In December 2012 I invested 3.4% of the UKVI defensive value model portfolio into Greggs PLC and also added it to my personal portfolio too with a similar allocation.
Last week I sold those shares for an annualised return of 15.8% per year over that slightly less than 2 year period.
This short case study digs into some of the details of how the buy and sell decisions were made, and why a sensible investment strategy produced the relatively good results rather than skill or luck.
This relatively short investment in Greggs PLC is fairly representative of the sort of situation I would expect to see in a defensive dividend-focused portfolio most of the time.
A very quick summary from start to finish would be:
- Greggs was a solid dividend paying company with a long history and an established position in the high street food market.
- Investors were cautious about growth in the near-term and it’s shares were trading at a low level with a yield of 4% compared to the FTSE 100’s 3.6%.
- Following the decision to invest, Greggs had some ups and downs, but eventually…
- The future started to look bright again and so the shares went up considerably, as you can see in the chart below.
When Mr Market is happy about a company and the share price is increasing rapidly it is usually time for value investors to get out. There will always be other companies that Mr Market doesn’t like because of some short-term problem or other, and it is in those situations where value investors will generally prefer to invest.
The decision to buy
Like all of the companies that end up in the UKVI model portfolio, Greggs has a long history of profitable dividend growth. In fact, until 2013 it had grown the dividend every year for 27 years, the tail end of which you can see in the chart below.
This made it easy for Greggs to pass my array of quantitative investment checks that measure how quickly and consistently a company has grown over the last decade.
Another thing I insist on is relatively little debt, and with more cash than borrowings Greggs easily passed that test too.
As well as consistent inflation-beating growth and little debt I also prefer companies that have stuck to a simple business model over many decades.
That certainly applies to Greggs which has been plugging away for a very long time as a good quality, good value local baker (albeit one where bread is now baked in the company’s regional bakeries rather than in the local shop).
Over the years though the market has changed and now being a high street baker is more about “food on the go” than it is about buying and taking home a week’s worth of bread and cakes. But all good companies must adapt and that’s exactly what Greggs has done.
So Greggs certainly appeared to be a good company, but buying good companies isn’t enough to produce good investment returns.
To get a good return from an investment it helps if you pay the right sort of price as well. Shares that are trading on lofty valuations puffed up by hot air and enthusiasm from Mr Market have a nasty habit of falling at the slightest whiff of bad news.
Greggs on the other hand was already facing tough times; it’s long-record of dividend growth had slowed in 2012 and ground to a halt in 2013. This was largely due to the long-term decline of the high street baker and increased competition from other “food on the go” retailers.
The company was adapting, but too slowly and without enough ambition.
The end result was a flagging share price which, at 480p, was back to a level it had first reached in 2005, despite the fact that the dividend had doubled in that time and sales were about 50% higher as well.
So in December 2012 Greggs appeared to be a solid company trading at an attractive price, which made it a good fit with the rest of the model portfolio.
The decision to hold
As a long-term investor I expect to hold new investments for around 5 years, but it does vary depending on how each situation pans out. In this case the holding period was relatively short at just shy of two years. As well as short it has also been a relatively easy investment.
Much of the time value investors have to endure a fair degree of bad news from the companies they invest in (Tesco being a prime example), but with Greggs there was little in the way of grey-hair-inducing problems.
The main note of pessimism came in April 2013 when an interim management statement suggested that profits for 2013 were likely to be slightly below the lower end of “market expectations”. As ever the short-sighted Mr Market reacted badly and the shares fell by about 14% over the next few days.
As a long-term investor I don’t use stop losses in the model portfolio and so while disappointing, this “loss” of value was certainly not enough to warrant selling the shares.
Ultimately that was about as bad as it got.
In January 2014 the company released a positive trading update which stated that Christmas had gone well, more than 120 shops had been refitted to focus on “food on the go” and results were going to be in line with expectations (i.e. no worse than previously thought).
That was enough to spark a 10% increase in the share price which then seemed to attract momentum investors (who buy whatever is going up) because after that the shares drifted gradually higher.
Then on September 12th Greggs announced another positive update. It said that things were going well with the shop refitting program and with the business in general and that results were now likely to be materially ahead of expectations.
Of course this is exactly what Mr Market loves to hear and so the shares jumped up by another 10% to more or less where they are now.
