Chris and Clem Meet Up #10

"Chris and Clem Meet Up
- Friday Night 20th. November 2020"

"Chris and Clem's Story So Far ..."

Every fortnight this duo (Chris and Clem) meet up for a couple of drinks.

Their conversation for the past 4 months has been about the state of Chris' finances and his saving for retirement.

Until Clem started to talk with Chris about his personal finances, Chris was heading into trouble - but didn't realise it.

Chris took much heed of Clem's advice and cut back on just about everything. He constructed a spreadsheet with all his personal finances. 

But before all of this talk he had got into his head that the best way out of trouble was to change his job and re-locate.  To cut a long story short - Chris had an interview for  a dream job but, it was 300 miles away.

He was successful and ready to hand in his notice when his present employee offered him promotion, which almost matched the job down south.

After much soul-searching, Chris decided to stay and take the promotion.  His personal finances now well sorted.

His saving for retirement had just begun and under the tutelage of Clem, he was going to learn a lot - mostly about the investing wisdom of Warren Buffett.  Clem had asked Chris to study, in detail, the work of Warren Buffett.

This, Chris has started to do, and took it all to heart.

The story continues ...

"Chris' Finances Are Now in Fine Fettle"

"Wow!  I can't believe what a whirlwind last few months I've had." said Chris

"Nobutt  three month ago, Clem, you identified serious problems with my finances.  I owe you BIG time.  The beers are on me tonight.

"And as a further bonus to my ever-appreciating bank balance, I have sold the car, cleared the finance, no more insurance, no more maintenance, and I now drive around in a classy 2020 reg Ford Kuga.  I was given a choice by the company and I chose a SUV.

"Yes, I'll be paying a bit more tax but my increase in salary should more than make up for that. And, as a bonus, after clearing the little bit of money still owed on my old car, I have been able to bank just over 12 grand.  I got a great offer at 'We BuyAnyCar.com' 

£12,250 to be exact.

"That little lot has gone straight into my SIPP account."

"Good on you, Chris" Clem replied. "I think you are going to be destined for really great things. Keep the momentum going."

Chris' Monthly Expenditure Summary

"Hey, Clem - take a look at what my bank balance summary is now.

"532 quid left over this month and 163 last month.

"What a turn-around!

"And it's all your fault Clem.

"What would have become of me without your divine intervention?

"It's not worth contemplating"

"It's good to see someone that takes advice and runs with it.  You're one of a kind.  Not many would have taken my advice like you have" lamented Clem.

"More Secrets Chris Learned
About Warren Buffett"

"I haven't had much time to study Warren this past couple of weeks but that doesn't mean I didn't read anything.  I am intrigued by his rejection of what he calls 'Commodity Type Businesses' and his favour of 'Consumer Monopoly Type Businesses.'

"The big question will always be: "How do you distinguish one from the other?"

"Yes" said Clem, "I know just what you mean.  In my earlier stock trading 'career' I had a similar problem.  Knowing how to choose between the two types."

"I'm so glad I've got you to bounce my ideas off" said an excited Chris.

"Did you have anybody to set you straight, Clem"

"No," replied Clem, "I'm what you might call a self-taught, know-nought from the mid-West."

"You are never a know-nowt" retorted Chris, "You've taught me what everyone should be taught, and that is the basics of saving money.  It should be taught in schools.

"You've been, and I sincerely hope that you will continue to be, an inspiration to me. Not least, about the markets.  You are exceptional.  I remember my Dad talking about you when I was only little.  Now I am beginning to remember some of the stuff he used to say.

"He said that you were, amongst other things (all good of course) an author."

"Oh the heck" said Clem, "I didn't think that would have come up in our little talks. Yes, I did author a few books when I was living in the States. Good grief.  That seems like another lifetime ago.  I'll tell you about them another day.

"Right now, tell me what new stuff you've learned about finding Warren's two type of company."

"Alright," said Chris, "here's another piece to the jig-saw puzzle.  It's not much, but I promise to do better for the next time that we meet up.

"Investing in 'Consumer Monopoly Type Businesses' is what Warren Buffett does, and investing in 'Commodity Type Businesses' is what he doesn't do.

"He really goes for businesses that have a repetitive need for their branded products.  Branding seems to be stressed in this context.  Warren likes:

• Fast food restaurants
• Patented prescription drugs
• Name-brand foods
• Brand-name household goods and toiletries
• Brand-name clothing

"As you can see he likes brands, and brands.

"Furthermore, he knows what sectors he's going to find his 'Consumer Monoloy Type Businesses' they are in:

• Advertising
• Advertising agencies
• Insurance companies
• Financial institutions
  
• TV
• Newspapers
• Mgazines
• Direct mail and billboard companies

"Do you think I might have been influenced by the above when I naiively bought my shares?"

