Chris and Clem Meet Up #11
Chris meets Clem every other Friday down at the Golden Lion, except this time it isn't at the local - it's closed due to the lockdown so they meet up in the park in town, around two in the afternoon - and the drink is a sobering coffee - an alternative to Clem's pint of bitter.
Clem was an old friend of Chris' late father - and now he's become fond of his son. He reminds him so much of his past mate.
About 4 months ago, completely out of the blue, Clem happened to mention to the young (then 32 years old) Chris that he's gotta stay out of debt.
He suggested that Chris construct a spreadsheet, or something similar, to show what his in-comings and out-goings were.
It was easy for Clem to spot where Chris and his wife were going wrong. In fact, they were heading for a lot of trouble. After much tweaking and sacrificing, Chris finally pulled around the situation.
His personal finances are now looking good. What he really learned from Clem was that he had to get rid of all destructive debt.
He also applied for a job 300 miles away. He thought the increase in salary would be the answer to his problems. But in the end, he was given promotion by his present company along with a company car.
This action really turned around Chris' fortunes.
Clem then set about teaching Chris how to invest for his retirement. Sure, Chris contributed to a company pension scheme, but this would not be sufficient to provide for Chris' needs.
Clem, being an ex-stock trader, albeit an amateur, convinced Chris to start a Self Invested Personal Pension - or SIPP as they have become abbreviated.
This series of articles is about Chris' progress in growing his SIPP, under the tutelage of Clem. It turns out that Chris has become the star 'pupil'
But a lot of credit must go to Clem - for being so knowledgeable.
Clem strongly advised Chris to read as much about Warren Buffett as possible. 95% of what Clem was going to impart to Chris would be about that man from Omaha.
Chris took everything to heart and read lots about the $90 Billion investor and his methods.
In this series of articles he not only imparts the knowledge that he has learned but reveals his own ideas on growing his SIPP portfolio.
Chris has bought several company shares for his SIPP and shown a good profit. But he is the first to admit that it is more beginner's luck than good share selection.
The two meet again, albeit on a cold and bitter day in the park (due to Covid) and Chris reveals more about what he has read up on the great Warren Buffett. What trading he has done for his own portfolio, and he can't but help having a poke at Clem from what his Dad told him.
"Now then Chris" Clem asked expectantly, "what gems have you uncovered about the great man Warren Buffett?"
"Wow!" replied Chris "you're straight to the point this week aren't you?"
"I am" said Clem " I've only got a coffee here to keep me warm in this not so beautiful weather right now"
"I'll try to be as concise as possible then" repied Chris.
"By the way Clem - that's a lovely Santa hat you're sporting" chuckled Chris.
"Yes, I might look a prat, but I'm a warm prat" Clem snarled back.
"Right come on now, spill the beans, I'm not prepared to sit out here in the freezing cold for any longer than I have to"
"Nope, and neither am I" shivered Chris.
"In my quest for being able to differentiate betwee Commodity type businesses and Consumer Monopoly type businesses I uncovered a few more interesting and helpful snippets of information.
"Warren makes it clear that it is easier to identify products than it is to identify services. Yes, I know, it all sound obvious.
"But if you can identify a company that is selling something that people use every day yet it wears out quickly. But, it is cheap to replace the machinery that makes it.
"Consumer Monopoly type businesses find it cheap and easy to replace machinery whereas with Commodity type businesses, it is a major cost. And comes around often.
"Commodity type businesses are forever competing on costs, that's why when you look at their financials, their earnings, profits, etc. are all over the place. One year up, the next year down. Two years later into loss. No definite pattern.
"Whereas with a Consumer Monopoly type business you are looking for steady, but upward growth, in (ideally) everything - revenues, profits, earnings, dividends (if paid), - and all this information is available - and availalbe for free.
"Another good sign of a Durable Competitive type company is if it buys back its own shares. It will have accumulated enough spare cash to be able to do that. You might ask: why would it want to buy back its own shares? Why not just pay the excess earnings out as a dividend?
"They are all good questions but the straight answer is tax. If the company pays out dividends, the recipient has to pay tax on them. If the company retains those earnings and buys back its own shares (to any willing sellers) then those that decide not to sell their shares end up with a (fractionally) larger ownership of the company.
"Fractional that is , if you are shareholder like us small fry. Not so fractional if your name's Warren Buffett. He might own a considerable amount of the company's stock Say, 10% plus.
"In fact, and here's a giveaway, Commodity type companies do the exact opposite of buying back their shares. They issue MORE shares. They might have no option but to do so. The cash hungry tyoe of business that they are in, demands it.
"Before I bore you to death with everything W.B. here is a list of items that will help you decide if a company is a Commodity type or a Consumer Monopoly type of business.
