450 Aviva shares were originally added to the UKVI defensive value model portfolio back in early 2012. Aviva is exactly the sort of large, high profile company that I’d expect to see in such a defensive and income focused portfolio, but now – after a long spell as the portfolio’s weakest link – the rising share price has finally provided a decent exit point.
At the time of purchase Aviva’s shares had a very impressive dividend yield of 7.2%; almost double the market average. It seemed as if the stage was set for a quiet period of ownership, holding the shares of a leading company at an attractive valuation, and with the odds of success looking very good.
But that’s not how things turned out. Buying shares in Aviva has been an interesting, occasionally difficult, educational and ultimately profitable investment.
Holding firm in the face of adversity
The graph below tells the story of disaster and recovery that Aviva’s shares have been through.
Far from being a steady, boring investment, Aviva’s time in the model portfolio has been characterised by drama, disappointment and share price volatility.
Things got off to a bad start with the effective ousting of the CEO in early 2012 as a result of the ‘shareholder spring’. Shareholders voted against the remuneration report in such numbers that CEO Andrew Moss had little choice but to go.
At the bottom of this particular valley the shares were down by almost 30%. That’s a pretty big drop and if stop losses had been used then it’s almost certain that Aviva would have turned out to be a losing investment, perhaps losing 10 or 20% depending on where the stop loss was set.
Fortunately, I don’t use stop losses. I don’t like them because they imply that a falling share price is a reason to sell, and I think that in most cases, with large successful businesses, it isn’t. In this case it would have meant missing out solid double-digit annualised returns.
Eventually Aviva’s share price recovered into 2013 as Moss was replaced with Mark Wilson and his simple and understandable plan to focus Aviva on ‘cash flow plus growth’.
However, the market was less pleased when that plan turned out to involve a near 50% dividend cut. The market’s reaction was predictable, and the shares dropped by more than 12% on the day. Again the shares fell to almost 20% below their purchase price and again I stuck to my general strategy, which is to ignore the vast majority of short-term events.
It would have been easier to sell along with so many other investors, but to succeed as an investor you will usually have to be a contrarian; holding or buying when most other investors are selling, and selling when most are excitedly buying.
Patience leads to profit and annualised returns of almost 18% a year
More recently Aviva’s shareholders have had a little more to cheer about; the market has now decided it likes the company’s new strategy. The shares have gained more than 70% from their lows of 2012, going from around 265p to 444p.
I added Aviva to the model portfolio on 12th March 2012 at 360.7p and sold on 3rd January 2014 for 443.7p. The original investment after stamp duty and broker fees was £1,641.27, dividend income was £182.70 and the net return on sale after more broker fees was £1,986.82, for a total profit of £528.25. Although the model portfolio is a virtual portfolio made up of virtual cash and investments, my own personal pension is almost identical in makeup and so for me this is no mere academic exercise.
The investment’s total return was 32.2%, which over 21 months is an annualised return of 17.7%. That’s well above the annualised rate of return I would normally expect to get – which is closer to 10% – so an almost 18% return per year is very welcome.
As far as I can see this investment in Aviva has underlined several important points:
Don’t panic if bad things happen
For defensive value investors the share price falling a long way, the CEO leaving or the dividend being cut shouldn’t be the end of the world. If the company was strong to start with then in most cases it will weather the storm and provide a solid base for the shares to rebound when the bad news passes.
So how strong was Aviva? The chart below shows the company’s financial history over the past few years.
That certainly isn’t a picture of a defensive powerhouse. The trend of premiums written, earnings and dividends is flat at best and perhaps even downwards a little, and that’s before inflation is factored in.
Aviva has quite a mediocre history, but it does have a long history of paying dividends and it does have a large and international business with many market leading business units. So while I wouldn’t expect Aviva to grow like Reckitt Benckiser, I would expect it to maintain its value at the very least.
Given that the share price was so low to start with, the maintenance of its earnings power and dividend (admittedly at a somewhat reduced level) in the years ahead, combined with time and a random flow of good and bad news, was likely to provide an opportunity to lock in some decent returns at some point. And that’s more or less what happened:
- First of all some bad things happened, but the company didn’t go bust
- Dividends were cut, but not suspended
- The market eventually had a change of heart and the share price went up
- Buying low, holding through uncertainty and selling on the way up produced decent total returns on this investment, where fear-based selling could have locked in significant losses.
Have a clear view of what ‘cheap’ is and what ‘expensive’ is for each company
If you have a good idea of what constitutes expensive and cheap, you can ignore share price falls (as in most cases with defensive companies a cheaper share is a better investment to be held, not a worse investment to be sold).
You can also take profits when the shares go up beyond where they can reasonably be called cheap, because holding expensive shares is usually just as bad as buying expensive shares.
Aviva’s in the bag, now on to the next investment
Now that Aviva is sold and profits have been taken, I can relax; but only for a short while.