Clem said: "I wouldn't doubt it for a minute."

"And you'd be half-right.  It was early days when I bought those shares.  Just to remind you, I bought: ITV, Lloyds Bank, and BT Group and then some more Lloyds.

"Sure, they've all gone up, but more to do with the market's general rise than my super-duper selection skills.

"Ironically, the P/E ratios of those companies was low, and, with the exception of Lloyds Bank, below their sector averages.  Was it beginner's luck?  No, of course not, I'm a financial genius!

Examples of a Consumer Monopoly type business and a Commodity type business:

Consumer Monopoly type business

Earnings over a 10 year period (p):

Year
1   5.06
2   6.12
3   7.34
4   8.02
5   8.45
6   9.21
7   8.88
8   10.2
9   11.4
10 12.9

Commodity type business

Earnings over the same 10 year period (p):

Year
1    2.34
2    3.33
3    1.02 (loss)
4    1.77
5    2.34
6    3.32
7    4.67
8    0.87 (loss)
9    0.98
10  2.67

"Looking at the list above, and there is more, I am beginning to see where Warren Buffett is coming from. And of course, further proof of the pudding are the companies' financial statements. Warren likes to see consistent earnings growth, year in, year out. 

"You don't get that consistency with 'Commodity Type Businesses.'

"How am I doing?" asked Chris.

"I think you are the number one student of Buffettology.  Keep readings those books, they are obviously having the desired effect." replied Clem.

"Just one last thing about Warren's selection methods" interrupted Chris.

"As well as the company's earnings, Warren likes to look at their Return on Equity (ROE). What he is looking for, again, is consistency.  He knows that a good company with a consumer monopoly will have consistency.  Good earnings every year, and also a good ROE - every year.

"But, Warren being Warren, he goes deeper again.  if he can't find inconsitency there he looks for a company's Return on Total Capital (ROTC).  And it is invariably here, that Warren finds inconsistencies.  He knows that Commodity type businesses are inconsistent - if he can't find it in their earnings growth over the past 10 years or so, he'll look at the ROE, and if he can't find it there, he'll look at the ROTC.

"Well, at least that's what I read and how I understood it."

"Excellent stuff!" exclaimed Clem.  "You're doing well.  Soak it all up."

"Let me just squeeze in another bit of Warren wisdom" Chris jumped in.

Clem responded "OK, if you must"

"I also learned that another way to recognise companies with a Durable Competitive Advantage  is to take a look at how much long-term debt that they have." Chris replied glancing over at Clem with a "I can't believe you just said that" kinda look.

"Warren's kind of company earns a lot of cash and therefore has no need for long term debt.

"And if it has, it is esily payable within 5 years

"A Warren type company might use long-term debt to buy another company but it is certain that the target company would need to be a Consumer Monopoly type business and not be of the Commodity type of business.

"I'll just wrap up Clem in a minute.  The above table showing earnings are not fool-proof.  There are some Commodity type businesses that will show decent earnings growth.  So what Warren does he if doesn't find a discrepency with earnings he then takes a look at the company's Return on Equity (ROE)

"OK I'll shut up now.  I'll save the comparison of company ROE the next time we meet."

Clem sandwiched in with "Thank goodness for that, can I enjoy the rest of my evening now?"

"Not just yet" bellowed Chris.

"Chris' Own Share Selection Criteria"

"Remember the last  time we met Clem, I told you about the Yahoo App that I was using?" 

"Yeah," said Clem.

"Well, I've concocted a spreadsheet with a few of the companies that I found might need watching.  I've a lot more to investigate as well, but the picture below is a good guide as to what I am looking at."

Watchlist of Potentially Undervalued Stocks

"Despite Covid, or perhaps because of it, many stocks are trading well above their pre-Covid prices - yes, that surprises me too.  The highlighted shares are on my watchlist but not a buy because they are perhaps over-bought.  I'm looking for shares that are over-sold.

"And, of course, I will not invest in Commodity type businesses.  So that would rule out BHP Group, Rio Tinto, Anglo American and CRH.  Not my rules - but those of the sage himself.

"It's amazing, this Covid thingy has thrown up all kinds of situations.  And now, there is the news of a possible vaccine, is now the time to buy?

"My name would be Warren Buffet the second if I knew the answer to that.  But ... not wanting to 'miss the boat'  I bought some more shares with my little windfall."

"Oh dear" exclaimed Clem, "What have you done now?"

"Awe, come on, Clem, give me a little bit of credit. Even my original shares are doing really well. Lloyds are nicely in profit - bought at 26p and 28p and now trading at over 35p.  And ITV were bought at 60p and are now trading in excess of 95p.

