly be good to have an email address on the share register which I have long argued for. It would assist communication from companies to their investors, and enable other shareholders to communicate with their fellow shareholders (a basic prerequisite for shareholder democracy). But the need to have the same information on the register for those in nominee accounts is also required.

Some share registrars already maintain a record of email addresses of shareholders and have electronic systems for recording voting but these can be complex and waste shareholders’ time. They also claim that these records are not part of the official “share register” which is dubious.

However, there are practical issues here that are not mentioned. I don’t mind receiving some information from companies via email but maintaining a record of which companies have my email address (and which one from multiple email accounts, particularly after I have changed them) would not be easy. We really do need a secure central register of all public company shareholders that the shareholders can maintain themselves as regards names, postal addresses, bank accounts (for dividend payments) and email addresses. Also there is the problem that I don’t like trying to read Annual Reports that can be several hundred pages long, on-line. Much better to receive a paper Annual Report.

For the above reasons, I gave up opting in for on-line communication and have all my reports on paper.

It is important for shareholders to be able not just to ask questions at AGMs but to “speak” on anything relevant to the business of the company. Some companies have adopted Articles providing for virtual AGMs that limit this. They also need to be able to ask “follow-up” questions.

The FRC suggests splitting the AGM into two meetings – an initial one for presentations and questions/answers with a formal meeting for voting later. That seems a good approach.

The FRC Report is present here:  https://www.frc.org.uk/getattachment/48c4ee08-b7be-4b7c-8f19-bcaf3d44e441/Corporate-Governance-AGM.pdf

The FRC is proposing to bring together a “stakeholder group” to consider the need for legislative changes or propose alternative means to achieve the required flexibility.

Defensive Tech Stocks

On another subject, why have technology stocks proved to be such good defensive holdings during the pandemic?  The editor of Techinvest spelled it out in these words in a recent edition:

“Driving the high demand for FAANG stocks since the start of the Covid-19 crisis has been the flight to safety after markets sold off heavily in early March. While it may seem counterintuitive, big tech has been attracting buyers-this-year because if its perceived defensive qualities. At a time when many other industries are being adversely affected by the Covid-19 disruption, tech appears to be emerging in a stronger position, with demand increasing in areas such as online shopping, remote working, and digital connectivity. According to research by McKinsey, the speed of digital adoption has been so quick in response to the pandemic that five years’ worth of progress has been made in just a few weeks. Big tech, in particular, is seen as a major beneficiary of the accelerated demand for digitalisation and investors have been backing this theme”.

Yes the world is changing rapidly and investors need to take note of that.

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

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Share Centre Future and FT Spoofing Article

The Share Centre recently advised their customers of “Our Future with Interactive Investor”. It gave details of the transfer of accounts to the Interactive Investor platform following the acquisition of the Share Centre business. However they failed to point out one important point which customers need to be aware of.

Share Centre ISAs are “Flexi ISAs”. This means that you can take cash out of the ISA and put it back in so long as you do it in the same tax year. Many people may have taken cash out this year after stock markets fell and put it on deposit, with the intention of putting back in later.

But Interactive Investor do not offer a Flexi ISA so if a Share Centre customer took cash out they won’t be able to put it back in after the account transfer. The Share Centre should surely have warned people about this but I can see no reference to it in their literature.

Spoofing

There was a very interesting article in the Financial Times today on the subject of “spoofing” – the practice of entering and cancelling orders in rapid succession to manipulate the prices of shares, bonds or commodities. The article was headlined “US regulators step up battle with spoofing” and mentioned the $920m fine imposed on JPMorgan Chase this week. Apparently the company’s traders had been using this abusive practice for years. The size of the fine should surely deter the practice if companies can actually control their traders.

This practice is not just confined to the USA of course. It was also alleged to have taken place in Burford shares recently. It just needs large transaction volumes in an order book system to make it viable.

It is symptomatic of the sharp practices that are rampant in the financial world. It is of course a practice to be abhorred as it creates a false market in the shares of a company. It suggests that there are buyers or sellers queuing up to buy or sell the stock, and a general impression of activity when none might exist.

Why not put a stop to it by imposing a time limit before an order can be cancelled?  