My plan for 2014 and beyond is to alternate a sale one month with a purchase the following month. This will maintain the number of holdings in the model portfolio at 29 or 30 and it will keep the portfolio focused on high quality stocks and high yield stocks. It will also allow occasional profit taking where it’s prudent to do so.
On that basis I’ll be recycling the cash from Aviva’s sale back into another defensive value investment at the start of next month.
Mark Carter says
Nice writeup, John.
It’s interesting to see how the market actually interpreted the CEO resignation the wrong way. Instead of viewing it as a disaster, the market should have taken it as an opportunity to bring in a new broom to sweep clean. And at a bargain entry price, too.
John Kingham says
Hi Mark, that’s an excellent point. So often what seems like a disaster in the shot-term is in fact an opportunity to sort out some underlying issues. The dividend cut was another solid contrarian opportunity.
Thanks for the post, excellent as usual!
Have you been tempted to top up when shares are “on sale” such as after the CEO incident & the dividend cut incident? Whilst I try to stay on the investing side of the fence, rather than being tempted to join the gamblers in the apparently greener grass over there on the other side, I have sometimes gone overweight when a holding I believe in gets just too cheap. I’ve always intended to sell again after a positive correction but typically end up holding until I sell the whole holding or re-balance the whole portfolio.
John Kingham says
Hi Ric, no I don’t ever ‘top up’ after I’ve made the initial buy decision. The main reason is that I like to learn from my mistakes, and one of my mistakes was to keep ‘topping up’ shares in a company that eventually went bust. This was several years ago when I still invested in small-cap turnaround situations.
So the company started off at 5% of my portfolio and fell to 3%, so I topped back up to 5% as it appeared to be better value. Then it went down some more and still appeared to be better value so I topped up some more. Eventually it went bust and I’d put in about 10% of my whole portfolio, which taught me two lessons: 1. Stick to quality companies and 2. Don’t top up.
Now I just make one simple buy decision, hold for several years and then make one simple sell decision. I think it’s easier and stops me over-reviewing existing holdings.
Just come to this article on the recent massive share price increase from Aviva (to £5.10p). Interesting read, but I take issue with your “lessons learned when investing in small cap”. Lesson one: Yes, stick to quality companies, but lesson two: No. If you stick to quality companies, then a low share price is a buying opportunity, so topping up is worth it? Obviously no guanrantees, but a good general rule of mine that has worked for my investing so far. Averaging down has recovered my money on many occasions.
Interesting read. I looked at Aviva a while back and it always looked to me that it was one of those stocks where the dividend was high not because the company was undervalued, but because it was going through a “dramatic life event”. I’d seen a friend buy into HMV because the price had gone down so far that the dividend % was in the 7s. Soon after was the dividend cut, and then the purchase didn’t look so hot.
Once it hits that kind of level, you have to expect either an imminent re-rating of the stock price, or a dividend cut. I think there’s good money to be made in this kind of situation, but it really boils down to whether your emotionless analysis of the stock is better than that of Mr Market and his mood swings. The bigger the turmoil the company is going through, the less certainty I have in my own non-expert judgement.
This is a similar reason why I took a long look at AstraZeneca, when it was at about 2800. Again, a high dividend, because the market’s expectation was for lowering earnings. In the end, my judgement was that it was probably a good buy, but that I wasn’t certain enough in working out how much impact their loss of patents would have on their earnings to bet against the market.
18 months later, AZN is now 25% higher, so I’m kind of disappointed to miss out. But at the time it felt more like betting than investing, so I’m still happy I left it.
In that kind of situation, what does it take to convince you that the current troubles of the company are short term, or the market is making mountains out of mole hills?
John Kingham says
Hi Bob, I pretty much thought the same thing with Aviva. Either the shares were going to shoot up quickly, or the company would have some problems and the investment might take longer to work out.
I also own AstraZeneca and the thinking is the same. I look at the current share price and compare it to the company’s earnings and dividends over the last decade, not just the last year. So rather than looking at what the divided or earnings are today, I’m thinking what sort of magnitude of earnings and dividends should this company reasonably be able to pay out, even if things don’t go so well?
For both AstraZeneca and Aviva, looking at the scale of their past dividends and earnings and their consistency and growth rate (or lack of it), their share prices suggested (at least to me) that things would have to get really ugly before the shares were not cheap. In Aviva’s case things have gotten ugly, but only for a while, and now things appear to be on the mend, or at least Mr Market thinks so.
In most cases, given a strong company, a low price and enough time, the odds will usually be stacked in your favour.
Thanks for a fascinating article as ever John.
One thing you have not mentioned which I am curious about is what your trigger was to sell Aviva? Did you have an exit value in mind or have you decided that it is now poor value or that risk has increased in some way?
