Is this a rational reaction from investors?

There is no doubt that Hester’s departure will cause many other changes within the Royal Bank of Scotland in the months and years ahead, but what will those changes be?  Whether they will be for better or worse is far from clear.

It’s true that the announcement has highlighted tensions between the government and the bank, but surely these tensions were already well known?  And even if they weren’t, I don’t think it’s clear how the government’s input will affect the bank in the long-run.

What is clear is that the value of RBS fell by £2 billion because investors found out that the CEO was leaving.

If the market is rational then the sell-off doesn’t represent a knee-jerk reaction by irrational investors.  Instead, it represents an informed and calculated assessment of the value of RBS by the combined wisdom of many thousands of intelligent people.  If those people are right and Hester is worth £2 billion, then his income of less than £10 million means he was woefully underpaid; a statement I think few would agree with.

But this isn’t the first time we’ve seen the market overreact when a popular (or at least effective) CEO leaves a company.

The same thing happened at Reckitt Benckiser in April 2011 when Bart Becht announced his departure.  The news surprised many investors and the share price fell by around 7%, wiping more than £1.5 billion off the value of the company.

If the market was right then we must believe that Reckitt Benckiser really was worth around £1.5 billion less without this one man than it was with him.  Of course we can never know how the company and its shares would have performed had Becht stayed on, but we do know what happened without him.

After Becht announced his departure, Reckitt Benckiser continued to grow its sales, profits and dividends, just as it had before the announcement.  Despite the absence of Becht, the shares rallied from 3,115p on the day of his announcement to 4,546p today. That’s a gain of 46% in 2 years, not including dividends.

It seems clear that investors’ fears over the departure of a much admired CEO were misplaced, and if investors were wrong to sell then, they could be wrong now.

CEOs are an important part of any company, but their departure or arrival should rarely be a reason to buy or sell.  In most cases, investors would do better to focus on the long-term fundamentals of the company, and not who is or isn’t going to be CEO for the next few years.

One of the best tools for reducing risk, and perhaps increasing returns at the same time, is diversification.

Diversification is basically the same as ‘hedging your bets’, which is something that most people are familiar with.

The aim of diversification and hedging is to avoid commitment to a single outcome by taking multiple and often opposite positions, or, as the Cambridge Dictionary puts it, “to protect yourself against loss by supporting more than one possible result”.

Managing a diversified portfolio doesn’t take a lot of additional work, so it seems foolhardy, given that the future is so opaque, not to put diversification at the centre of an investment strategy.

There are three basic components of a well diversified portfolio:

1. Own a sufficient number of different companies

Studies have shown that holding around 30 companies will give virtually all of the diversification it’s possible to get from increasing the number of holdings. If a portfolio goes from 30 to 100 companies then the effect on the portfolio as a whole is marginal, especially in relation to the additional trading costs, not to mention the additional work of managing another 70 stocks.

If 30 sounds like too much then a portfolio of 10 stocks will be about half as volatile as any single one, and about 25% more volatile than a portfolio of 30.

However, another important factor which is rarely mentioned is the psychological impact of a concentrated portfolio.

Although a portfolio of 10 stocks is theoretically only about 25% more volatile than a portfolio of 30 stocks, the portfolio of 10 stocks has 10% invested in each company. It’s not hard to imagine a single stock having a good run and ending up at 20% of the portfolio.

For most investors I think 20% in a single company is far too much and is likely to result in sleepless nights and emotionally driven decisions due to the importance of that one holding.

On the other hand, the 30 stock portfolio only has 3.3% invested in each company which will still only be 6.6% if the share price of a particular holding doubles.

With such a small amount invested in each company the 30 stock portfolio will probably be far less emotionally taxing than the 10 stock portfolio, and is therefore likely to be managed on a more rational and cool-headed basis.

The exact number of companies that an investor owns is ultimately a subjective decision based on the balance between risk, trading costs, emotional stress, and the time and effort costs of watching a given number of companies.

In the case of the UKVI Model Portfolio it takes the cautious route and targets 30 holdings.

2. Own companies from a range of different industries

The simple approach to diversification outlined above, of just holding ever more companies, is a good start, but it can be improved upon.

If you hold 30 companies and half of them are banks then their share prices are still likely to move in tandem.  The banks themselves will also be affected by the same risk factors.

To avoid this scenario it’s a good idea to deliberate diversify a portfolio in terms of the industries in which the various companies operate.

This doesn’t have to be a complicated affair; you can simply decide on some rule which ensures that there is sufficient industrial diversification.

For example, in the popular High Yield Portfolio strategy the rule (from memory) is that each of the 15 stocks in the portfolio should come from a different industry, or more specifically, a different FTSE Sector.

Alternatively, the approach used in the UKVI Model Portfolio is to hold no more than two or three stocks from any given FTSE Sector, which produces a similar level of diversification.

3. Own companies that operate in different geographic regions

The last major pillar in any sensible diversification strategy is to ensure that the companies generate their sales and profits from a wide geographic area.

It’s one thing to own 30 companies from a range of industries, but if they all make their money in the UK then the portfolio as a whole will suffer greater swings both up and down as the UK economy booms and busts.

Given that most UK investors live and work in the UK, having a portfolio of shares overexposed to the UK as well is an unnecessary and easily avoidable risk.

Once again the rules here can only be subjective and there is a trade off between the geographic diversity of a portfolio and the familiarity which you have with the companies in it.

As a guideline, the FTSE 100 generates around 20% of profits from within the UK, which means it is very geographically diverse and is why its movements often don’t correlate with the UK economy.

As another example, the UKVI Model Portfolio has a policy of having no more than 50% of revenues generated from within the UK.

You can find the geographic spread of revenues for a particular company as part of the Morningstar Premium service, although there may be other sources too.

The important point is to be aware of these various forms of concentration risk (from holding too few companies, being in too few industries or operating in too few countries), to have policies in place to control the risks, and to act on those policies consistently over the long-term.

Once the steps are in place they shouldn’t add more than five minutes to an existing investment process, and the return on those five minutes, in terms of risk reduction, could be huge.

That’s exactly what we’ve seen with FirstGroup.

If you look just at the returns from FirstGroup then they’re pretty impressive.  Dividends have gone from around 11p in 2004 to almost 24p in 2012, and they went up every year.  Ditto for revenues.  And it was going that way for earnings too until the financial crisis.

Investors thought this was a safe, defensive company with a bright future of reliable growth stretching out into the distant future.

In reality it was anything but.

The problem with risks is that they can often be ignored until they can’t.  They can sit dormant for many years and the longer they sit there doing nothing, the easier they are to ignore.  Paradoxically, this risk ignorance will usually increase the size of the risk and therefore its impact when it does eventually turn from probability to reality.

One popular measure of debt manageability is interest cover.  Through most of the last decade FirstGroup’s interest cover was around 4, and since 2009 it had been consistently below 3.

That means anything from 25% to more than 33% of operating profits were going straight out the window to lenders rather than shareholders.

Not only is that offensive to me as a shareholder (although thankfully, not a shareholder of FirstGroup), it’s also incredibly risky to have such massive obligations to lenders.

