Three companies in the UK Value Investor model portfolio are currently facing huge amounts of negative sentiment.
Their dividend yields are over 7% and there are obvious and entirely plausible reasons why each company might be about to cut its dividend.
However, no dividend cuts have yet been announced (apart from a very tiny cut in one case) so it’s impossible to tell (yet) whether Mr Market is right to be so pessimistic.
Perhaps these companies will surprise Mr Market with excellent results a year or two from now and, as a result, their share prices will soar. Or perhaps Mr Market is right and dividend cuts will be announced very soon.
We just don’t know for sure.
But regardless of the final outcome, these three companies hold many lessons about the ups and downs you should expect when you invest directly in individual companies, and the nerve you’ll need if you want to avoid selling at the first sign of trouble.
3 High yield bargains (or are they?)
Disclosure: I own shares in Ted Baker, British American Tobacco and IG Group.
Based on my research I think the use of tobacco isn’t declining in the UK or in other western economies.
Rather the excessive excise tax is pushing smokers to procure it from the grey market is why reported tobacco use is falling. As a result, it skewers the statistics. A lot of clinicians, health economics and politicians will be in for a nasty surprise when health problems related to smoking continue to exist despite the rock bottom official statistics for use of cigarettes in the west.
John Kingham says
Hi Reg, that’s a good point. I’m not sure the move to black market cigarettes is enough to offset the overall decline, but it’s significant. Either way, it doesn’t really help BAT as it still means less customers smoking legal cigarettes.
David Spector says
Aren’t many grey market cigarettes still provided by major manufacturers and simply imported from countries with more lenient tax regimes? If there is a no deal Brexit won’t duty free day trips to Calais start again on the very next day as ferry operators rush to re-introduce one of their main sources of income? My mum is in one of those Investec ethical share schemes . Reading their “blurb” convinced me to buy BAT. Allegedly, the WHO considers that the total number of adult smokers is rising, worldwide. Thus I would be buying into a world leader with an ever expanding consumer base, albeit in the Third World. Secondly, BAT are one the market leaders in the West, selling tobacco replacement products. Finally, few democratic governments can afford, electorally, to “disenfranchise” millions of voters over a short to medium period of time. Labour tried this, and are still losing a lot of votes to parties who claim that they will introduce smoking in pubs and clubs.
John Kingham says
Hi David, I’m not sure on the numbers in terms of how much BAT sells into the grey/black market. To be honest I don’t think it’s material to the company’s long-term future.
Your point about disenfranchising citizens/voters also has relevance to the potential US ban on menthol cigarettes. Those cigarettes are disproportionately smoked by a subset of the population, and banning just menthol could be seen as an attach on the freedoms of said subset.
In the long-run though, I don’t think cigarettes have a good future in the West, but at least BAT seems to be doing well in scaling up its next-gen products (vaping etc.)
I own all three.
Ted sadly entered at the same time as yourself.
BATS – luckily sold at the very peak after a long period of holding as with Reynolds.
I bought back into BATS but at 20% above today’s price – I confess to being surprised at the depth of the fall.
Got out of IG group at 879 back in August last year and bought back a good chunk at 580-590 level.
Looks like their global reach will stand them in good stead, together with no debt-pension-capex requirements and very good cash generative situation — assuming all 4 of those things are still valid going forward – don’t see why they would not be as they are selling largely the same products/services – it should provide a good return.The 7% dividend is covered by cash, if not immediate profits.
John Kingham says
Hi LR, I think IG is the most interesting of the three. It’s a fantastic business so it will be very interesting to see how it copes with regulatory changes over, say, a five-year period compared to its less fantastic peers.
Perhaps they’ll all get hammered, but I think it’s more likely than not that IG benefits from the changes in the long-run. And IG’s annual results are due soon, so we’ll have a better idea after that.
I think if a market exists for tobacco then it means that people will shift to the use of alternative product for their nicotine fix especially if it replicates the same experience is available at a lower cost and is less toxic. The success of such product will only be possible with the support of large powerful company. Typically FMCG, Pharmaceutical Company have the infrastructure but purely due to negative connotation I doubt they would enter the industry. This leaves the market to good old tobacco company who have the money and network to market the product.
BAT happens to pass both test. People forget that in 2000 when the Masters Settlement took place the share price for BAT crashed as they assumed it would be financially bankrupted, which wasn’t the case.
I have no doubt that combustible cigarettes use will die out. However the idea that people will quit smoking in mass is very unlikely. I strongly believe that heated tobacco will become the norm.
People forget that tobacco was a rich mans product which had to be hand rolled or smoked in a pipe. It was James Albert Bonsack who invented the automated cigarette machine that changed the tobacco industry making it a mass market product. I personally think vaping and heated tobacco are game changers! Once sufficient data is established both the scientific community and governments around the world have to accept it in the same line as alcohol and fast foods.
The only caveat is this will take a decade or so to unfold and given the myopic time frame of investors of our era the uncertainty will depress the price. I am not telling anyone to buy the stock but people should do some research on the tobacco industry to understand where it is heading.
John Kingham says
Very interesting Reg.
I think it will even take a little more than a decade though for the various next gen products to scale to meaningful levels.
Admittedly, the number of youngsters I see ‘vaping’ (or similar; the precise technology underpinning the clouds of smoke they generate usually escapes me) seems to grow all the time, and there are at least a handful of ‘vaping’ outlets in my local town centre.
But there are lots of technical, regulatory and cultural factors to overcome, and even BAT thinks it next gen will be about 30% of its business in 2030 and 50% in 2050. So this is a very long-term transformation, but that’s okay by me as long as they keep growing the dividend in the meantime.
