Here's how the Share Sleuth portfolio quadrupled in value

Richard Beddard looks back on a decade of the Share Sleuth portfolio and at positioning for the future.

If you have read my contribution to Money Observer's 40 tips for better investing, you will know I do not dwell on performance. However, it is not just Money Observer that is celebrating an anniversary this month. On 9 September, the Share Sleuth portfolio was 10 years old.

The last decade has not obviously been a propitious time to invest. The Share Sleuth portfolio was born towards the end of an 18-month-long contraction in the economy, the longest UK recession since quarterly figures on economic growth were first published in 1955.

Emergency measures

The credit crunch had left us with quasi-nationalised banks and the government much more heavily in debt, and deploying an economic contrivance called quantitative easing designed to stimulate spending and investment.

Like nationalisation, quantitative easing was an emergency measure, deployed because the Bank of England had decided that interest rate cuts alone would not be enough to stimulate borrowing and reflate the economy. No one knew how long it could last, but by buying government and subsequently corporate bonds with newly minted money, the Bank pushed up bond prices, which pushed down bond yields and the cost of borrowing. The new money also pushed up share prices.

I understood none of this in 2009, and it still confounds me now. To my mind a recovering stock market just made investing more difficult. The FTSE All-Share index had risen 43% over the previous six months, so finding value was harder.

Nobody knew how long quantitative easing would last. In fact it is still with us today, nursing us through the tortuous Brexit process, and it is something of a mixed blessing. Those with assets such as property and shares have done well, but those without have prospered less, in relative terms at least. The economic and political consequences are just becoming apparent.

In hindsight, it was a good time to start a portfolio. A £30,000 investment in accumulation units of an index tracking fund (i.e. with dividends reinvested in the fund) would be worth £65,267 today, more than twice as much. The notional £30,000 we drip-fed into shares in the Share Sleuth portfolio during its first year is worth £124,290, more than four times as much as it was in September 2009, including dividends and trading costs.

That is a big relief because the objective of the portfolio is to beat the market handsomely over the long term, and it shows that perhaps, for all my efforts, my decisions may cumulatively have added value.

To put it another way, the benchmark investment in a broad UK index has gained just over 100% and the Share Sleuth portfolio has gained more than 300%. Or, to put it a third way, the benchmark grew at a compound annual growth rate of 8% and the Share Sleuth portfolio achieved over 15%.

This month, in response to a reader's request, we show the annualised performance, including dividends, of each constituent in the portfolio table, with the following caveat: the annualised performance of shares owned only for a short while can be very misleading and is not comparable with the annualised performance of shares held for many years. Nevertheless, two of the portfolio's older constituents are also among its best performers on an annualised basis, and hence they have generated spectacular returns.

Unique business

I am talking about Games Workshop (LSE:GAW) and Dart Group (LSE:DTG). Games Workshop was one of the founding members of the Share Sleuth portfolio, bought on 9 September 2009. Dart followed just 16 days later. The table shows fewer shares in these companies than the portfolio originally held, because I have reduced the portfolio’s holding in Games Workshop once since my original purchase, and I have reduced the Dart holding twice.

The simple percentage returns in the table require explanation. They show the percentage capital gain on what remains of the initial shareholding. The rump of Games Workshop shares has returned 1,505% in capital gains, and the rump of Dart shares has returned 1,241%.

But if we factor in the shares I ejected from the portfolio for lower gains, and also the dividends each company earned over the period, Games Workshop is the clear winner. SharePad, the software we use to do the accounting, tells me Games Workshop has returned a stonking 1,343% – an annualised return of 31% for 10 years. Dart has returned 627% for an annualised return of 22%.

Though the portfolio would have done even better had I decided to keep all the shares in these two companies, I am not beating myself up about it. When I reduced the holding in Games Workshop, I was not as confident as I wanted to be that its dramatic surge in profitability and the stock market valuation it had achieved as a result were sustainable. The holding had also grown to be the portfolio's biggest. Selling some of the shares was my way of keeping hold of the remainder and maintaining diversification.

In common with other airlines and package tour operators, Dart's accounts are very complicated and, though I admire the company's strategy, I am not sufficiently confident in my calculations of its profitability and valuation to go "all-in". We cannot hope to be right all the time, if being right is simply measured by the subsequent performance of a share after we have bought or sold it. We can only hope that the cumulative outcome of our decisions is positive.

We all know the disclaimer: "Past performance is no guarantee of future results", so I will not spend any more of this article looking backwards. Neither am I going to peer forwards because, as should be apparent from my naive views about the state of the economy 10 years ago, I cannot see the future. Instead, I will report on how the portfolio is positioned now, for the future.

One way of looking at how well positioned it is, is through the lens of my Decision Engine, a scoring system. I score each share using five criteria: profitability, risks, strategy, fairness and value. A company can score 0, 1, or 2 for each of the first four criteria relating to the quality of the businesses, and my spreadsheet calculates a valuation score of between -2 and +2.

Value, therefore, can potentially have a bigger impact than any other single factor, but the four business quality factors together outweigh the value factor. You can see how I scored a handful of companies that have recently published annual reports, including portfolio heroes Games Workshop and Dart, in Share Watch.

Beating index tracker funds since 2013

Using the Smith trick

Another way is through aggregate financial statistics, a trick used by the fund manager Terry Smith in his annual letters to fund holders. I have calculated the portfolio's average values for four key statistics – net gearing, return on capital, cash conversion and earnings yield – again weighted proportionately (see infographic). 

If the Share Sleuth portfolio were a company, I would rate it a buy, but only just. The average Decision Engine score of all the shares in the portfolio (weighted in proportion to each holding's size), is 7.1 out of 10.

A score of 7.1 is just above my arbitrary level of 7, required to add a share to the portfolio. Net gearing of 25% is well below the 50% level at which I begin to fear a company is too dependent on outside finance, and return on capital of 30% is well above my 10% benchmark for a viable business. Cash conversion of 73% is just below the 75% threshold I prefer, so there is a bit of work to be done there, and an earnings yield of 6% is higher than 5%, below which I struggle to justify a purchase. A 6% earnings yield is equivalent to about 17 times adjusted profit.

It is a close call, so despite quadrupling £30,000, my verdict on the portfolio after 10 years is: "could do better".

The Share Sleuth portfolio

314% return since inception in 2009

Notes: No new additions Transaction costs include £10 broker fee, and 0.5% stamp duty where appropriate Cash earns no interest Dividends and sale proceeds are credited to the cash balance *Annualised return includes dividends, unlike the raw return in the previous column £30,000 invested on 9 September 2009 would be worth £124,290 today £30,000 invested in FTSE All-Share index tracker accumulation units would be worth £65,267 today Objective: To beat the index tracker handsomely over five-year periods Source: SharePad, 9 September 2019.