Investors should have known better.  The debts were not hidden; they were in plain sight for all to see.  Investors who bought into this company at more than 700p (while today the shares sit closer to 120p), with a dividend yield of just 2.5% and a PE ratio of almost 20, were taking on huge risks for very little potential return.

Those risks have now become real events, but for many it is too late.

Investing is about taking on risk.  There is no other way to achieve rates of return above the “risk free” rate, or above what you can get in a cash savings account.  But if investing is about taking risk then investors must understand the risks they are taking, and for the most part that begins with looking at a company’s financial obligations and most obviously, its debt levels.

Most investment errors stem from a lack of understanding of risk; whether its operational risk from the underlying companies or price risk from elevated share prices.  In all cases a close attention to and deliberate management of risk is a must if an investor is to do consistently well over the long-term.

Two types of dividend investing strategies

There are two broad strategies which come under the dividend investing umbrella.

The first is the trusty old high yield strategy.

With this strategy the first consideration, and sometimes the only consideration, is the current yield on offer.  If the yield is “high” – however that is defined – then the shares are a potential purchase.  On the other hand, if the yield is “low”, then the shares will not be bought, no matter what the growth prospects of the dividend may be.

The second strategy is the dividend growth strategy.

The aim here is to focus on dividend paying shares, but to put more weight on the ability of the company to grow the dividend in the long-term, rather than just on the current yield.  Some dividend growth investors will even buy if the current yield is below the market average.

High yield investing is never really popular

High yield investing is almost always a contrarian strategy to some degree, and that means it’s almost never truly popular.

The logic is simple.

When shares are popular their price is pushed up by demand from investors.  When share prices go up, dividend yields go down.  Therefore, if a share is truly popular it almost never has a higher than average yield.

That’s why high yield investors never have to worry (much) about stock market bubbles.

However, there is a caveat.  If you’re a high yield buy-and-hold-forever investor then you do still have to worry about bubbles and the excessive popularity of any shares you hold.

If you buy a high yielding stock and sit on it for 10 years, then there is a good chance that at some point those shares will become popular.  This will drive the share price up and the dividend yield down.

Your original high yield share may end up in a speculative bubble and if you’re excited by the gains then you may be desolated by any subsequent losses when the bubble ends.

One way to avoid this is to keep an eye on the yields from your shares (both dividend and earnings yields), and if they move below average then perhaps it’s time to re-evaluate that investment in case it has become overpriced.

Dividend growth is where the danger lies

Dividend growth investing is the current favourite, and that’s not exactly a surprise.  Low and negative bond yields are pushing investors into riskier assets, and a relatively safe first step into equities from bonds is to stick with blue chips.

Many solid, high quality blue chip stocks trade at a premium to the market, and that’s entirely reasonable as they can generate high rates of growth, more consistently than the average company.

But how much of a premium is too much?  Is the current dividend growth premium too high?

One of the metrics included in the UK Value Investor Stock Screen is Growth Quality.  This measures how consistently a company has produced a growing stream of profits and dividends.  Blue chip companies tend to have an above average Growth Quality score.

So what do current valuations tell us about the popularity of dividend growth investing, and whether it’s time to get out or stick with this strategy?

The table shows the results from FTSE All-Share companies with a decade of unbroken dividend payments.  They’re shown in order from the most consistently growing companies (high growth quality) down to those that have little growth and/or little consistency (low growth quality).

The first thing to note is that, as you’d expect, growth rates are highest for those companies that grow consistently.  On the other hand, companies that have little consistent growth have a negative growth rate on average, which of course isn’t brilliant for a dividend growth strategy.

Looking at valuations, let’s take the dividend yield as this is an obvious valuation metric for dividend investors.  You can see that investors are accepting a lower yield (i.e. paying a higher price) for companies that can generate high quality growth.  Again, I think that’s entirely reasonable and to be expected.

The question is whether or not that premium is excessive.

Looking further down the quality range it seems that yields grow as quality falls.  Again, that’s what I would expect.  Investors are less sure of getting higher dividend payments in future from low quality companies, and so they demand a higher dividend payment today in the form of a higher dividend yield.

Does there appear to be a spike in the valuation of high quality companies?  I don’t think there is.  The difference in yield between each range of stocks is 0.4% to 0.5% in each case.  Investors are generally paying more for higher quality stocks, but I don’t think they are overpaying for quality just yet.

What about PE ratios?  Although I’m not a fan of PE ratios they can still be useful when looked at as an average across many stocks, which is what we have here.

You can see that shares of the highest quality companies have the highest PE ratios, and again the pattern is decreasing PE ratios as the quality of the companies goes down.

There is a bit of an anomaly in that the lowest quality companies have relatively high PE ratios on average.  I expect that’s because these companies have quite choppy earnings and so in any given year their PE ratios may be quite high simply because the earnings in that year are particularly low.  In that case the dividend yield may, on average, be a better valuation metric.

In any case the average PE ratio of the highest quality companies (21.6) is about 25% higher than those of the next group of stocks (PE of 17.3), and those in turn are 8% higher than for even lower quality companies (PE of 16).

Conclusion

I don’t think dividend investors should switch to another strategy just yet.  High yield investing is almost never truly popular, and there is scant evidence that most dividend growth stocks are overvalued.

However, that doesn’t mean that some individual dividend growth stocks aren’t overvalued.  I know of several high quality blue chip stocks which I would say are very overvalued, precisely because they are seen as bastions of safety.  But while those companies may be safe, their share prices are not.

One way to avoid overpaying for high quality, dividend paying companies is to always keep a close eye on valuations. 

If the dividend yield is far below the market average, and the PE ratio far higher, then no matter what the quality of the company, or how well it performs in the years ahead, your investment returns may prove to be deeply disappointing.

If however, you stick to high quality companies at relatively low valuations, your investment returns may pleasantly surprise you.

• Having a higher dividend yield at all times
• Growing the dividend income faster than inflation and faster than the market
• Growing the capital value in line with the growth of the dividend

To achieve this I focus on buying shares from a diverse group of large, high quality businesses.  Each of those businesses should have a long history of increasing profits and dividends, and the share price should be low relative to the earnings and dividend payments of the company.  You can find out a bit more about this strategy here.

This review will show whether or not BG Group’s shares are up to those standards, whether they’ll only be considered at a lower price, or if they would never be considered because the company just isn’t good enough.

Overview of BG Group

BG Group is effectively one half of what used to be British Gas; the other half is Centrica.  BG Group kept the ‘upstream’ business involved in the exploration and production of gas, while Centrica took the ‘downstream’ activities of supplying gas and electricity to retail customers.

BG is a large company, with a market cap of more than £36 billion.  That puts squarely at the top end of the FTSE 100.  It has over 6,000 employees working in more than 20 countries, and describes itself as a ‘world leader in natural gas’.

From an initial glance this is clearly the sort of large, diverse and market leading company that I like.

Starting with the company’s accounts

As usual I’ll start this review with the company’s accounts.  Ultimately it doesn’t matter how much you like a company, or how well it’s positioned within its market – if it isn’t producing a steady stream of growing sales, profits and dividends, it isn’t doing a good job for shareholders.

You can see the results that BG Group has achieved for shareholders during the last decade using the key metrics of revenue, earnings and dividends per share.

