Go-Ahead is one of the UK’s busiest public transport companies, with a focus on urban markets. It is split fairly evenly between rail and bus, with most of the company’s revenues coming from rail, while most of its profits come from regulated and deregulated bus divisions. Public transport is a relatively steady business to be in, and Go-Ahead has a reasonably steady history of revenues, profits and dividends.
This defensiveness was one of the the factors that made it an attractive investment back in 2012. The other factor was the low price, which gave the shares a PE ratio of 9.2 and a dividend yield of 6.2%.
I added Go-Ahead’s shares to the model portfolio on the 13th of February 2012 at a price of 1,304p. Overall the investment paid out 8.1% in dividends while the shares appreciated in value by 28% (as you can see in the ShareScope chart above). This occurred over a holding period of 1 year and 8 months, giving an annualised rate of return of 21.6%. That’s well above the rate that I’d expect the model portfolio to grow at, so all in all I think this was a fairly successful investment.
The plan for this investment was the same as it has been for previous investments in the model portfolio:
- I found a strong, steady company where the shares appeared to be relatively cheap
- I bought them without speculating about any particular outcome, other than that the company would continue to pay a sustainable dividend with the potential for future growth
- I sold the shares because, having gone up, they no longer appear to be such good value
Plant your investment capital in fertile ground
A quick re-cap of the model portfolio’s purpose here might be helpful. The portfolio’s goal is to have a higher dividend yield, as well as higher income and capital growth than the FTSE All-Share. Just as important, it has the goal of being less risky too, as measured by “beta”, but in real terms that means it should fall less than the index when we next hit a bear market.
The long-term returns that investors get from the FTSE All-Share come from a combination of dividend income and dividend growth. In aggregate the dividends from all the companies in that index are relatively stable, and growing more often than not. In contrast to the stability of dividends, the index itself is volatile (i.e. risky) over short and long time horizons.
This volatility is driven not by the actual results of the underlying companies, but by the market’s sentiment towards a given company, or equities as a whole. If investors think the company will do well, valuations are driven high. If investors think the company will do badly, valuations are driven low. It is these swings between high and low valuations which makes stocks volatile, uncertain and “risky”.
In order to have higher income and capital growth than the market, the model portfolio is built from a collection of companies whose aggregate earnings and dividends are expected (based on their past record) to grow faster than the market’s earnings and dividends.
In order to reduce downside risk, and to produce the high dividend yield which is also a goal of the portfolio, companies are only held while their valuations are low. When Go-Ahead was added to the model portfolio in early 2012 it ranked highly on the stock screen because of the following factors:
- High 10 year growth rate: 8% compared to around 4% for the market
- Low valuation (using price to 10 year average earnings): 10.7 compared to around 13.9 for the market
- High dividend yield: 6.2% compared to 3.5% for the market
In addition it had a long history of profitability and dividend payments. More generally, it had a strong position in a relatively defensive and predictable market sector, where the current economic environment wasn’t a major threat, as it was (and is) to many other sectors. You can see Go-Ahead’s financial results for the last few years in the chart below:
Give your investment seeds time to grow
Once an investment has been selected, the next thing to do is nothing, or at least, almost nothing (it’s advisable to at least read the RNS announcements so that you can see the latest financial reports and any other significant news). A plant must be left to grow, and you cannot force it to grow by staring at it. The same is true of most investments.
It takes years for companies to grow by any significant amount, and so that is the time-frame over which you should expect to invest in and own a company. In Go-Ahead’s case, between the annual reports of 2011 and 2013 (respectively, the latest reports when I made the decision to buy and sell) revenues grew by 12%, 10-year average earnings grew by almost 20%, and the dividend remained unchanged.
The market’s estimation of Go-Ahead’s future also changed. When the shares were purchased in 2012 they were being traded for 10.7 times the companies 10-year average earnings. Today the market rates them as being worth 11.7 times the last decade’s average earnings.
That change in sentiment, driven partially by Go-Ahead’s so-far-successful project to grow its bus profits to £100m, boosted returns to shareholders by around 9%. Combining the earnings growth, change in valuation and dividend income gives a total return of just over 36%.
Trim investments if the share price grows too fast
The decision to sell investments that have had a good run is critical for boosting returns, increasing yields and reducing risks.
Holding onto winners is all well and good when it is the company that is “winning”. But holding onto shares where the price has risen far faster than the sales, profits and dividends of the underlying company is a risky strategy. It is the epitome of the greater fool theory, where the investor expects other investors to bid ever higher prices for the company, just because they have in the past.
This desire to buy and hold what has gone up is the driving force behind all of the investment manias, from Tulip-mania to the more recent dot-com and housing bubbles. In each case prices were held up by nothing more than wishes and crossed fingers. Gravity, and economic reality, always wins in the end.
A better approach is to continuously remove those investments where the price has gone up, yields have gone down, and valuation risks have increased. By replacing those investments with others that have more attractive valuations, returns can be boosted and downside risks reduced.
Go-Ahead is another example of how a relatively low risk and, dare I say it, boring company can produce excellent returns if the shares are bought and sold with care. Despite the company’s lack of growth, the 6% starting yield not only lead to dividend gains of 8% during the period of ownership, it was a major factor in the eventual re-rating of the shares which lead to the more than 20% capital gain in less than 2 years.
The moral of the story is much the same as it was for the other case studies: Find a steady company with the potential to grow its dividend, buy when the price is low and sell when the price is not so low. Repeating that process over and over again is likely, at the very least, to lead to what Ben Graham called “satisfactory results”.