"Remember, people do still invest in Commodity type businesses, but not Warren Buffett. It's all part of his "stock screening" process. He likes to invest for the long term - sometimes as long as 30 years.
"Wow, anyways here's the check list:
1. Are Earnings in a strong upwards trend? Both historically and for future projection.
2. Does the company have a brand name product (or service) that is recognisable?
3. How much long-term debt has the company? If it has to - can it repay its long-term debt out of 5 years of earnings?
3. Are the company shares rising? Is the company book value rising? Warren likes to see both.
4. What does the company do with its excess earnings?
5. Will the company buy back its own shares? Has it already got a history of doing so?
6. Has the company an organised labour force? For example, a union. Most Commodity type businesses do have unions and from time to time they threaten industrial action until they get what they want. Needless to say, this has a negative effect on the company's welfare.
7. Has your chosen company consistetly shown a high return on shareholders' equity? More than 12%
8. Has the company shown a consistently high return on total capital employed? More than 12%
9. Is the company "inflation proof" ?
"It's all your fault Clem" said Chris
"What'd'ya'mean? said Clem taken aback.
Chris jokingly replied: "Youre the one that got me involved in all this Warren Buffett stuff, now I feel trapped. I spend all my spare hours drooling over books about him. I can't get enough. I find his words of wisdom - and those of this side kick - Charlie Munger - truly inspirational.
"In fact, Warren talks a lot about only buying shares when the short-sighted stock market over-reacts to bad news.
"Such pearls of wisdom. I like particularly one of is sayings: "I like to buy my stocks just like I buy my socks - when they are on sale."
"How profound is that?" said Chris on a final note.
"Oh, dearie me" Clem said laughing out loud. "You've really got the bug - stick at it, it'll make you a lot of money - just like it did for me."
"You'll be pleased to know Clem, that I have identified, in true Buffett fashion, a share that I think will serve me well. Although, beginner's luck or otherwise, the ones that I have bought have served me well so far. Nobody would blame me if I were to sell them and take a very quick profit.
"You have done incredibly well" said Clem, "I'd stay with them for now. Ride your luck a little bit longer. Or, if you are happy with the fundamentals, keep them. It is, afer all, a long-term commitment, this saving for retirement lark."
Chris butted in: "It's not that I don't want to buy any more it's that my powder is running dry. I need to wait a few more months to build up some more capital before I dive in again. I do still have about £11,000 in the kitty. Unless, of course, I were to uncover some real gem - in which case I would sell some of my existing stock in order to fund it."
"Fair dinkum" Clem said sarcastically.
"Actually," said Chris, "I have been contemplating buying a couple of 'out-of-favour' stocks. Good companies that have suffered really badly because of Covid but what you might call 'recovery shares.'
"I have a short list. I've mentioned some of them to you before - Carnival Cruise Lines, Cineworld, TUI Travel, Royal Mail, Rolls Royce, the list goes on.
"Warren doesn't go for things like recovery shares, he likes to play the surefire earnings game. And who can argue with that?
"One company, there are others, that I dug deeper on was: Countryside Properties (CSP) - no, not Countrywide Properties. They are predominently housebuilders based around the London area. Their shares looked good at 383p with a P/E of 11.74
"I bought 1000 shares at 383p. All the figure look to be trending in the right direction and their final year figures have just come out. A tad disappoiting - they made a loss, but that was entirely due to Covid. They are a relatively new company to the market, entering in 2016 - so there is not too much history - but I like what I saw.
"Their results yesterday came with news that they were splitting up their operations. The market seemed to like this and marked the shares up 20p at 461p They finished the week at a convenient 450p
"And I like the look of Hargreaves Lansdown (HL.). Ironically, that would be almost a pure play on the SIPP market. Why not? It is surely a market that is going to grow for many years to come.
"I've done some basic research on the company and the figures are impressive. What could be off-putting is the P/E ratio. It was meandering around the 25 level. A tad too high for my liking. It is definitely one for my watch list. The shares are currently trading around the 1440p mark and a P/E/ of 21.83 (still not low enough for me to buy).
"However, for the P/E of HL. to drop to as low as 12 would require the shares to fall all the way down to 700p using historic earnings figures. That clearly would require a major shift in the share price - something extremely unlikely.
"This is where Warren and his future earnings projections give him an enormous advantage. We're not Warren, but HL.'s interim results will be out at the end of January 2021 which will give us a better clue.
"Hargreave's last five years of earnings have been: 57.9p, 52.1p, 49.7p, 44.7p, and 37.4p
"Is it not then unreasonable to assume that earnings for the next year will be a continuation of that upwards path? After all, we've studied Hargreaves Lansdown and they are a good, well-managed company in a niche that will grow for many years to come.