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

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Boris Johnson Not Backing Down and the Technology Stocks Bubble

Today I received an email from the Conservative Party signed by Boris Johnson and entitled “I will not back down”. The first few sentences said:

“We are now entering the final phase of our negotiations with the EU. The EU have been very clear about the timetable. I am too. There needs to be an agreement with our European friends by the time of the European Council on 15 October. If we can’t agree by then, then I do not see that there will be a free trade agreement between us, and we should both accept that and move on. We’ll then have a trading arrangement with the EU like Australia’s. I want to be absolutely clear that, as we have said right from the start, that would be a good outcome for the UK”.

But he says the Government is still working on an agreement to conclude a trade agreement in September. However the Financial Times reported that there are problems appearing because the “UK government’s internal market bill — set to be published on Wednesday — will eliminate the legal force of parts of the politically sensitive protocol on Northern Ireland that was thrashed out by Mr Johnson and the EU in the closing stages of last year’s Brexit talks”. It is suggested that the EU is worried that the Withdrawal Agreement is being undermined. But reporting by the FT tends to be anti-Brexit so perhaps they cannot be relied upon to give a balanced commentary on the issues at present.  

Of course this could all just be grandstanding and posturing by both the UK Government and the EU to try and conclude a deal in their favour at the last minute. But we will have to wait and see what transpires.

Well at least it looks like Brexit news will dominate the media soon rather than the depressing epidemic stories.

Technology Stocks Bubble

Investors seem to have been spooked last week by the falls in the share prices of large technology stocks such as Apple and Tesla (the FAANGs as the group are called). This resulted in overall market falls as the contagion spread to many parts of the market, particularly as such stocks now represent a major part of the overall indices. I am glad to see my portfolio perked up this morning after substantial falls in my holdings of Polar Capital Technology Trust (PCT) and Scottish Mortgage Investment Trust (SMT) both of whom have big holdings in technology growth stocks although they are not index trackers.

I’ll give you my view on the outlook for the sector. Technology focused companies should be better bets in the long-term than traditional businesses such as oil companies, miners and manufacturing ones. There are strong market trends that support that as Ben Rogoff well explained in his AGM presentation for PCT which I mentioned in a previous blog post.

But in the short term, some of the valuations seem somewhat irrational. For example I consider Tesla to be overvalued because although it has some great technology it is still in essence a car manufacturer and others are catching up fast. Buying Tesla shares is basically a bet on whether it can conquer the world and I don’t like to take those kinds of bets because the answer is unpredictable with any certainty. I would neither buy the shares nor short them for that reason at this time. But Tesla is not the whole technology sector.

Some technology share valuations may be irrational at present, but shares and markets can stay irrational for a very long time as different investors take different views and have different risk acceptance. In summary I would simply wait to see if there is any certain trend before deciding to buy or sell such shares or the shares of investment trusts or funds focused on the sector.

Investment trusts are particularly tricky when markets are volatile as they often have relatively low liquidity and if stocks go out of favour, discounts can abruptly widen. Trading in and out of those kinds of shares can be very expensive and should be avoided in my view.

I don’t think we are in a technology stocks bubble like in the dot.com era and which I survived when anyone could sell any half-baked technology business for oodles of money to unsophisticated investors. But it is worth keeping an eye on the trends and the valuations of such businesses. Very high prospective/adjusted p/e ratios or very high price/sales ratios are still to be avoided. And companies that are not making any profits or not generating any free cash flow are ones of which to be particularly wary (Ocado is an example – a food delivery company aiming to revolutionize the market using technology). Even if the valuations are high, if a company is achieving high revenue growth, as Ocado is, then it might be able to grow into the valuation in due course but sometimes it just takes too long for them to do so. They risk being overtaken by even newer technologies or financially stronger competitors with better marketing.

Investors, particularly institutional ones, often feel they have to invest in the big growth companies because they cannot risk standing back from the action and need to hold those firms in the sector that are the big players. Index hugging also contributes to this dynamic as “herding” psychology prevails. But private investors can of course be more choosy.

This is where backing investment trust or fund managers who have demonstrable long-term record of backing the winners rather than you buying individual stocks can be wise. Keeping track of the factors that might affect the profits of Apple or Tesla for an individual investor can be very difficult. Industry insiders will know a lot more and professional analysts can spend a lot more time on researching them than can private investors. It is probably better for private investors to look at smaller companies if they want to buy individual stocks, i.e. ones that are less researched and are somewhat simpler businesses.

