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Nicholas Hyett runs Benjamin Graham's rules of investing over the FTSE 100 and FTSE 250.
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
Benjamin Graham is best known for having taught Warren Buffett – one of the most successful investors of recent times – and had a formidable investment track record in his own right.
He's often called the "Father of Value Investing" because of his focus on a company's price. That style has been out of fashion in recent years, with a focus instead on "growth companies" like Amazon and high quality "compounders" like Unilever. However, all that support has caused high prices for growth stocks so we thought it might be worth taking a look at some more value focused options.
In his book "The Intelligent Investor", Graham set out some minimum criteria companies had to meet before he would consider investing. A great deal has changed since Graham’s time. However we've run his rules over the 350 largest companies listed on the London Stock Exchange to see which UK companies he might be interested in today.
This article shouldn't be considered as personal advice. Individual shares carry more risk and investing in them isn't for everyone.
|UK Companies that meet Graham’s requirements for "Enterprising Investors" *|
|Crest Nicholson Holdings|
|St Modwen Properties|
*Based on data from Refinitiv Datastream at 16/06/20
Now it’s worth bearing in mind that these were ‘minimum conditions’ necessary for Graham to even consider investing in a company. Given that a value approach often throws up some more troubled companies he would then go on to have a closer look to decide whether to invest. We’ve done exactly that for a couple of companies below.
Any lessons you choose to consider from Graham’s approach will depend on your personal goals, circumstances and attitude to risk. As always, remember that all investments can fall as well as rise in value so you could get back less than you invest.
Barratt Developments is the UK’s largest housebuilder by sales – and one of several housebuilders in the list above. The sector was forced to shut down almost entirely in the early days of the coronavirus outbreak. And although construction is back underway, following social distancing rules means output is unlikely to be what it otherwise might have been.
Housebuilding is generally a cyclical business – in short this means it rises and falls along with the wider economy. When times are good, demand for new houses is high and so are prices. During a recession though house sales and prices can fall hard. With a severe recession looking likely, it’s perhaps unsurprising housebuilders make an appearance in a list of "value" stocks.
However, Graham’s approach is also designed to look for signs of financial strength. At the end of April Barratt Developments had £430m of cash available. The group has also taken steps to preserve cash by cutting the dividend, suspending land purchases and trimming management pay. Together with a further £700m in available debt funding that should provide the company with enough dry powder to weather the immediate storm.
In fact housebuilders fared much better than we had expected in the crisis so far. While sales have fallen – unsurprisingly given show rooms are shut – customer interest has continued, and rival builders have continued to sell properties at pre-crisis prices.
Longer term the sector continues to enjoy several tailwinds. That includes a nationwide housing shortage, a national obsession with home ownership and (for the time being at least) record low interest rates that keep mortgages comparatively affordable.
For all that we remain cautious about housebuilders in the medium term – and with Barratt Developments trading on a price to book value of only a little over 1 we’re clearly not alone. Nonetheless the combination of a strong balance sheet and long term growth drivers could prove profitable for those prepared to accept a rocky ride.
On paper at least Pearson should be a winner from the current lockdowns. The group has spent years and millions of pounds shifting its textbook business online, and with schools and universities shut digital education materials should be in high demand.
However, despite all those efforts, physical and semi-physical operations still account for a large chunk of overall sales. Unsurprisingly the closure of Pearson’s test centres and lack of examinations in many countries this year have seen revenues fall.
There’s good news too though. The group’s managed to attract hundreds of thousands of new digital users in the UK and sales in Global Online Learning are up 6% in the first quarter. We suspect that, with disruption perhaps dragging into the next academic year, many schools and universities are seriously considering online teaching for the first time. That could have a lasting impact on demand for Pearson’s products, and existing relationships with schools will come in useful if changes are introduced at short notice.
However, a good deal of the new customers are taking advantage of Pearson’s offer to make certain resources available free of charge during the lockdowns. We’ve never been worried about the demand for high quality, online learning materials, but rather whether users would be prepared to pay for them. We’re not sure that question has been answered yet.
In order to fund the shift to digital Pearson has been selling off its most valuable print assets. Most recently that includes its remaining stake in Penguin Random House, for which it received £530m. We’ve not always been convinced by that policy, but it does mean the group’s balance sheet is in a relatively good place. Education can benefit from economic uncertainty too – since the unemployed return to education to skill-up.
It would be remiss not to mention the fact there’s serious change coming at the top for Pearson though. Long serving CEO John Fallon is due to step down shortly, and the CFO has also been replaced within the last 6 months. However, with transition to digital well advanced and market opportunity clear it might not be a bad time for a clean slate.
Pearson has staked a lot on a digital future. That future is still uncertain, but after a messy few years the story is now a lot simpler.
Vesuvius specialises in "metal flow engineering" – essentially designing and manufacturing components used in blast furnaces and metal casting.
Because of the extreme conditions under which its products operate they have a relatively limited life and so sales rise and fall with global steel manufacturing. Because steel is a key industrial input, and industrial demand turns on and off quickly in a downturn, Vesuvius is in many ways a classic cyclical stock.
Steel markets were already challenging, and coronavirus has inevitably made things worse. The group saw sales fall 28% in April.
While the outlook for global steel markets is out of its control, the current crisis hasn’t taken management totally by surprise. As a cyclical stock Vesuvius was already running a relatively conservative balance sheet. Net debt at the start of the year was around 1 times cash profits, with considerable breathing space over the limits imposed by lenders. The group has trimmed capital expenditure plans, cancelled its dividend and expects to save around £30m from other cost saving measures this year.
Vesuvius does have some long term attractions. Not only are its products complex and specialist, which means it can boast high barriers to entry, but it invests heavily in Research & Development (R&D) to make sure it remains cutting edge. In 2019 the group spent £29.1m on R&D, equivalent to 33.6% of profits, across 6 R&D centres around the world.
Unfortunately the challenge for investors where Vesuvius is concerned is gauging how long the current downturn is likely to last. That’s difficult, if not impossible, to judge and previous commodity downturns have led to significant share price falls. However, when the market does turn Vesuvius will hope to join the rally.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
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