John Kingham says
Hi Neil, that’s an interesting question.
My sell ‘trigger’ is based on the UKVI stock screen that I build each week. The screen combines the four elements of quality and value (growth rate, growth quality, price to 10 year earnings average and price to 10 year dividend average) and ranks each eligible stock in the FTSE All-Share (about 200 companies are eligible, i.e. have an unbroken 10 year record of dividend payments).
Every other month or so I’ll select a company from the portfolio which has a low rank, i.e. has a weaker combination of quality (growth rate and growth quality) and value (price to 10 year earnings and dividend averages) and sell it, so that it can be replaced the following month with something that better combines quality and value-for-money.
For somebody who doesn’t have access to that screen (i.e. isn’t a UKVI member) but still wants to use the same metrics for quality and value, they could work out each factor for their stock using the free worksheets and spreadsheet that you can find here:
If you compare each factor to the same for the FTSE 100 (for example) you’ll see which stocks beat the market by 0, 1, 2, 3 or 4 factors. Those that beat the market by 3 or 4 factors may be worth hanging onto, but those that only beat the market by fewer than 3 factors may be potential sell targets, and the weaker the stock compares to the market the more likely it is to be poor value, and therefore a sell.
It’s not an entirely mechanical process. For example, Aviva has been the weakest stock in the portfolio for many months but I held on to it because it hadn’t produced a decent return. In January it was still the weakest stock but the recent run-up in price meant that I could sell and make a decent double digit annualised return. So there is some discretion involved, but not much.
So really you broke your own rules with Aviva. It was the weakest stock but you held on to it hoping for a rebound and you were lucky. Is that right? Or are there circumstances where you would sell at a loss and cycle into something where your money would be better employed? It seems to me you have to compare the gain hanging on with that of using the capital to invest in another better valued company. If your process is right on average the latter should be the better approach.
John Kingham says
I wouldn’t say I broke my own rules, I would say that it’s not a 100% mechanical system, and that I like to have some input into the process, otherwise I might get bored and start to fiddle excessively with the system. So by allowing myself some discretion I keep myself motivated and interested, whilst operating well within the confines of the system as a whole.
As for luck, I would say yes the share price movements were luck, but being able to discern between good value and less-good value was not luck. The movements of share prices is random, but if you have a robust value model for the underlying company then buying low and selling high is ‘simply’ a matter of waiting for the random movements to fall in your favour.
I would sell at a loss if the the price to value ratio was poor enough, i.e. if the stock ranked very badly, perhaps below average for the whole market and not just badly relative to the portfolio’s other holdings. When I sell something at a loss you’ll see it in the blog, so it will be a good chance to dissect my thinking as and when it happens.
Your last point is correct; in theory I should be better off selling and reinvesting into something that my ranking system prefers. However, I am human and I hate to sell something just because a spreadsheet tells me to, especially if it means locking in weak gains. But as you can see I eventually bowed to my system when random share price movements (luck, if you will) provided me with a more attractive exit.
Unfortunately in life we can never know how things would have turned out if we had made a different choice, so we will never know if I would have been better off selling Aviva a few months ago and re-investing into something else.
This itself is an interesting discussion. I started investing about 5 years ago and have since been slowly building up a portfolio. I don’t think I’ve ever sold a share. I’ve had stocks which have dropped to about 25% of what I paid for them, but I still hold them. These companies I bought knowing they carried risk, and put in enough that I wouldn’t need the cash back, or feel (too) stupid if it evaporated. Locking in the loss feels excruciating, especially when I wouldn’t be getting much back, and I don’t need the cash. I still have spare cash in the investing pot, so it’s not stopping me from investing in something new (if/when I find it).
I also have stocks which have increased by 50-70% from their purchase price, and I haven’t sold them either. Their yields on my cost are now solidly in the 5-6% region, which is pretty good given that they are also growing well at the moment. Selling them feels like I’d lock in the capital gain, but would have to then start from scratch finding something that will eventually give me similar yields.
But as you’ve demonstrated in past posts, taking well considered profits when the value has sharply increased and reinvesting them in new opportunities is a powerful way of achieving the compounding effect. The trouble is finding the next opportunity and having the confidence to let go of something old and familiar for something new.
John Kingham says
Hi Bob, I guess you just have to stick with what you’re comfortable with. If that means buy and hold, then fair enough if that works for you.
As you say making the decision to sell something familiar to buy something new can be hard, so I look at each investment as an opportunity to learn. So when I sell I get a chance to review the investment from start to finish, and build any lessons into my system.
I get over the fear of swapping the known for the unknown by having a fixed system that says I must buy or sell one company each month. This is quite unusual (I haven’t seen anybody else who does this) but I like and I think it works to keep me active and learning, and it forces me to weed out the less attractive stocks like Aviva. But there’s nothing wrong with buy and hold if that’s what you want to do.