"I looked at my crude spreadsheet created from the Yahoo Finance App and there were so many shares with a lowish P/E and near their low for the year.  Which offered the best value?  Again, I'm not Warren Buffett.

"I've long been an admirer of GlaxoSmithKline.  I think they've been well over-sold.  But then, so have a lot more.  Notably, banks, some insurance companies, tobacco companies, and a whole host more.

"Oh, what to do, I thought to myself."

"I didn't really want to sell any of my existing holdings. Currently, I have ITV, Lloyds Bank, and BT Group.

"But, and it's a big but, I'm a little cautious of this market.  It plummeted in late February/early March and recovered a lot of the losses, although some companies haven't, and now with this vaccine on the horizon it's all beer and skittles.

"Because of the way people get carried away, I don't trust it at all.  What do you think Clem?"

"I can't disagree with you."  Clem couldn't resist. "We have seen it all before.  On the back of some good news, euphoria takes over and the market does crazy things.  More so Wall Street than the markets over here. But what happens over there - happens over here.

"When Wall Street sneezes, London catches a cold"

Chris said nervously: "markets can't go up and up, just like they can't go down and down. But of course, nobody, but nobody can predict when, or where, the turning points will be.  I'll be watching volume very closely this next few weeks, and won't hesitate to sell everything if things turn bad.

"I've already got some decent profits and I don't want to lose them."

"Yes" said Clem in a kind of a gloomy voice, "I wouldn't trust this market either.  Just imagine if the vaccine that they claim to work on 9 out of 10 people, turns out to be, well, not as successful as they first thought.  My God.  The markets would do a u-turn like we've never seen before.  It doesn't bear thinking about."

"Thankfully, there is more than one vaccine out there."

"Enough of this doom and gloom." said Chris "for now, let's be positive, but wary."

"Last time we met Clem, I told you that I liked the look of Imperial Tobacco, Aviva, and Legal and General. What I actually bought with effectively the money I received from the sale of my car was:

• 1000 shares in Aviva @ 272p - total consideration: £2,720 (ignoring small commission)
• 2,000 shares in Taylor Wimpey @122p - total consideration: £2,440
• 2,000 shares in William Morrison @164p - total consideration: £3.280

"I was a tad hesitant to buy knowing that the market could tank on any kind of bad news, but I want to take advantage of this short rally - if it is indeed a short one."

"Well said Chris" Clem butted in. "And another sign of an over-heated market is takeover activity.  We've had quite a bit of that lately. 

"First there was the Canadian bid for RSA Insurance, and just this week we've seen a preditor trying to pick up a stake in Countrywide, the estate agents.  Recently, there had been lots of action in G4S which is now trading near its peak of 221p against a low of 69p - quite a difference.

"There are a lot of companies out there ripe for picking up.  Some are trading at ridiculously cheap prices.

"Takeovers, whilst not a reason for the end of a rising market, are just one factor that typify such.  Which makes your comment about the market topping out not as daft as it sounds. You are absolutely right to be wary. 

"Only time will tell."

"What I've tried to do with the above purchases is buy some kind of value - based on lower than average P/E - but also to balance my fledgling portfolio.  I now have in my portfolio:

• a banking company
• a food retailer
• a telecoms company
• an insurance company
• a specialist house-builer
• a television company

"I shall delve deeper into these, and other potential companies, as I gain in knowledge.  With the exception of Lloyds Banking Group, all the above shares were trading on low P/E ratios when I bought them. 

"What I want to do next is dig deeper and find out about their historic earnings, and more importantly, their projected future earnings."

Chris' Portfolio Summary

"I just gotta show you this.  Look at those figures - no not those girls at the bar - these over to the left.

"I have managed to show a profit of £4940 in TWO MONTHS.

"I think even Warren Buffett would be proud of me.  I'll not be getting carried away.  I fully realise that I took advantage of a rally in the markets.  You'd probably call it beginner's luck - and you'd probably be right.

"Whether I keep some, or all of these stocks, will depend on my final research - which I know I should have done first - but then I would have missed the rally.  In fact, I reckon I could have done even better.  But I'll not be greedy."

"Well done, Chris" said Clem, "you're turning into a real pro at this.  You are heading for a    £ milliion  pension pot and more at this rate.  Oh, how I envy you."

"Chris and Clem's Next Meet Up"

"Now then super-sonic" Clem bellowed out in a loud voice, "let's meet up again, as usual, in two weeks' time - that'll make it the 4th. December."

"Fine by me" said Chris, "you know I love our little get togethers."

"Flattery will get you everything" Clem replied while walking away.

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