... and it is unfortunately, a big but. Warren does not put too much faith in historic earnings he likes to think in future earnings. And if he discovers a company that is a genuine Consumer Monopoly type of business - he will spend time on it.
"I believe Hargreaves Lansdown is a company with a Durable Competitive Advantage. I also think the same will be true of Countryside Properties but it might be a tad to early to talk about them - they are relatively new to the market and have just turned in a loss - albeit for the Covid period. Time will tell.
"One thing I haven't found the time to do right now, is how to estimate future earnings of a company. As you know, Warren swears by this.
"I thought I might take the last 10 years of earnings and plot a graph, which, for the type of company we are looking at will be a steady upward gradient, and, all things being equal and the company continuing as it always has - project that graph 10 years into the future.
"Not quite how Warren would do this, but I don't have the time or the know-how to do it his way."
"Have a go" said Clem, "it sounds as if it might be interesting."
"OK I will" replied Chris, getting excited again. "As an engineer, I would find this kind of exercise right up my street."
"Below is a very rough idea of what I intend to do for all the research that I do."
"But, just take a look at the wee graph that I sketched out (above). Here you can clearly see that the last 4 or 5 years of earnings have been roughly linear. There's no reason to suggest that future years will not continure in the same vane. We can only estimate.
"I have pencilled in the five known years of earnings and projected the trend of earning forward into the future - roughly 10 years hence.
"You can extrapolate future earnings from this graph, which admittedly, relies on an estimate. But current growth continuing, I suspect will not be too far off the mark.
"Take for example, earnings for year 2021. We don't know what these are yet but the above graph gives our best guessimate. Around 64p. Compare this with 57.9p for 2020 and 52.1p for 2019 and the numbers don't look too far out of place.
"If the current share price was still valid in 2021 then the P/E ratio would drop to: 1440/64 equating to 22.5. Note that if the share price were to fall (to say, 1200p) then the P/E ratio using the same adjusted earnings would equate to: 18.75
"If you look in the company accounts, you will see basic earnings, diluted earnings, and adjusted earnings.
"Which one of these should you use when calculating the P/E ratio?
"That's a question I have asked and never got a satisfactory answer to. But I will.
"Until then, I will continue to use the adjusted earnings figures. This of course, gives me the worst case P/E ratio. If I were to use the diluted earnings (like most brokers do) the 2020 P/E ratio would fall to: 1440/65.9 = 21.85
"Fudging the figures or normal accouting practice? I don't know. I'm not an accountant.
"I would have said that the type of earnings you are using when quoting the P/E ratio should be mentioned - so to eliminate any mis-understanding.
"Having looked fairly deeply into
this company, I am convinced that they will, if not sooner, but definitely
later, become part of my core portfolio. The figures over the past
five years are excellent. Exactly the type of company I am looking for.
"I'd prefer to see the last 10 years of trading and will try and find the information, but for now, they look good.
"The trend of every thing is upward. Revenue. Profits. Earnings. Shareholder's Equity. Dividends (albeit a little off in 2017) but overall, quite what we're looking for.
"But I'm going to do a Warren. I'm going to sit tight, be patient, and be ready to buy these when the price is right. Watch this space."
"Ooh, you almost spilled your coffee as you spurted all that out." stated Clem, "but it's good to see a little bit of your research has caught your eye."
Chris "caught my eye it has. But I need to wait now for the opportune
moment to buy. I'm confident it will not be too far away. Their next (interim) results are due at the end of January.
"I even went as far as jotting down the figures to show you. I've brought my iPad along so you can see the figures.
"Alright" said Clem "Let's take a look at them together,"
"Impressive" agreed Clem. "You really are full of surprises Chris. It's a real pleasure to see you on the right track.
"Just at first glance, I would want to question why there was no special dividend in 2017. There's probably a decent explanation for it, but I'd like to know what. All the other figures seemed to be OK. "
"Yep, I noticed that as well, but with it being the only "blip" in the figures, I thought it was just the company being a little cautious." said a shivering Chris.
"Maybe." Clem replied with chattering teeth. "This meeting in the park at this time of year is not a good idea. Next time we should be back in front of the Golden Lion log fire."
"I do think you may have found a good company here. Not a buy for now, as you righly said, but one to watch. The P/E is bout 21 as we speak. If it were to fall to around 12, that would really get my attention.
"I think the sector this company plays in will grow for many years to come. Well spotted. See if you can find another one for the next time we meet up."
