After a relatively short two-year holding period and some unexpectedly rapid share price gains, I have decided to sell Victrex.
In this blog post I’ll outline why I bought Victrex, what happened during its brief two-year holding period, and why I’ve decided to sell now.
But first, here’s a quick rundown of how this investment in Victrex worked out:
- Purchase price: 1447p on 5th Aug 2016
- Sale price: Sold half at 2679p on 5th Jan 2018 and half at 2749p on 7th Nov 2018
- Holding period: 2 years 3 months
- Capital gain: 85.6%
- Dividend income: 7.5%
- Annualised return: 44.9%
Buying, holding and selling Victrex: A brief overview
It was and is the world leader in high performance PEEK-based polymer solutions, where PEEK (a type of advanced plastic) is used as a superior alternative to metals and other plastics in a variety of industries including automotive (e.g. lightweight gears), aerospace (e.g. lightweight brackets) and medical (e.g. spinal implants). The industrial use of PEEK is still in its infancy.
Back in 2016 the company had a dividend yield of 3.2% and a PE ratio of almost 15. Those aren’t exactly bargain basement numbers, but with a ten-year growth rate of almost 15% and a dividend yield of 3.2%, Victrex was attractively priced relative to similarly fast growing companies.
The headwinds faced by Victrex appeared to be short-term, so I added it to the portfolio on the assumption that the company would recover at some point.
From day one, the investment worked out better than I expected.
Victrex quickly returned to growth, raising its dividend by 15% in 2017 and 10% in its 2018 interim results. Mr Market fell back in love with Victrex and the share price shot up by more than 100%. I’m selling now to reinvest in more attractively valued companies.
Buying Victrex as a reasonably priced, fast growing world leader
When Victrex joined the model portfolio in 2016, there were some signs that its high growth days were behind it.
For example, in its 2015 annual results the company only managed to grow revenues, earnings and dividends per share by 4% each. That was a far cry from the consistent double digit growth rates Mr Market had become accustomed to.
In fact, Mr Market was so disappointed he pushed the share price down almost 40% between the start of 2015 and the start of 2016.
But when you take a look at Victrex’s long-term results, 2015 hardly looked like a disaster:
But Mr Market doesn’t think about the long-term, so the combination of slower growth in 2015, plus headwinds in Victrex’s Oil & Gas and Medical markets (oil prices halved in 2015 so oil & gas companies were short on cash, and the number of US spinal fusion surgeries had been flat since 2011) were enough to drive optimism out of the share price.
Management, on the other hand, expected these headwinds to be short-lived.
And thanks to those share price falls, Victrex’s dividend yield increased to a respectable 3.2% while its PE10 and PD10 ratios (price to ten-year average earnings and dividends) were well-within the levels I’m comfortable with.
Looking beyond the company’s impressive long-term growth figures, progressive dividend and reasonable dividend yield, it also had other attractive features.
The main one that springs to mind was its ability to produce consistently high post-tax returns on capital employed.
For example, the average FTSE All-Share company manages a return on capital employed of around 10%, while Victrex managed to produce returns of more than 20% in every year bar one from 2006 to 2015.
That’s very impressive and it’s good evidence that Victrex has some kind of sustainable competitive advantage (probably from a combination of strong brand, large scale, long experience and numerous patents).
Another attractive feature was its strong balance sheet. Although Victrex had a long record of profits and dividend payments, it does sell into highly cyclical markets such as oil & gas and consumer electronics. So it has the potential to be cyclical, and the last thing you want in a cyclical companies is too much debt.
In summary then, Victrex appeared to be a good company trading at a reasonable price. It was facing some headwinds, but management thought they would be short-lived and not affect long-term growth, and I thought there was a good chance they were right.
Holding Victrex while it stumbled and then quickly returned to growth
I added Victrex to the model portfolio in August 2016, so the first post-purchase annual results were for 2016, published in December that year.
When those 2016 annual results came out, they confirmed Mr Market’s fear that Victrex might be going ex-growth.
Some of the bad news included:
- Revenues and profits down by low single digit percentages
- No dividend increase, which was a first for Victrex after 25 years as a public company
- Sales down 30% in Consumer Electronics
- Sales down 10% Energy and Industrial
Despite these less than brilliant results, the company’s core markets were still growing and management were optimist (aren’t they always?) about the company’s prospects.