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

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Terry Smith on Market Timing and PI World Presentation by David Thornton

David Thornton, who is the Editor of Growth Company Investor, did an interesting presentation for PI World this week. He made an interesting observation in that he likes to avoid stocks that are both highly valued and lowly valued, i.e. on high or low P/Es. This is very wise. The high P/Es are typically discounting a lot of future growth and show the enthusiasm by investors for the business. In reality the high valuation may be a mirage and is being driven by share price momentum and the keenness by retail investors to get on the bandwagon for small cap shares. At the other extreme, they may be lowly valued because the business has some fundamental weaknesses or big strategic problems. Growth at a Reasonable Price (GARP) may be a better investment strategy for overall long-term performance.

See https://www.piworld.co.uk/2020/07/03/piworld-webinar-david-thornton-small-is-beautiful-why-small-caps-what-to-buy-now/

Terry Smith of Fundsmith has written an interesting article on market timing for the Financial Times. He is very opposed to trying to time the market and suggests that taking your money out of the market, as many people did in March, was a bad mistake. He equates it to driving while only looking in the rear-view mirror.

For an institutional fund manager, who cannot move large positions easily, that may be wise. It has certainly worked out well for the Fundsmith Equity Fund which has bounced back, and more, from its low in March.

But I am not totally convinced that it is wise for all investors. Markets do not always recover rapidly as they have done from the Covid-19 epidemic – at least so far although that story may not yet be ended. In the case of the Wall Street crash of 1929 it took 25 years to fully recover. So taking money out of the market early on might have been very wise.

Hedging your bets by taking some money off the table and hence managing your risk exposure is surely a sensible thing to do when the market is heading down. There are three things to bear in mind though:

  1. Small cap shares such as those on AIM can be very illiquid and hence a few sellers can drive the shares well below fundamental value. These are not the kinds of shares to dump in a market sell off unless they are directly impacted by the negative news (e.g. by the virus epidemic closing their businesses and they are at risk of going bust).

 

  1. You also need to be wary about Investment trusts. These again are often not actively traded so they can suffer not just from declining share prices in their portfolio holdings but from widening share price discounts. When the discounts get very wide, it is time to buy not sell.

 

  1. If you have moved into cash, it is very important to know when to buy back into the market. You need to keep a close eye on the direction of the market because bounces from market lows after a crash can be very rapid. Many retail investors sell at the first hint of a crash, but miss out on the recovery which is very damaging to overall portfolio performance. They miss out because they are demoralised and have lost faith in stock market investment. You do need to take a view though on whether a bounce is just emotional reaction to the realisation that the world may get back to normal, and how the recovery may affect individual stocks. In other words, you may want to move your cash back into different holdings.

As a holder of the Fundsmith Equity Fund, I would not normally argue with his investment wisdom but he may be in a different position to many retail investors. I did take some cash out of the market after the peak bull hysteria of late 2019 and in March after it was clear some companies would be badly hit by the epidemic. This provided some funds for picking up other depressed companies. But Fundsmith was not one I dumped.

The Terry Smith article is here: https://www.fundsmith.co.uk/news/article/2020/07/02/financial-times—there-are-only-two-types-of-investors

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

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Coronavirus Impacts – Victoria, Auto Trader and Bowling Alleys

Stock market investors are clearly becoming nervous again following a rise in Covid-19 infections in the UKA – particularly in the Southern and Western states. This has affected the US stock markets and, as usual, it has affected UK markets in sympathy.

There were two announcements this morning that were interesting as regards the impact of the virus epidemic and the resulting “lockdown” of the population. Home working has become more normal or people have been “furloughed” or permanently laid off.

Victoria (VCP), a manufacturer of floor coverings, had to close their factories but they have all now reopened. Their customers are mostly retailers and many of them had to close but are now reopening or already have done. The company says group revenues for the last three weeks are now at 85% of pre-Covid-19 budgets.

Interestingly they say this in today’s trading update: “It is important to remember that 93% of Victoria’s revenues are derived from consumers redecorating their homes, not construction or commercial projects, and consumer demand for home decorating products appears to be strong across the world. This is not altogether surprising, given the extended period consumers have spent in their home over the last four months, which is likely to have encouraged the impulse to redecorate”. Clearly it’s time to do some DIY jobs.

Auto Trader Group (AUTO) announced their final results for the year ending March 2020, which contained an update on current trading. They provide a web portal for car dealers, who all had to close. Auto Trader provided free advertising in April and May plus a 25% discount in June. As a result they lost money in those months. The company has also chopped the dividend, cancelled further share buy-banks, did an equity placing and used the Government’s Job Retention Scheme. A vigorous response in essence, rather like that of property portal Rightmove.