I think the best way to find companies that have a good chance of producing growing earnings and dividends in the future is to look back at what the company has done in the past.  In this case, BG has definitely produced the goods, with a long and consistent record of growing revenues, earnings and dividends per share.

While this doesn’t mean the historic growth rate is guaranteed going forwards, it does show that the company has been able to grow – and not just once or twice, but repeatedly over many years.

Converting past results into useful numbers

Although the chart looks nice, I prefer to have numbers which are directly comparable between one company and another, or one company and the relevant market index.

Long-term growth rate

The first number I use is the annual growth per share over the past decade.  For BG Group that number 15.1%.  That means that, according to the financials, BG Group has managed to grow at around 15.1% per year.

To put that into context, the companies that make up the wider market (i.e. the FTSE 100 or FTSE All Share) generally grow, in aggregate, at around 4%-5% a year.

So it’s safe to say that BG Group has, in the past at least, been a high growth business.

Long-term growth quality

It’s nice to find a company with a high growth rate.  However, if the results are erratic, or if the company occasionally makes a loss or cancels the dividend, that historic growth may not be a good indicator of what might happen in the future.

Common sense and academic studies suggest that companies which can produce consistent growth of profits and dividends over long periods of time will tend to be able to maintain that consistent growth into the future.  More importantly, they may be able to maintain consistent growth better than more average companies.

I call this consistent growth of profits and dividends the “quality” of the company’s growth.

As the chart above shows, BG Group has made fairly steady progress over the years, resulting in a growth quality score of 83%.

This compares to the FTSE 100 which has achieved a growth quality score of 74%.

These numbers confirm what the chart suggests; that BG Group is a company which has produced consistent, high quality growth at high rates over many years.

From a purely accounting point of view, I would call it a high quality business.

If you’d like to know how to calculate the growth rate and growth quality numbers, see the strategy guide and related worksheets.

Looking at the numbers is just the start.  Now that BG Group has shown itself to be a consistent producer of growing profits and dividends, the next step is to dig a little deeper and see what the company actually does, and how it fits in with the rest of your portfolio.

Emphasising diversity over stock picking

Diversification is hugely important.  It’s far more important than the individual stock picks you make.  I believe that for the most part the stock market is pretty efficient, and that means it’s very hard to pick winners, or to know how things are going to work out in the future.

Your best defence again uncertainty is to spread your bets and focus on maintaining a diverse portfolio rather than a concentrated one.

For me that means:

• Having 20 – 30 companies in the Model Portfolio
• Spreading investments across many different FTSE Sectors
• Building a globally diverse portfolio, with revenues coming from around the world.

A deliberate policy of diversification across these various fronts, combined with focusing on large, market leading, highly profitable and growing companies, will in most cases massively reduce the risks associated with investing in individual shares.

In this case, BG Group is in the Oil & Gas Producers sector, and the Model Portfolio only holds one other Oil & Gas company, so adding BG would not make the portfolio overly concentrated in that area.

BG also generates revenues primarily from outside the UK, which should help to keep the portfolio from becoming overly reliant on a single country.

Looking for companies that are diverse in their own right

Some companies are dependent on single customer or supplier.  This is generally a bad idea as it gives power to those outside parties, and puts the company at risk if the relationship breaks off.

In the same way, some companies are reliant on just a few resources (a small group of employees, patents or natural resource), without which the company would struggle.  Again, this is a risk that you might not your companies to take.

I prefer to stick with companies where the customers and suppliers do not have power, and where no single resource (whether a patent, copper mine or group of brokers) generates most of the company’s profits.

Looking at BG, it has a wide range of exploration and production projects spread across the globe.  It also has a sizable and varied gas shipping and marketing business.

I would say that perhaps the biggest lack of diversity is the reliance on oil and gas prices.  Both can be volatile, although the spike and subsequent collapse of oil prices around 2008 only show up on the company’s results as a minor blip.  It may be that diversification away from exploration and production into gas shipping and marketing has helped to smooth things out.

Focus on successful, market leading companies

Once a company gets into a relatively dominant position within an industry, it is often hard for smaller competitors to compete.  Economies of scale, purchasing power and other factors often mean that past success can more easily be replicated in the future if a company is at the top of its industry.

As the chart above showed, BG is a very successful business, with above average growth rates produced with above average consistency.

It’s also a market leader, shipping, for example, about 50% off all the gas transported into the Pacific basin from the Atlantic basin.

Avoid companies that are having major problems today

When you’re looking for shares that are cheap relative to the dividends and profits of the company, you have to expect some unpleasantness.  If everything was rosy and all news surrounding the company was positive, the shares wouldn’t be cheap.

Instead, they’d look more like Diageo’s shares, which have almost doubled since 2010, while the company has grown by perhaps 20%.  A big increase in the share price may sound attractive, but the dividend yield is now just 2.2%, while the PE is 27.  No matter how good the company (and Diageo is a very good company), it cannot be worth an infinite price.

So, some bad news should be expected, although it’s important to differentiate between trivial bad news and significant bad news.

For BG the bad news came back in November 2012, when the company issued a statement which amounted to a profits warning, stating that 2013 production would be in line with 2012, rather than the 10%-20% growth that some analysts had expected.

The shares dropped from around £13 to £10, although they have since recovered to £10.76 as at today.

This is a good example of how hard it is to see into the future.  The professional analysts couldn’t, and BG’s directors couldn’t either.  That’s because nobody can see into the future which is why it’s important to:

• Stay diversified and
• Buy shares on bad news (at low prices) and sell on good news (and high prices)

All companies will have both good and bad news, even the very best companies.  It makes sense to pick companies that are strong, and buy them when trivial bad news has pushed the share price down to an attractive level. 

Then, hold those companies and collect the dividends until some good news (and high share prices) comes their way; as it eventually does in most cases.

As for BG’s profits warning, I don’t think it can be classed as a significant problem.  To me it looks like the sort of thing that all companies go through from time to time, whether they be Tesco, Apple or Vodafone.

In time, and in most cases, the tide will turn and other investors will pile in and push the share price back up on good news.

Only buy companies which are virtually certain to be bigger 10 years from now

If your investments aren’t growing they will be eaten by inflation.  An obvious response to the threat of inflation is to stick with companies that are virtually certain to be larger a decade from now.

That means companies where:

• The products are unlikely to be replaced or disrupted by technology
• The company is unlikely to suffer from changes in cultural tastes and demands
• The company’s competitive position is strong enough so that it can, at the very least, maintain its share of the pie
• The market is growing rather than shrinking

With BG I think all these boxes are ticked.  The company is a market leader, has a proven history of growing market share, and sells and distributes a product which is in demand and where demand is unlikely to go down for a long time yet.

Gas is a finite resource, but I think any significant move away from it is likely to be several decades away.  In the medium-term there may even be a shift towards gas.

I would be very surprised if BG didn’t at least keep up with inflation over the next decade, although of course, anything can happen.

BG Group is a company that I would be happy to own, but only at the right price

The price of an asset is just as important as the asset itself.  Whether it’s a classic car, a house or a company, at one price it will be a good investment and at another it will be a poor investment.