In particular, they were optimistic about its ability to move from selling raw polymer pellets to selling components like thin films, coatings and gears:
“Although we recognise the time required to drive market adoption, we remain excited by the potential of our strategy. Moving downstream from polymer to parts, into selected semi-finished applications and components, will see Victrex extending the PEEK market, further differentiating us from competitors. Our focus remains on accelerating these opportunities, whether organically or through investment.” – David Hummel, Chief Executive of Victrex, 2016 Annual Report
Investors were unimpressed and the share price stayed flat for the first half of 2017.
Then Victrex published its 2017 interim results and everything changed.
The results showed revenues and profits up by more than 10%, with an increase to the dividend of 4%. It seemed as if Victrex’s problems were going to be even more short-lived than I’d hoped.
Like clockwork, Mr Market pushed the share price back up again as he mentally extrapolated Victrex’s successful first-half of 2017 into the distant future.
In fact, Victrex’s share price went up so quickly it took the investment to more than 6% of the model portfolio’s total value. That’s the point at which I’ll ‘top slice’ an investment in order to lock in those gains and – more importantly – reduce the portfolio’s exposure to that one company.
So in January 2018 I sold half of the Victrex position, reducing it back down to about 3% of the portfolio.
Next up were the 2017 annual results, which continued the the good news theme by announcing further growth and a special dividend.
Shortly afterwards, the 2018 Q1 results showed incredible revenue growth of more than 41%.
Mr Market reacted again, at one point taking the price to almost 140% above my original purchase price.
In fact, Mr Market seems to have massively overreacted to both the bad news and good news, given the relatively minor changes to Victrex’s actual financial performance:
Selling Victrex because an optimistic future is baked into its share price
Mr Market is famous for his short-sighted and emotional response to company results and statements about a company’s future prospects.
If a company misses a profit target, uses words like ‘headwind’ or ‘tough trading environment’ or, god forbid, cuts its dividend, Mr Market will often fall into a depressed slump and try to offload the company’s shares onto you at knock-down prices.
But if the company has a good year or two, perhaps raising the dividend by 10% or 20% per year, then Mr Market will usually want all of the company’s shares for himself, so he’ll offer to buy yours at an unreasonably high price.
This is obviously crazy, so the whole point of value investing is to try to profit by behaving in a way which is the complete opposite to our crazy friend, Mr Market:
“You are not going to get good results in security analysis by doing the simple, obvious thing of picking out the companies that apparently have good prospects — whether it be the automobile industry, or the building industry, or any such combination of companies which almost everybody can tell you are going to enjoy good business for a number of years to come. That method is just too simple and too obvious — and the main fact about it is that it does not work well.” – Ben Graham
In the case of Victrex, doing the opposite of Mr Market meant:
- Buying a previously successful company when its share price had fallen by almost 40%
- Buying a company when Mr Market was worried that its best days were behind it
- Buying a company when there was a high possibility that the dividend wouldn’t grow for several years
- Thinking about the company’s long-term past and long-term future, rather than whether its performance over the last 12 months was good or bad
And now I’m trying to do the opposite of Mr Market again.
Victrex has returned to growth in 2017 and 2018 and today Mr Market wants all of Victrex’s shares for himself. And to entice us into selling, he’s offering a high price relative to the company’s historic earnings and dividends.
For example, thanks to Mr Market’s elevated price, Victrex’s dividend yield is now down to 2% while its PE10 and PD10 ratios are 33 and 72.
As a general rule I’m not happy holdings stocks with yields below 2%, and I don’t like to see PE10 and PD10 ratios above 30 and 60 respectively, either.
As a value investor I’m not comfortable owning companies at historically high valuations, or having an enthusiastic Mr Market as a co-owner.
I would rather sell to Mr Market today and reinvest the proceeds into another good company that Mr Market is offloading at a low price because of his excessive short-term fears.
So that’s why I’ve removed Victrex from the model portfolio and my personal portfolio.
As usual, I intend to reinvest the proceeds into a new holding next month.