Last Updated September 5, 2013
I know that some of my best investment returns have come about not from some amazing insight into what the company was going to do, or what the economy was going to do. Instead, they’ve come from combining solid and stable companies, with an attractive starting valuation and a healthy dose of patience.
I think the best way to invest is to look for companies where their earnings power and underlying value is following a relatively stable upward trend. All you have to do then, more or less, is buy them when they’re cheap, and sell them when they’re dear (if only it were that simple).
Enter Go-Ahead Group
Go-Ahead is one of the largest public transport groups in the UK. They’re split fairly evenly between buses and trains, with over a million passengers a day travelling on their rail services and almost two million on the buses.
As a public transport company they’re fairly well insulated from economic ups and downs, as people have to get to work and travel around no matter what.
Step 1 – Find a company with a stable intrinsic value
You can see Go-Ahead’s results over the last decade below.
Even though Go-Ahead is a defensive company, its earnings have still been affected by this long recession. However, even though earnings show a boom and bust peak between 2006 and 2008, the general picture is one of relative stability with a long-term upward trend.
Sales are up, the dividend has been maintained and even in the depths of a recession, earnings are above where they were 10 years ago. I think the future for Go-Ahead is likely to be much the same – stability, profit, dividends, and some mild growth.
What does that have to do with intrinsic value? Although intrinsic value isn’t something which we can actually calculate, it is based on sales, profits, cash flows and dividends. If these things are broadly stable, predictable and dependable, then so is the company’s intrinsic value. This means that it will be easier to work out when the share price is high or low in relation to that intrinsic value.
Step 2: Buy when the price is low relative to value
Buying low means buying low relative to the intrinsic value. Since we cannot know the intrinsic value we have to use proxies like sales, earnings and dividends. This means buying shares when the earnings and dividend yields are high (and the sales yield too if you wanted to calculate that).
In Go-Ahead’s case, the dividend yield today is around 6%, largely unchanged from when I first bought into this company in February 2012.
While 6% is a long way from being the highest yield in the market, it is well above average, especially for a dividend which has a very good chance of being maintained and increased in the longer-term.
Although the high yield is far from the only reason I bought this company, the dividend is often one of the most reliable indicators of a low price, and a high yield is one of my core requirements.
Step 3: Be patient
If you’re buying shares and have even the slightest notion that you are going to sell within the next year, then you are not an investor – you are a trader.
The same thing applies if you are more concerned about the share price than you are about the underlying fundamentals of the business. Investing is about investing in businesses, not pieces of paper or share price that bounce around on a screen all day long.
Personally, I like to look at equity investments as an extension of cash and bonds. This is a way of viewing equities as something which Warren Buffett called the equity bond.
Since we cannot know what the share price of any company will be tomorrow, next week or next year, it make sense to look at equities as long-term investments.
In my case I like to imagine that I am buying an ‘equity-bond’ with a 5 year term. So when I buy shares I think about whether I’d be happy to buy them if I had to own them for a fixed term of 5 years.
This means that I start thinking about whether the company will be around in 5 years. Whether it will be bigger or smaller in 5 years, and what the dividend will be in 5 years. Each of these questions has a massive influence on the sort of companies I’ll invest in.
It means that I look for companies that are virtually certain to still be around in 5 years, are very likely to be bigger, and are very likely to have paid a reliable and growing dividend throughout.
Of course, neither I nor anybody else knows how the future will pan out, which is why I like strong and stable companies. Even though I cannot know what the future looks like, at least I’m less likely to be wildly wrong with a company like Go-Ahead.
One more useful feature of imagining a 5 year fixed holding period is that I don’t worry too much about what’s happening today, either with the company or the economy. I know that today is just one tiny slice of the amount of time that I’m going to be holding my investments, and therefore should only make up a tiny slice of the importance.
So Go-Ahead fits my criteria for a strong, stable company that is very likely to grow over time. I bought it at an attractive valuation and I intend to sell it as and when the valuation is no longer attractive. The timing of this is entirely in the hands of Mr Market, but if it takes 5 years or more than that’s fine by me. In the mean-time I will be patiently collecting my dividends.