In the stock market there is never an obviously ‘correct’ price for shares, and so the price is set simply on the supply and demand for those shares on any given day.  Most of the time, for most companies, this gives a share price which is reasonable.

However, on any given day there will always be some shares that are expensive and some that are cheap, and of course it’s the quality assets at cheap prices that I’m looking to add to the UKVI Model Portfolio.

Two ways of comparing price and value

Dividend yield

Given that returns come from dividend income and capital gains from the growth of the company and changes to valuation ratios, it’s a good idea to start by looking for shares that have a high dividend yield.

For BG Group’s shares the yield today is just 1.55%, which is far below the yield of 3.2% that you can get from a FTSE All Share index tracker.  In addition, the index tracker is a lower risk investment than BG.

Price relative to cyclically adjusted earnings

I’m not a fan of the standard PE approach to valuing shares, as the E part (current earnings) is too volatile from year to year to be of much use.

Instead I prefer to use the price to cyclically adjusted earnings ratio, or PE10, which uses a 10 year average of earnings in order to smooth things out across the ups and downs of the business cycle.

Using that measure, BG group has a PE10 ratio of 15.7, while the FTSE 100 has a PE10 ratio of 14, making BG shares somewhat more expensive than the average of large companies.

It’s clear that from a simple valuation point of view, BG Group’s shares are far from cheap as they have a higher valuation ratio and a lower dividend yield than the average large-cap company.

Combining the quality of the company with the price of the shares

Many investors are led astray by looking just at dividend yields or PE ratios, or by looking for companies that are surrounded by good news.  Usually this is a mistake.

A much better approach is to look at both the long-term quality of the company, as well as the price that you’re being asked to pay for it.

It’s relatively simple to compare BG against the wider market (perhaps the FTSE 100) to see if it has a reasonable change of outperforming the market over the next 5 years or more.

If there is no obvious reason why the shares could beat the market, then it may be worth putting them onto a watch list with a lower target price to buy at.

In terms of the four factors that I have looked at here:

• Growth rate – BG has a long-term growth rate of 15.1%, while the FTSE 100 manages just 4%.
• Growth quality – BG has a consistent record of growth and a quality score of 83%.  The FTSE 100, with its lower growth rate, only has a growth quality score of 74%.
• Dividend yield – BG falls behind the market here, with a yield of just 1.55% compared to 3.2% for the market index.
• Share price to cyclically adjusted earnings – BG is currently priced at 15.7 times its cyclically adjusted earnings, while the market index is cheaper at just 14 times.

You can see from the above four points, and from the rest of the analysis, that BG Group is an above average company (with growth that is both faster and of higher quality than average), but the shares are not attractively valued (with a lower dividend yield and higher PE10 than average).

BG is a high quality company, but the shares at 1,076p are not cheap enough – It’s one for the watchlist

I’m happy to invest in BG, but not at these prices.  I think that if the share price fell to below £9 them I might start to be interested in adding it to the UKVI Model Portfolio, but realistically I think the share price would need to be closer to £8 for BG to be a real contender.

At that price the yield would still be low at just 2.1%, but the PE10 ratio would be better than the market average at 11.6, and at that price you would also have the high growth rates and high historic consistency and quality.

This is confirmed by the fact that currently, on the UKVI Stock Screen, BG currently has a rank of 84, just slightly better than the FTSE 100, which comes in at number 90 out of 165.

What to do now

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Reckitt Benckiser is a fantastic company.  Every day it sells millions of pounds worth of products like Dettol, French’s Mustard and Nurofen to customers worldwide.  In financial terms it has a perfect record of consistent dividend and earnings growth over the last decade – so why would I want to sell it?

The answer certainly isn’t because the shares have done badly.

I made the decision to add Reckitt Benckiser to my own portfolio and the UK Value Investor Model Portfolio back in April 2011, exactly two years ago.  At the time they were selling for £32.82.

Since then the shares have paid out dividends of £2.59 each.  The share price has also appreciated significantly, reaching £46.28 on the day that I sold.

Total returns from this two year investment were 47.2%.  That’s 7.9% from dividends and 39.3% from capital gains.  In annualised terms that’s 20.8% a year, which is well clear of my target return of 15% a year.

Buying a quality company

I buy shares after working through both a quantitative and qualitative analysis.

The first step is to look at how the shares rank on the UK Value Investor Stock Screen.  This screen ranks shares on two key factors – The quality of the underlying business and the value for money that the shares represent at their current price.

Taking the quality aspect first, Reckitt Benckiser really is hard to beat.

When the shares were bought in 2011, the company had increased revenue per share in every year of the previous decade.  It had also increased earnings in every one of those years – and it had also increased the dividend in every single year.

That’ a 100% record of consistent growth in sales, profits and dividends.

If you’re looking for companies that can grow earnings and dividends consistently in the future, then looking for a proven track record is a sensible place to start.

You can see Reckitt Benckiser’s financial results in the chart below.

Of course, the point of buying a high quality business is that you hope it will continue to produce high quality results once you have bought the shares.  In this regard Reckitt Benckiser did not disappoint.

There are two obvious ways in which a company can produce returns for shareholders:

1. Dividends – In the two years that Reckitt Benckiser has been in the Model Portfolio, dividends worth 259p have been paid or become due.  This is a return of around 7.9% on the original investment.
2. Growth – By growth I mean growth of the company.  If a company is able to sell more stuff to more people at higher prices each year, and in the process generate more profits, cash and dividends each year, then shareholders gain as they each own a fixed fraction of that growing company.

There are various ways of measuring a company’s growth, none of which are totally accurate.  My preference is to look at the growth of the company’s average earnings per share over the last decade.

Using average earnings helps to smooth out the yearly ups and downs which most companies suffer from.  This in turn creates a more stable estimate of ‘value’, whereas looking at just the latest earnings might lead you to assume that a 10% fall in profits this year should result in a 10% drop in the value of the business.  In most cases, it shouldn’t.

In Reckitt Benckiser’s case, the average earnings were 122.5p when I bought the shares.  Today that number stands at 163.4p.  That’s an increase of 33.4% in the company’s historic average earnings in just two years.  Although that’s probably overstating the true level of growth somewhat, the company has definitely grown by a considerable, double digit amount in that time.

So by buying a high quality dividend paying company, the return was 7.9% from dividends, and 33.4% from the growth of the business.

At an attractive price

In April 2011, at £32.82, the dividend yield was 3.5% and the price to earnings ratio was 17.  Neither of these is especially attractive, but that’s because PE ratios and dividend yields are overly simple ways of valuing shares.

The approach I use looks at cyclically adjusted earnings, dividends, growth and consistency, in order to get a far more detailed picture of what a company is worth, rather than just looking at the most recent earnings or dividend numbers.

Even though by conventional measures Reckitt Benckiser’s shares looked somewhat expensive at £32.82, when long-term earnings, dividends, growth and consistency were taken into account, they didn’t.

And that view seems to have been right.

With the price at £46.28 in April 2013, the value of the shares had increased faster than the value of the company.  Even though value of the company (according to its average earnings) had grown by 33.4%, the shares had gone up by an additional 5.9%.