Car dealers are reopening but for most you cannot just walk in to the dealer. You have to make an appointment. This encourages web shopping for a new car which is to the advantage of Auto Trader. The company announcement (and what was said in their web cast which was otherwise somewhat boring as it consisted mainly of reading a script), was generally positive but it leaves a question as to how soon car sales will recover. They don’t seem to be losing many dealers and dealer stock figures are what matter rather than sales. But dealers’ revenue and profits might come under pressure as many car purchases can be postponed. Cars do wear out of course, but with mileage reduced as there were, or are, few places open to go to and more home working is taking place, this could reduce car sales.

This is therefore a company where one needs to look to the future and how they can capitalise on the trend to shop for cars on the internet, like one might shop for groceries or clothes of late. One competitor mentioned in the conference call was Cazoo who sell (or lease) cars directly on the internet. No test drives or inspection first. You just get 7 days to trial it before acceptance. This is clearly a different business model that might affect traditional dealers although they also provide service of course and concentrate on new cars which is a more complex sales process. There may also be an issue of trust when using an on-line service. But the process of buying and selling cars certainly needs simplifying from my last experience of doing so.

At least bars and restaurants can reopen, albeit with severe restrictions on social distancing. That will certainly reduce their sales volumes and increase their costs, resulting in a big hit to profits. Still a sector to avoid I think.

Bowling alleys were expecting to be able to open from the 4th July based on what Ten Entertainment (TEG) and Hollywood Bowl (BOWL) said. But the recent Government announcement has put a stop to that along with the reopening of gyms and swimming pools. They now hope to reopen in August.

Is this ban rational? I can see why indoor gyms might need to remain closed. A lot of heavy breathing and sweating in close proximity. But bowlers don’t exert themselves much from my experience and if alternate lanes were used social separation would be good so long as they used their own shoes.

Note that I hold shares in some of the above companies. But thankfully not in Wirecard which I previously commented upon and which is now filing for bankruptcy proceedings.

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

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Why Do People Queue, and Retail Renaissance?

This blog post was prompted by pictures of people shopping on Oxford Street last night and a tweet from Emilios Shavila showing a queue for Primark at my local shopping centre in Bromley – it looks to be at least 100 yards long. Why does anyone queue to buy non-essential items? Have they not discovered internet shopping?

This is very puzzling as personally I can’t stand to queue for anything and I don’t think I have been in a shop for over 3 months, and very rarely also in the last year. Do people like the social interaction of shopping? Or is it because they can take a friend along and ask them “do I look good in this?”. Perhaps retail shops are not quite heading for extinction just yet, but I certainly would not be investing in them at present unless they had a very strong on-line business element. I feel that shopping habits really are changing and the epidemic has  hastened the move to on-line retail therapy.

The good news is that US retail sales bounced upwards by 18% in May which is a record since 1992 according to the FT and confounded forecasts of a rise of only 8%. That followed a decline of 15% in April. Will the UK follow a similar pattern? Let us hope so because retail spending can have a big impact on the overall economy.

One company that might be affected by High Street footfall is Greggs (GRG) who gave an update on their plans for outlet reopening this morning. Many of their shops are still on High Streets although they have been diversifying into other locations such as motorway service stations and train stations. Greggs has over 2,000 shops altogether and plan to reopen 800 on the 18th June. The rest will reopen in July.

The share price has jumped by 7% at the time of writing, but they do say that they “anticipate that sales may be lower than normal for some time”. Shore Capital reiterated its “Sell” rating on the share because they consider the High Street will take time to adjust to life in a post-coronavirus environment”. They also consider that Greggs will incur significant extra costs as a result of the measures they need to take.

My view (as a shareholder in Greggs) is that I still find it impossible to judge the likely profits (or losses) at Greggs in the short term despite quite a lot of detail in today’s announcement. It’s really a bet at present whether you see it as a valuable property in the long term or not while ignoring the short-term pain. That’s not the kind of investment bet I like to take so I will simply wait until the picture becomes clearer. Regrettably the same logic applies to many other companies at present.

On a personal note, one organisation that has solved the queuing problem is the NHS. Apart from converting my hospital appointments to telephone consultations, the latest manifestation was a new “drive-thru” blood testing service. You get a timed appointment so I drove up on the dot and immediately had it taken through the car window. No need to even get out of the vehicle. Absolutely brilliant. But I am not sure that will be quite so practical in mid-winter.

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

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