To me this is a perfect example of Mr Market’s short-sighted nature. Greggs’ financial results, like those of any company, will always be uncertain. Sometimes they’re better than expected, sometimes they’re worse.
To assume that we can predict the future profits of any company accurately is sheer madness. But that is precisely what Mr Market tries to do.
When a company “misses” those predictions and expectations Mr Market becomes depressed and sells the shares, which pushes the price down. If the results “beat” those expectations then Mr Market becomes excited and buys the shares, which pushes the price upwards.
It is a hyperactive dance from one company to the next based on nothing more than whether or not actual events match expectations in a world where expectations are just as likely to be wrong as they are right.
Meanwhile the long-term investor, who thinks of buying companies rather than trading shares, can pick up the occasional bargain (and yes, sometimes the occasional dead parrot) when Mr Market panics and sell him back the exact same company at a higher price when Mr Market’s mood has swung the other way.
The decision to sell
On October 3rd Greggs shares were priced at 599p and still ranked highly on the UKVI stock screen. It is still, in my opinion, a reasonably valued company. However, at 599p it has a dividend yield lower than the market average and has a higher PE10 ratio, while its historic growth rate is only around 5% a year.
From that starting point I think it’s far from obvious why the shares should return 16% a year over the next two years as they have during the last two. That doesn’t mean they won’t, but for me the investment case is much less compelling than it was in 2012.
And so for that reason I have sold all of the shares in Greggs from the model portfolio and my personal portfolio.
Next month I will be reinvesting that cash into a new, more attractively valued company, and I expect to be writing the case study on that investment somewhere between one and ten years from now.
diy investor (uk) says
Great summary and analysis as usual – thanks.
For my sins, I foolishly decided to off-load this one from my income portfolio following the warning on profits in Aug 2013. I must admit I was not convinced the new CEO had the correct strategy to turn things around but, so far, you cannot argue with a 50% increase in the share price.
Well done for hanging in and reaping the reward.
Be interested to hear your opinions on EMH!
John Kingham says
Thanks John. My opinion on the Efficient Market Hypothesis (assuming that’s the EMH you’re talking about!) is that the market is very efficient over the short-term but gets gradually less efficient over longer time horizons.
Efficiency for me doesn’t mean that the market “correctly” prices shares; I don’t think a “correct” price is possible. What efficiency means is that it isn’t possible to say “this share will go up tomorrow”. That’s an efficient market.
Where I think the efficient market idea is wrong is that it says that (as far as I know) the probability distribution of future returns is always the same.
So for example if we know that the market goes up by 10% a year, but with a standard deviation of 5% (I have no idea what it actually is offhand) then that will be true going forward regardless of whether it’s 2000 (a high market) or 2009 (a low market).
That just isn’t true in the real world. In the real world the distribution of probable 10-year returns in 2000 and 2009 were entirely different, and it was possible to say that they were obviously going to be entirely different in advance, i.e. without hindsight.
In an efficient market that wouldn’t be possible, but it is, so the market isn’t efficient when you’re thinking about returns over 5 or 10 years.
Anyway, that’s my opinion on it. And more or less the same thing applies to relatively defensive companies as to the market as a whole, although with more uncertainty.
Out of curiosity, if you were confident in your initial analysis and purchase decision at 485p, did you consider buying more shares when the price was much lower in late 2013? And if you didn’t, why not? I’m just interested in your reasoning.
John Kingham says
Hi Andy, No I didn’t consider buying more when the price dropped. The reason is that I’m never confident about my analysis, or about how an investment might work out.
I am under no illusions that I can develop an accurate picture of how a company operates, especially one that has 1,700 shops and 20,000 employees. And even if I could, I still don’t think I’d be able to predict the future and know what will happen.
The result of that attitude is that once I’m reasonably happy that the odds are in my favour (which is about as ambiguous as I can be) I will invest, but only a small amount of capital, i.e. 3% to 4%. Once that capital is invested, that’s it. I won’t invest more no matter how low the shares go, just in case I was wrong to start with and the company goes into permanent decline.
So I believe more in diversification and limiting your “bets” than I do in predicting the future.
30 Something Dude says
If you’re looking for something else to invest your spare change in try Telecom Plus (TEP), I think it ticks a lot of boxes
John Kingham says
I’d have to agree; Telecom Plus certainly seems to have an outstanding track record, although I haven’t looked at it in detail.