"You know I'll do my best. I'm only just getting started, but all this reading about Warren Buffett has further picqued my interest. And I'm only really looking at UK shares. I couldn't find the time to go any wider. UK companies I feel more comfortble with." exclaimed Chris.
"Nothing wrong with that" said Clem, "the great man himself advocates only keeping watch on a few dozen shares throughout your lifetime."
"I already have found another company that I really like - Glaxo Smith Kline. They are way out of favour at the moment. I think I'll dig a little deeper and try to find out why.
"Afore we depart" Chris chipped in "I'd like you to take a look at the spreadsheet I'm working on to do with my SIPP.
"It's amazing. I started with nothing only 6 months ago and my SIPP portfolio is now standing at nearly 36 Grand.
"I have actually contributed over £20K, the taxman hs added his generous bit, and there's the small matter of about £6K+in profits (ignoring dealing costs etc.)
"I have highlighted the cost of what shares I have purchased (in green) and their vlaue now (highlighted in yellow).
"I think by the end of the year, or sooner, I will decide which ones I want to keep and which to discard.
"Wow! Chris, I knew you haddone well with your share selections but this performance in just a few months is astonishing"
"Yes, I'm pleased too, but let's not get carried away. This last month in particular has seen something of a presidential and Santa Claus rally. Things might be rather different come the New Year. Maybe. Maybe not.
"If the Covid business keep on going the right way, there is Brexit deal (or no del), and the economy makes a sharp turn-around - who knows? We might have a raging Bull Market on or hands.
"Now that would be well-timed. Don't you thik Clem?"
"I do" replied Clem "Now can I get back home to my nice warm fire?"
"Before we wrap up for tonight, are you going to tell me about your murky past. At least that's what my Dad used to call it." said Chris almost appologetically.
"Oh, did he? I shall have to be careful in future. He probably got me to consume rather more than I should have done. My "murky" past as you put it, was a long time ago. I'm in my eighties now - back then I was a teenager.
"I was born and raised in a small town in the mid-west of the USA. When I was young, it was really hard to find job. My first gig was as a bell porter at a rather seedy hotel down town.
"I can tell you, I saw, and heard, things that no young man should see. What an education."
"Was that it?" cried Chris
"Hell no" Clem replied "that was just the beginning."
"Tell me about some of the stuff that you saw. Was it a kind of 'What the butler saw' kind of thing?" said Chris, beginning to get excited.
"It was more like 'what the butler saw and did' " replied Clem. "And that's enough of what I'm going to tell you."
"Awe, come on Clem. My Dad said it was more than that. He said that you authored books. Is that right?" Chris said trying to prize more out of Clem.
"OK" said Clem. "If it'll shut you up. Bloody hell, you're like a dog with a bone. I met some very interestig people when I worked at that seedy hotel - ladies of the night, lots of them - and the "gentlemen" that used to visit them.
"There was one gentleman in particular who you could tell was different to all the others. I kinda liked him and I'm sure he liked me - the tips he gave me were extremely generous." said Clem.
"But what kind of stuff did you author?" asked Chris, being more inquisitive by the minute.
"It was different back then" stated Clem. "Writing a book and getting it published was not easy."
"But wat did you write about?" asked the excited Chris.
"Well, the first book I wrote was called "The Confessions of a Bellboy"
"And what about all the others?" asked Chris
"As I said" exclaimed Clem "In that job I met some real interesting people. Not least the gentleman that took a shine to me, and tipped me really well. I could tell that he was a man with some story to tell."
"It only turned out that he was some super successful stock trader - a broker in fact."
"Oh, the stories he used to tell me in the elevator when I took him up to the seventh floor to meet one of his 'ladies' In fact, it was because of him that I got started "dabbling" in the markets."
"You've had a very colouful life" said Chris.
"Oh, it was colourful alright" said Clem "I worked at that hotel for 4 or 5 years and that gentleman taught me tricks of his trade that just wouldn't apply in today's markets - but they did then."
"Let me guess" Chris said even more excitedly "you got an education in stocks from this guy and invested all the tips that you got on the information that he gave you."
"You really are sharp" said Clem "and not too far from the truth."
"You wrote a book on the subject?" asked Chris
"Now you're getting too close" said Clem "Can we make that the subject of another day? It's a little bit of a sore subject with me."
"Sure" replied Chris "When do you want to meet up next?"
"When we can sit in front of a nice warm fire, with a cold beer" said Clem.
"It's too chilly to meet like this again, but by the 18th. December the pub will be open again for business - let's say two weeks from now - that'll be the 18th. December. A week before Christmas" Chris said to a shivering Clem
"Yep, 18th. of the month. I'll be there" said Clem "You'll be able to recognise me - I'll be the old man with a Santa hat on."
"Ho, ho, ho."