This additional 5.9% return is the boost that you can get from buying companies at low valuations.  If you give Mr Market enough time his mood will often improve, and he will happily pay a higher price to earnings ratio than you did.

Qualitative quality

After looking purely at ‘the numbers’, I always like to look at what the company actually does.  I have a series of questions, in checklist form, that I ask of every company I look at, covering:

• The past – I always look back over the company’s past, to make sure the company has a stable and competitive history within its industry.
• The present – I also like to look at the present situation, to make sure the company isn’t facing any significant threats to its ability to make profits in the future (after all, the shares are cheap so there is often bad news surrounding these investments.  However, you have to separate significant bad news from minor bad news).
• The future – Finally, I like to think about the future, and whether there is any major risk that the company’s industry or core products and services could become obsolete in the next decade.

Reckitt Benckiser sailed through all these tests, and that’s why I bought at £32.82.

So in summary, Reckitt Benckiser is a high quality company, capable of consistently high earnings and dividend growth.  In 2 years, the UK Value Investor Model Portfolio received a dividend return of 7.9%, capital gains from the growth of the company of 33.4%, and an additional capital gain of 5.9% as the shares were re-rated upwards.

Why sell Reckitt Benckiser?

Reckitt Benckiser is still a fantastic company.  It is still exactly the sort of company that belongs in the Model Portfolio, and it’s still exactly the sort of company that defensive and income focused investors like to own.

However, the quality and value of the company is only one side of the investment equation.  The other side is price, and how much cash you need to part with to buy the company, how much you can get if you sell, and what else you could buy with that cash instead.

At its current level, Reckitt Benckiser is it one of the least attractively valued stocks in the Model Portfolio, when quality, growth, value for money and dividend yield are taken into account.  Just as importantly, the UK Value Investor Stock Screen tells me there are shares in other high quality, dividend paying companies that are more attractively valued.

This doesn’t mean Reckitt Benckiser is a ‘sell’.  I don’t think that kind of blanket labelling is of much use.  What matters is how one company’s shares compare to the others that you already own, and what else is out there in the market.

In Reckitt Benckiser’s case, it is still quite attractively valued, and is much more attractive than the average company, with a Stock Screen rank of just 37 out of over 160 companies.

If your portfolio is full of average companies at average prices, then Reckitt Benckiser could be the best thing that you own, in which case you might be better off selling something else.

But to beat the market you have to focus on owning shares with the lowest valuations and highest yields from the best companies, and for me, at £46.28 Reckitt Benckiser’s shares no longer meet all those criteria.

Of the UK banks, Barclays has –so far – coped with the crisis relatively well.  It hasn’t suspended its dividend, which for income investors is at least something.

But just like the other banks, Barclays’ shares have taken a colossal hammering.  Before the crisis the shares were about to reach 800p, while at their lowest in 2009 they almost touched 50p.

Investors who were brave enough to get in at the moment of maximum fear have had a good run back up to around 300p or so.  But the shares have been falling again for the last 3 years, and we are of course still well below the old highs.  Does this in itself signal a great bargain?

What is an investment anyway?

First of all let me define what I mean by an investment, or perhaps what I don’t mean.  What I don’t mean is the purchase of some shares in the hope that the shares will go up in the next year.

You may be surprised but generally I’m not looking for anything much to happen at all.  Actually I prefer it when things are relatively uneventful.  Instead of looking for excitement, I’m focussed on buying good companies at low prices.  Companies which – over many years – can be expected to sell more, earn more profits and pay more dividends back to me.

If at some point down the road Mr Market decides to get excited about the company and bid the shares up excessively, then I’m happy to sell and bag the additional profits.  But that is not my intention at the outset.

The reason for this oh-so-dull approach is that history and piles of academic studies have shown that pretty much all investors are very bad indeed at knowing what will happen to any given company and its shares in the short-term (which I class as anything less than 5 years).  On the other hand, the long-term may be far more predictable.

Looking beyond the share price

Looking at Barclays’ share price and how it’s changed in relation to itself is pointless.  What really matters is how the current share price relates to the amount of cash that the company is able to return to investors over time.  Here is what Barclays’ shareholders have seen, in terms of earnings and dividends per share, in the last decade.

That is not the happiest of charts.  It tells a sorry tale of a company nearly falling off a cliff.  The share price mirrors the trials and tribulations of the business, peaking in 2007 and falling into the abyss in 2009.

Do turnarounds turn?

The first problem that I have with Barclays is that it’s a turnaround situation.  I’m not a big fan of turnarounds, even though they’re a favourite with many value investors.  Personally I prefer to avoid trouble and stick with companies that are cheap and still performing well.

On that basis alone I think I’d probably avoid investing in Barclays’ shares, but let’s carry on anyway and see what else comes up.

Assuming we’re still interested, what can we assume for the future of Barclays?

If we use simple extrapolation then it doesn’t look good.  The company has effectively shrunk its returns by about 12% a year in the last decade.  Roll that forward long enough and Barclays will effectively become worthless.

Of course, it’s overly simple to extrapolate the past, so what if I were optimistic and said that the next decade would look like the past decade in reverse?

Let’s stick with that optimistic scenario and use it to work out if the shares are attractive at their current price of around 300p.

Estimating the future

In the last 10 years, and therefore in the next 10 years in our optimistic scenario, Barclays earned an average of 30.5p per share.  With the shares at 300p that puts the current price at 9.8 times the average earnings for the next decade (again, using this optimistic scenario).

9.8 times future earnings is not a bad multiple, but it’s a long way from the best, especially given the uncertainty around whether or not this level of earnings will actually appear.

Looking at dividends, the average dividend in the last 10 years was around 16p.  That’s an average yield of 5.3% over the next decade relative to the current 300p price tag, but it does require the dividend to more than double from today’s level.

Cheap if things turn out well, not so cheap if they don’t

A PE ratio of 9.8 and a dividend yield of 5.3% are both good numbers.  If Barclays can achieve those earnings and dividends sustainably through the next decade then a 300p today doesn’t look to bad, at least on the face of it.

The problem is that it may be many years before those results arrive, and there is of course much uncertainty about the timing of their arrival.  Will it take 3 years or 10?  What if it takes more than a generation for us to see a banking boom like the last one?

On the other hand there are shares of good, solid companies available right now with yields at or above 5%, and that’s using current earnings and dividends, not some optimistic guestimate of what Barclays may be able to produce in the distant future.

The question for me is this:

Why would I want to invest in Barclays where I need things to turn around and get better to justify the price, when there are other businesses available on more attractive terms that have no need for a turnaround?

For me, Barclays is definitely not high on my list of potential investments.  It’s hard to say exactly what price I’d be interested, and I’m not a fan of ‘target’ prices, but I think that if the shares got down below 150p then I might be tempted.

There are many other factors at play, most of which relate to the ability of the company to pay that dividend and preferably grow it over time.  But there are other factors like knowing when to sell and move on, and how to mix and match high yield shares to reduce risk and increase returns.

So here are 10 resources that I use or have used to find and manage my investments.

Use a proven and usable strategy

Investing is hard enough, but you’re only going to make it harder by not having an overall strategy.  If you buy and sell shares without a plan then you more likely to get blown around by all the huff and puff and nonsense that gets pumped out by some media outlets (sometimes known as the “wall of noise”).

