Interactive Investor

Share Sleuth: sticking to my knitting after worst yearly performance

5th January 2023 09:02

by Richard Beddard from interactive investor

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Richard Beddard explains why the quality of the businesses he owns gives him plenty of confidence for the long term.

Sticking to your knitting 600

Happy New Year! This transition from one year to another draws us inexorably to look back at what happened in the year gone by, and look forward to what might happen in the coming year.

That presents me with a problem, because the traditional way investors do this is to compare the difference between the value of their portfolios at the beginning of the year and their value at the end of the year.

They may also attempt to rationalise the difference and resolve to do things a bit differently if the performance was poor.

This would at best be a waste of time for the Share Sleuth portfolio, because I do not set out to beat the stock market every year.

I understand if you are somewhat sceptical of my motive in stating this, because the Share Sleuth portfolio lost 16% of its value in 2022, its worst performance ever, and it would be convenient to brush this under the carpet.

To disabuse you of that notion, I have elevated the section on the performance of the portfolio from the bottom of this monthly portfolio update where it usually resides.

That said, having discussed the portfolio’s returns, we will move on to something much more important, the performance of the businesses held in it.

The value of the Share Sleuth portfolio

The value of the Share Sleuth portfolio Jan 2023

Past performance is not a guide to future performance.

At the close on Tuesday 3 January 2023, the Share Sleuth portfolio was worth £178,332, 494% more than the £30,000 of pretend money I started with in September 2009.

In comparison, the same amount invested in accumulation units of a FTSE All-Share index tracking fund would be worth £74,830, an increase of 149%.

After dividends paid by Bunzl (LSE:BNZL), Garmin Ltd (NYSE:GRMN), Next (LSE:NXT) and Tristel (LSE:TSTL), the cash balance is £2,999.

That is insufficient to fund a purchase at my minimum trade size of 2.5% of the portfolio’s total value (about £4,500).

Share Sleuth table January 2023

Table notes:
December: No new trades.
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.
£30,000 invested on 9 September 2009 would be worth £178,332 today.
£30,000 invested in FTSE All-Share index tracker accumulation units would be worth £74,830 today.
Objective: To beat the index tracker handsomely over five-year periods.
Source: SharePad, 4 January 2022.

Playing the long game

There is a reason the objective of the portfolio is to do better than the accumulation units of FTSE All-Share index tracking fund over periods of five years or more, and that is that I do not know how to beat the average in every single year.

My focus is on the strategies businesses are employing to earn more money, and those take years or even decades to play out.

Over the last five years, Share Sleuth has increased in value by 65%. The benchmark index tracker has increased in value by 17%.

Over the shortest performance period of five years and the longest, Share Sleuth is trouncing the market, but the five-year performance does feel slightly underwhelming in absolute terms.

Given the events of the last three years, maybe I should be more grateful.

The quality of the Share Sleuth businesses

Share Sleuth’s strong performance over the past 13 years may be an endorsement.

Far more important, though, is the quality of the businesses in the portfolio now, because they will deliver the profits that will drive their share prices in future, and Share Sleuth’s performance.

You have probably noticed the Share Sleuth table looks a bit different this month. That is because I have included the two colourful sections on the right.

The first shows my scores for each share, with the average for the whole portfolio at the bottom. The second shows four key statistics for each share, with the weighted average for the whole portfolio at the bottom.

The two sets of numbers are somewhat connected as the statistics contribute to two of the scores: profitability and price.

Interpreting this chart is fairly straightforward, though the headings require expanding.

“P” stands for profitability, “R” for risks, “S” for strategy, “F” for fairness and “P” for price. These are the criteria I score each company by, and they are explained in more detail in the FAQ at the end of this article.

“D/C” stands for debt as a percentage of capital, a measure of the company’s financial obligations (including leases and pension deficits) at the end of the most recent financial year compared to the amount of capital invested in its operations. I prefer companies in the portfolio to be 50% funded by financial obligations or less.

“RoC” stands for the average profit the company has earned as a percentage of capital through good years and bad, a measure of profitability. I prefer businesses in the portfolio to earn more than 10% return on capital.

“CC” stands for cash conversion. It is the average cash flow earned by the company as a percentage of average profit. Often companies bring in less cash than the profit they recognise because of investments they are making and so on. 75% cash conversion is a decent proportion.

“EY” stands for earnings yield. This is profit as a percentage of the market value of the firm, where profit is derived from the average return on capital through good years and bad. The earnings yield is the basis of the price score.

Green is good, yellow is indifferent, and pink is questionable. The more green there is, the better.

The averages tell us that if the portfolio were composed of shares representing a single business, it would, in my estimation, be good value. The average score is 7 out of 9.

The profitability of this conglomerate of 29 businesses is high, the risks are moderate, the strategies are coherent, stakeholders are happy and the profit is a reasonable percentage of the share price.

In terms of financials the conglomerate has more cash than it has obligations. It is highly profitable (return on capital is 34%). Cash conversion is a tiny fraction below my 75% rule of thumb and though that has turned this statistic pink it is probably not significant. The earnings yield is 5%.

A 5% earnings yield implies that if my conglomerate were not to invest in growth and instead pay all of its earnings as dividends we would earn a 5% income in a typical year.

Since most of the companies are investing in growth, and at high returns on capital, I expect the portfolio to do significantly better than that over the next ten years.

2023 and beyond...

I have no better idea whether the world is a more perilous place to invest in 2023 than it was in 2022, when the pandemic was worse, but the geopolitics at least felt better.

Whatever happens, short of catastrophe, I will be doggedly investing in people I trust to make money through thick and thin for everyone.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.

Richard owns shares in all of the companies in the Share Sleuth portfolio.

For more information about Richard’s scoring and ranking system (the Decision Engine) and the Share Sleuth portfolio powered by this research, please read the FAQ.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

Details of all recommendations issued by ii during the previous 12-month period can be found here.

ii adheres to a strict code of conduct.  Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.

In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.

Related Categories

    UK sharesAIM & small cap sharesNorth America

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