I expect to see slow growth in dividend in the next few years due to the need to invest in NGP and for deleveraging. However I am not too concerned as long as BAT is able to sustain its marketshare and increase book value.
Eugen N says
The only company I owned from these was BAT. Bought it in 2002, sold it in 2017, when I needed more money to move house. At that time it was the last on my screen, so it was a natural sell. Held a bit longer onto Japan Tobacco and Philip Morris International, which was a mistake. Personally I think that habits are changing, and people in Developed Word would give up smoking a lot quicker than people think.
My two pence about the other two companies: I would not invest in a small company involved in fashion, it is hit or miss, and the investor has no edge. There are no barriers to entry, fashion changes, new players come in with better ways to market to clients etc.
IG Group makes money by helping their clients to lose money – I cannot see this as a great business concept. Regulation would just get harder and harder in this area.
There are a lot better companies out there.
John Kingham says
Hi Eugen, I just want to pick up on one of your points:
“IG Group makes money by helping their clients to lose money ”
Although the practice of profiting from client losses is common in the CFD industry, IG always hedges all of its client’s trades, and always loses money on those hedges. So it only profits from transaction fees and never ever from client wins or (more importantly) losses.
Here’s the company’s CFO talking about hedging in the 2019 annual results Q&A:
“when you’re in a situation in which clients are making profits and you’re not [fully] hedging, you are pretty much compelled as business, as a company using other people’s money, to do something about it [i.e. to stop clients making a profit]. You have to do something about it. We do not [because IG is always fully hedged]. We want our clients to trade profitably. We encourage them to trade well. We give them tools and techniques to do so [so that they stay on as clients and generate more transaction fees for IG]. That is very different to how providers who don’t [fully] hedge have to deal with when clients make profits. And we don’t think that that is in any way in the interests of the client, and it certainly is not in the interests of creating a sustainable revenue stream.”
Eugen N says
I know they do not take the other side of the deal like others.
However, they still ‘help’ their customers lose their money. More than 90% of their customers end up losing their money. It may be slightly less than 90% for this company, but still a high percent!
I just do not think it is a good business model. I am not an ethical investor, but betting is something that I would not invest in, mainly because they are businesses where people lose their money.
John Kingham says
Hi Eugen, this is actually a very interesting topic, so apologies in advance for this long reply.
Around 75% of IG’s clients lose money, although that’s not the same as saying they “lose their money”, which to me implies that they lost ALL their money, which isn’t the case. On average winning and losing clients net out to zero (it’s a zero sum game) so what the average client loses is their transaction fees.
Here’s Bridget Messer, IG’s Chief Commercial Officer on the subject of client losses:
“More than a third of our clients achieve a positive result in [May], and overall the median loss was £64. Saying that another way, the average client spent £64 in the month pursuing their passion of trading the markets.”
So here we have the usual average client loss, in this case £64 in May. The question then is why would anyone trade when the expected outcome is a loss of £64 per month?
Here’s Bridget again:
“our clients understand that this is not an investment product. We ask them what percentage of clients they think make money from trading and the most frequent response is less than 20%.”
So clients absolutely know that the expected outcome is a loss of around £64 per month, obviously depending on how much each individual trades (the more they trade, the greater the expected loss). So, why do it?
“our research tells us that clients love the intellectual challenge of using their knowledge, experience and judgement to read the markets and take a position. These clients are informed, decisive, adventurous people and they like to engage in an activity that plays to those attributes.”
To me, this is like any other exchange of value in the market. If I go to a gym, I go because I like to work out, I like to push myself and, perhaps, if I work hard and do a good job, I’ll have a fitter body eventually. In exchange, I “lose” say £30 per month to pay for gym membership. That money is “lost”, with no guarantee of the outcome I’m after (a fitter body), but I like working out so I pay anyway. But most people who go to gyms don’t get fit, so the money is wasted.
I see trading as basically the same thing. People trade because it’s an interesting and exciting intellectual challenge, and they may make a quick buck, but they may not. The cost of this is the ongoing transaction fees, and traders accept that cost in pursuit of the non-financial value they get from trading and the potential for financial gain.
I have no ethical problem with gyms, and I have no ethical problem with trading. As long as regulation is in place to protect the inexperienced (and I’m all in favour of sufficiently strong warnings, margin limits, etc) then I see trading platforms as entirely legitimate businesses adding value to the lives of many traders.
One last point, because this comment is already too long:
IG goes out of its way to NOT attract new traders as they tend not to trade much, so they don’t generate much revenue for IG and the cost of acquiring those clients isn’t worth it if you’re not profiting from their newbie losses. And if new traders do want to use IG’s platform, IG has a free “academy” to try to at least get them up to speed with the basics.
So as far as I can see IG is doing just about everything it can to help its clients win, and is also in favour of tougher regulation to educate inexperienced newcomers.
Eugen N. says
It seems you believe all that blurb the company said.
I don’t, because I have seen people loosing a hell of a lot of money than £64 per month on platforms like this.
I pressed the ‘professional’ button on their registration page and there no request to prove my status as a professional, I have just self-assesed myself as one.
Your comparison with going to the gym is forced. There are benefits of staying healthy and plenty of evidence, but there is no evidence of any benefit from betting, in fact it has a damaging effect on health. In the end, after a while, many of their clients lose interest in betting, it is not fun to lose money. If they do not lose interest and lose more than £100 per month, I would think there should be legislation in place to ban them or to reduce the value of their bets (like with recent reduction of the bets on high street slot-machines). I have seen divorces and many other bad things due to betting.
I would not invest in betting companies. I am not an ethical investor as such, but I have also decided very recently to shun tobacco companies going forward.