Stock picking strategy

If I had to distil my high yield strategy down into just a couple of books, I’d first have to pick The New Buffettology by Mary Buffett.  It’s a great overview of the whole quality value investing philosophy (although she calls it selective contrarian investing) of buying above average businesses at below average prices.

I know it isn’t directly about high yield shares, but as I say it is about investing in quality companies at low prices, which is an oblique (and perhaps better) way of looking for high yield shares rather than just looking for high yields.

Portfolio management strategy

Another superb book is The Intelligent Asset Allocator by William Bernstein.  This book is avidly against stock picking and promotes the idea that the markets are efficient and cannot be beaten by mere mortals.  Although I disagree, the book still has many fundamental ideas about investing, about risk and return, and about how diversification across assets that move independently of one another (i.e. one zigs while the other zags) can reduce risk and improve returns at the same time.

I think combining the stock picking ideas of The New Buffettology and the portfolio management ideas of The Intelligent Asset Allocator will take most investors a long way towards a sensible investing strategy.

Get access to long-term data

Once you have a strategy you need to put it into action.  One of the key features of the strategy that I use here at UK Value Investor which I share with Buffettology is looking at long-term data.  I prefer to look at company data over the whole of the last decade, rather than just the latest 1, 3 or 5 years that most investors seem to look at.

There are various places that you can find this fundamental data:

Morningstar Premium is one of the best known, and has lots of data for most equities going back 10 years.

Although Morningstar is mostly focused on funds, they do have good data and analyst reports available as part of their Premium plan.  If you go to their site and type Vodafone (for example) into their search box at the top, you’ll be taken to a page where you can access some really useful stuff.

It’s got all the standard information like share price (with an interactive chart) and key financial data for the past few years, plus some additional ratios like EV/EBITDA and ROCE.  You can get 5 years of historic data for free, but as a premium subscriber you get:

• 10 years of historic data
• Morningstar’s research report
• Ratings for fair value, uncertainty and economic moat

You can find out more about the Morningstar equity research methodology by downloading their methodology guide (PDF), which in itself is a useful guide to assessing companies and their shares.

Stockopedia is another solid source of information and data, and comes with a range of tools that will be new to most UK stock pickers. 

Although I’ve spoken about Stockopedia quite recently in this lengthy review, I’ll cover the basics again here.

It’s a relatively new site with a focus on a range of ‘guru screens’ which PRO members can use and change as they see fit.

You can get the same kind of information that you get with Morningstar (minus Morningstar’s proprietary ratings and research), but you also get more ratios like the Magic Formula, F-Score and many others.

There are many other features including virtual portfolio where you can get some great aggregate data on your own holdings, and there’s an active community of investors who write and comment on articles.

Sticking with the stock screening theme, Sharelockholmes is another great alternative with a huge range of both fundamental and technical metrics.

Sharelockholmes may look a little bit “old school” compared to some of the other tools in this list, but it’s very affordable and very powerful.  It does one thing and it does it well, which is to allow users to build as many screens as they like from a very wide and growing list of metrics.

The data looks like it comes directly from the annual reports, which is slightly different from the other providers who (I believe) get it from computer data feeds.  This means that Sharelockholmes has data that some others don’t, such as adjusted earnings.

I like this site for its simplicity and speed.

ShareScope is another screener, this time with a heavy focus on technical (chart-based) factors, and the best virtual portfolio tool that I’ve seen.

ShareScope is one of the most popular tools for active investors in the UK, and has won more awards that I care to mention.  It’s a downloadable bit of software rather than a website, which has pros and cons, such as it being faster than a web site but more of a strain for computer to run.

There are two main bits of ShareScope for fundamental investors rather than technical traders.

• A powerful data mining (screening) tool
• The best virtual portfolio software that I’ve seen

The screening and data tools have fundamental data going back up to, and in some cases more than, 10 years.  It’s easy to put together a screen and then drill into each company to see what it’s really like.

As for the virtual portfolio facility, it’s the only one that I’ve seen that will work out dividends and tax returns too!  It’s very useful for the private investor.

Read company results and announcements to understand each company in greater detail

It’s fine to start off with screeners and purely quantitative approaches, but investors generally want to know more about a company than what its PE ratio is.  They want to know what the company does, how long it’s been doing it, what the industry is, and so on.

My preferred approach here is to look at the regulatory announcements, which include annual and interim results, interim management statements and other material news items that may be of interest to shareholders.

Investegate.co.uk is the first place that I head to for this information.  They have a great archive where you can dig back at least 10 years on most companies, which is further back than most companies will have on their own websites.

To find these results:

1. From the home page you can run a search by company name or EPIC code.
2. From the list of search results you can just click on the company name in the “Company” column.  This will take you to the announcements page for that company.
3. Click on the little button with the two downward arrows and you’ll get all the announcements going back many years.
4. Just search for “report” or “results” and you’ll quickly find lots of qualitative information to go along with your quantitative data from the tools above.

The site also has some nice fundamental data on the fundamental tab, such as shares in issue (useful for calculating revenue per share which is something that none of the data providers seem to pay much attention to).

You can even subscribe to updates either by logging into Investegate or by picking up the RSS feed.

This site isn’t without problems though, as sometimes the announcements don’t seem to come through.  I’ve have missed the occasional report or statement because of this, so although I will keep using Investegate for their announcements archive, I’m also experimenting with getting these announcements from other sources.

I’m currently trialling the one from the London Stock Exchange, because I guess if anybody should be a reliable source of regulatory announcements it’s the LSE.

Control your behavioural

So by now you have a strategy, good sources of data, ways of screening out most companies that you’re not interested in and perhaps even some software to run and analyse your own portfolio.  You’ve also got access to all the company results going back a decade so that you can see what they did to produce all those sales, profits and dividends.

But that’s not it, because knowing how to invest and having the tools to invest is only half the battle.  The other half, which is arguably more important, is being able to apply your strategy, consistently and with discipline, over very long periods of time.

I guess it’s a bit like keeping fit.  If reading about it and having access to a gym was all we needed, then everybody would have bulging muscles, a six pack, and be able to run a marathon in 2 hours.

The truth is that knowing what to do is less important than actually doing it.

The power of checklists

Checklists are one of my favourite ways of making sure that I stick to my investment plan.  I try to turn everything into a checklist, and if you’re don’t realise how powerful checklists can be, you might want to read The Checklist Manifesto by Atul Gawande.

Make checklists for everything, for example,

• When you buy and sell (I make 1 buy OR sell decision each month, regardless of what I think the markets doing, which helps me to stay detached from the “wall of noise”)
• What quantitative factors you look for in the company’s results and in the share’s valuation
• What qualitative factors you look for in each company
• How you build your portfolio, i.e. your diversification policy, and what industries you prefer or won’t invest in.
• How you react to different situations, like dividend cuts, rights issues or losses.

Stay detached from your investments and the “wall of noise”

I think one of the worst things that an investor can do is to check their portfolio every day, or even every week.  Although I check regulatory items every day because they are pushed to me through my RSS reader, I don’t actively look at the business news every day, and I certainly don’t check my portfolio’s value even every week.

News and share prices are random and therefore you might as well keep track of which names are most popular for baby boys; they’ll each have about as much correlation to long-term investment results.

My tool for avoiding the wall of noise is purely psychological.  Basically I look at the stock market with long-term “blinkers” on.  In other words, I focus purely on where each company and its share price will be 5 years from now.

I know from experience that 99.9% of the news that comes out will have no relation to where the company and its shares are in 2018.

Instead of watching a screen and seeing that Tesco shares are now 0.6% down from where they were yesterday, but 0.4% up from the day before, I prefer to spend my time running my business, building train sets with my son and reading books about physics.

Find something else to do which is more interesting than watching share prices (which should be pretty easy for most people) and go and do that.

Life is far too short and precious to spend any more than a minimal amount of time staring at a screen with a share price on it!

So there we have it.  Get a strategy, get a good stock screener, get access to long-term data and information, and finally get control of yourself through checklists and a long-term view.

Before I get into the details, I have to admit that sometimes I feel sorry for Neil Woodford.  Sometimes… but not very often.  The poor man has every move scrutinised to the nth degree by commentators everywhere, and recently I seem to have become one of them.

More than anything this is because I’m interested in the same sort of large, high quality, dividend paying companies, and Woodford effectively walks around with a target painted on his back as the UK’s uber-investor.

It’s also that Woodford is a man whose approach to investing is one that I usually admire.  He generally runs a concentrated portfolio, he takes very long-term positions (with a holding period typically measured in years rather than the industry average of several months), and he actively tries to improve the businesses in which he invests, rather than just being a passive trader of shares.

But he isn’t always right, so it’s instructive to see how his moves compare to your own thinking, or in this case, my thinking.

Morrisons vs Tesco

I guess it’s pretty obvious that these business are very similar.  In both cases the core business is supermarkets, which is unsurprisingly a fairly defensive industry, where investors can generally expect reliable profits and dividends.

Of course there are many differences between the two companies as well, of which I’d say Tesco’s wide international presence is perhaps the most significant.  However, I’m not going to focus on the nuances of strategy, market focus, strengths, weaknesses, opportunities, threats and all the rest of it.

A core part of my investment philosophy is that economies, industries and companies are for the most part unpredictable.

They are complex adaptive systems, and they exist in a world full of thousands of other companies, each of which is also a complex adaptive system, and together they make up the universe of companies, which in total is a hugely complex adaptive system which nobody and nothing can predict in detail.

So, with that theoretical and philosophical rant over, I will focus on what I prefer to look at, which is the long-term ability of a company to generate returns for shareholders, and the price that we’re being asked to pay for that company’s future returns.

Which has the highest intrinsic growth rate?

Without growth your investments will be eaten alive by inflation, so even in the most steady and stable dividend paying companies, growth is important.

Morrisons has managed a very impressive track record of growth over the last decade.  Very impressive means that my estimate of the company’s intrinsic growth rate is over 17% a year.  Of course that’s unlikely to be sustainable in the very long-term, but it’s still way above the FTSE 100’s intrinsic growth rate which is nearer 4%.

But… growth is ultimately limited by top-line growth, and for Morissons the revenue growth rate is around 6%, so unless that starts moving up more quickly, it will eventually be an upper bound for earnings and dividend growth too.

Tesco also has an impressive growth rate, just not as impressive as 17%.  However, it’s not all doom and gloom as the company has an estimated intrinsic growth rate of around 10% over the last decade, which is nothing to be ashamed of.

For Tesco the revenue growth rate is 10%, so in this case my estimate of intrinsic growth (which is a combination of revenue, profit and dividend growth) is close to the top-line growth that the company is able to generate.

And the winner is… Morissons

Although I think in reality it’s closer than the 17% versus 10% numbers I’ve quoted suggests.  And remember that there is generally a low correlation between past growth and future growth, so it may be worthwhile looking at just how reliably these companies can generate growth.

Which has the highest quality growth?

Growth is one thing, but if it comes in fits and spurts, or just once or twice a decade, it’s hard to rely on it with any confidence.

On the other hand, companies that can consistently generate a growing stream of profits and dividends may have something in either their industry or themselves which makes their growth more predictable and reliable.

For Morrisons, their growth quality rating is 90%, which effectively means that 90% of the time they have produced growing sales, profits and dividends.

Tesco on the other hand has a growth quality rating of 98%, which pretty much puts them in the “elite” class in terms of past reliability.  Very few companies can manage more than that.

And the Winner is… Tesco

In this test Morrisons suffers from some weak results in the middle of the last decade and falling earnings after the start of the Great Recession in 2008.  Tesco managed both periods better, perhaps due to its wide international diversification.

But both companies have a good track record of growth quality when compared to the average of dividend paying FTSE 350 stocks.  Those companies manage an average growth quality rating of 82%, so clearly being a supermarket does add consistency to both profits and dividends.

Which has the highest dividend yield?

This is a pretty simple test using the latest announced dividends.  For Tesco the yield is 3.9% and for Morissons the yield is 4.3%.  In both cases this is above the FTSE 100’s yield of 3.4%.

And the winner is… Morissons

However, this is a pretty thin margin and could well change, even by the time I publish this article.

Which has the lowest valuation?

It’s all well and good finding companies which have consistently generated high rates of growth, but if you overpay for a company it can negate an awful lot of growth in the underlying business.

I think it’s far better to under-pay for a business and then reap additional rewards if and when the shares are re-rated to a more normal level.

I like to measure valuation using the cyclically adjusted earnings of the company, because this helps to iron out the minor ups and downs that are inevitable in any given year or three.

By this measure, Morrisons is expensive relative to the average FTSE 100 company, with a cyclically adjusted PE of 16.5 compared to the FTSE 100’s 13.9 (not adjusted for inflation).

Tesco is even worse off with a cyclically adjusted PE of more than 16.

But once again there is a “however”… PE ratios are a pretty blunt instrument for determining value.  For example, a high PE can be reasonable if there is consistent and high growth (true for both of these companies).  Also, the PE can be high if a larger than average portion of earnings are paid out as dividends, and yet the company can reinvest retained cash at high rates of return and therefore still generate above average growth rates (true of both these companies).

So a high PE is often a sigh of quality at a reasonable price (QARP to perhaps coin an acronym), rather than mediocrity at a high price.

And the winner is… Morissons

Using this crude (but perhaps effective) measure of value, Morrisons comes out on top once again.

Morissons wins the battle…

But does it win the war? 

Using these kinds of metrics can be a helpful way to find high quality businesses which are available at unreasonably low prices (which I prefer to the “reasonable” price referred to in GARP or QARP).

Both of these companies have produced high growth rates more consistently than average.  In that regard they are both high quality businesses.

They also both have higher dividend yields, which suggests below average prices.

They have higher than average cyclically adjusted PE ratios, but this is misleading as quality companies deserve a premium relative to an average company.  When compared to other dividend paying FTSE 350 companies that have growth quality ratings above 90%, they are both cheap.  The median CAPE for those high quality growth companies is 28, compared to 14 and 16 for these two supermarkets.

So I would say that both Morissons and Tesco are high quality businesses operating in a defensive industry, and they are both available at a price which could easily be described as cheap.

But is one better than the other?  That’s hard to say and is by no means obvious, at least to me.  Although Morissons comes out on top by winning on growth rate, dividend yield and valuation, and only losing to Tesco on growth quality, the margins between them are generally quite small.

Using the UK Value Investor Stock Screen, Morissons ranks at number 23 out of about 160 dividend paying FTSE 350 stocks, while Tesco comes in at number 15 on the list.  Both of them rank way above average, and both are so close to each other that I doubt there is any material difference between them.

So back to the original question, and whether I think Neil Woodford was right to sell Tesco and buy Morrisons:

My opinion is that in the next 5 years they will both probably beat the market, but which one will beat the other will be more down to luck than anything else.

I think Woodford’s switch between the two is an example of an investor selling on bad news and buying on good news, which is an appealing but dangerous game to play.

Disclosure – I own shares in Tesco, and Tesco is held in the UK Value Investor Model Portfolio.

If you’re not familiar with Stockopedia, it’s a website that was set up in 2007 with the tag-line of being “the first social network for UK private investors”.  That may have been the case in 2007, but these days the main draw of the site (other than the discussion pages where you’ll sometimes see articles from yours truly) is Stockopedia PRO, their premium service.

Both Stockopedia PRO and UK Value Investor provide stock screens, model portfolios and data on individual companies and shares.  Where we differ is how we go about it:

Stockopedia PRO is about choice, while UK Value Investor is about focus

We both allow our subscribers to go far beyond PE ratios and dividend yields.  In each case this is done by taking raw data from company accounts and turning it into something which is hopefully more powerful, based on rigorous academic research.

I’ll get the disclosure out of the way first:  I have a mild business relationship with Ed and Dave (head honchos over at Stockopedia) where we collaborate in certain ways, e.g. suggesting features or offering discounts on the other’s services to our subscribers.  This article certainly isn’t a paid advert, and I would have written it primarily for UKVI subscribers even if there were no links between us.

Stock screens

Most investors like stock screens because they allow you to quickly home in on those stocks you’re likely to be interested in.  Simple, free screens allow you to screen based on PE ratios, yields and occasionally more complex factors, while Stockopedia PRO and UK Value Investor offer screens that are pre-built for a particular investing style.

Lots of choice

Stockopedia PRO’s screens are wide scope, with at least 65 screens covering Quality, Growth, Short Selling – you name it and there’s probably a screen for it.

Some screens are based on famous formulas, like the Magic Formula or Piotroski’s F-Score, while others are based on investors like Warren Buffett, Ben Graham or Peter Lynch.

If you dig into each screen’s page you’ll find a description and details on the rules of the screen and the thinking behind the stock picking strategy.

Of course I’m going to say that if you’re after high quality, high yield stocks then I think the UK Value Investor screen is the best.  But if you like to go beyond those quality value stocks and look at small cap growth stocks, or deep value plays, then Stockopedia can be a great addition, even if you already subscribe to UK Value Investor.

Highly configurable

One powerful feature of Stockopedia’s screens is that you can ‘fork’ existing screens and create your own version, which you can then tweak to your heart’s desire with a huge range of screening factors.

If you want to bend the Magic Formula with high dividend yields, that’s easy, and your combinations can be as wild or as simple as you like.

I will issue one warning here though:

It’s important that you know what you’re doing when you start building your own stock screens.  There’s a reason that the UK Value Investor screen is fixed, and it’s because I want to make my subscriber’s lives easier, and having a fixed screen is one less thing to think about.

It can take years of study and real world experience to be able to put together effective screens, and Stockopedia’s screens can be a great way to learn about screening, but just remember to treat them with care.  If you’re new at this then perhaps stick with the default screens for at least a while.

Having said that, if you want a wide range of choices with lots of flexibility and configurability, then the Stockopedia stock screening tools are the best I’ve seen.

Summary – Stockopedia PRO screens are many and flexible, while the UK Value Screen is singular and deeply focused.

Stock reports

This is one part of Stockopedia PRO where UK Value Investor subscribers, and others of course, may see the most value.

If you’re a UK Value Investor subscriber then you already have access to a unique and, in my opinion, very powerful screen, and a human managed model portfolio which demonstrates a complete approach to high quality, high yield value investing.

However, what you won’t have access to is reams of data on a vast number of different stocks.

A huge range of fundamental factors

That’s where Stockopedia PRO comes in.  It has a huge number of factors available for use in the stock screens, and they are also visible on each stock’s ‘report’ screen.  I’m pretty sure that almost everything you could imagine as being useful is in there.

Price to book, price to sales, price to cash flow, PEG ratio, operating margin, pretty much all the financial data for the past 6 years, broker consensus, valuations using all manner of different approaches… I could go on all day.  And it all looks very clean and modern to boot.

Another warning though – Despite us humans having up to 500 trillion synaptic connections in our brains, there is only so much information we can digest (unless you’re Warren Buffett who can, according to many accounts, memorise whole books virtually verbatim just by scanning each page).

The point is that you need to know what factors you are interested in, and be able to ignore the ones you’re not interested in.  Knowing what you’re interested in and what you’re not interested in can take many years of research, so again, treat this tsunami of information with care.

Summary – Stockopedia PRO gives you a huge range of basic and advanced fundamental factors, while UK Value Investor provides a small number of unique, tightly integrated factors.

Portfolio analysis tools

This is another feature that I really like and which I know is of interest to some existing UK Value Investor subscribers.

From personal experience I know that most of the stock broker websites out there are visually and informationally bland.  One of the things I’d like to see is a breakdown of a portfolio’s size allocation and sector allocation.  Stockopedia PRO allows you to do the same for your own real money or virtual portfolios.

Just enter your current positions and you’ll get to see the performance and fundamental data for each holding, as well as total profits and losses (although profits are generally preferable).

But there’s more.  Just click on the ‘analysis’ tab and you get a chart of your performance, an asset allocation breakdown (e.g. cash and equity percentages), as well as aggregate ratios for the whole portfolio like PE, EPS growth, dividend cover, etc.

Click on ‘allocation’ and you’ll see sector breakdowns, a value/growth and large/small ‘Morningstar’ style grid, and sector weightings versus the market average.

If that’s not enough, you can even see all the latest regulatory news items for all your holdings, plus upcoming events like dividend payments, results announcements and AGMs.  You can subscribe to the events in your computer’s calendar too.

All in all this is very nice, and when automatic dividends are in place (possibly later this year) it will be even better.

Overall conclusion

I’ll start with what I don’t like.  There’s not much I don’t like to be honest, but I would say that the breadth and configurability of Stockopedia PRO may be too much for some investors, either those that don’t know what they’re doing or those that can’t stop themselves endlessly tweaking everything.

Something that I’ve focused hard on with UK Value Investor is minimising distractions and focusing in on the few things that have a high signal to noise ratio, in other words those things that really matter.

On the other hand, if you do have a reasonable amount of knowledge and/or self-control then Stockopedia PRO offers some amazing features, all wrapped up in an attractive and simple to use design.

By combining UK Value Investor with Stockopedia PRO, you can get the focussed approach of one with the advanced tools of the other.