UK Value Investor 2015 04 - Sample a · Selling: Balfour Beatty PLC (BBY) Page 8 FTSE All-Share...
Transcript of UK Value Investor 2015 04 - Sample a · Selling: Balfour Beatty PLC (BBY) Page 8 FTSE All-Share...
Page 1
IMPORTANT NOTICE: UK Value Investor provides information, not advice. It is for investors who want to make their owninvestment decisions and are capable of doing so without advice. If you think you need advice then you should seek aprofessional advisor. Please see the important notes on the back page for further information.
Contents
FTSE 100 Valuation and Projection Page 2
Model Portfolio Review Page 2
Selling: Balfour Beatty PLC (BBY) Page 8
FTSE All-Share Stock Screens Page 13
Metrics, Maximums & Minimums, Strategy Guide & Colour-Coding Key, Income Portfolio Performance Back pages
New highs and new lows
Another month, another new high for the FTSE 100. This time though it reached a new high above the
psychologically important 7,000 level (psychologically important for some anyway). I won’t say much more
than that as I wrote about the market’s current level versus its fundamentals last month. Although this tells
us nothing about where the UK market will go in the short to medium-term it was inevitable that this day
would arrive at some point. Personally I’m glad that it has finally broken through that barrier.
The new low I’m referring to is the first sale of a company from the model portfolio at a capital loss. While it
will never be enjoyable to lock in a loss on an investment it is important to know how to approach them:
1) Realise that the occasional loss is inevitable. Over a period of 10 years a portfolio like the model portfolio
is likely to invest in up to 80 to 100 different companies (30 in the first year and approximately six new ones
each year after that). There is no way on earth an investor is going to invest in 100 companies and not see a
single loss.
When a loss occurs I like to use my favourite analogy, which is property investing. If a company is sold at say
a 50% loss then that will equate to a portfolio loss of around 1.7% if the portfolio holds 30 companies. A 1.7%
loss is like having to spend £4,250 to repair the roof on a £250k buy to let property. It’s an annoyance, but
that sort of occasional expense is inevitable. However, the loss is less than half of a single year’s income and
would be barely noticeable over a 10 or 20 year period in which the property might easily see a £250k capital
gain. Making a small loss is only an issue if it occurs every year, so it’s important to try to avoid the same
problems in future, which is my next point.
2) Learn and implement the right lessons. The most important thing to do
after a company has been sold at a loss is to carry out an autopsy into the
root causes and whether they were visible beforehand.
If the problems were visible beforehand, put the necessary steps in place
to reduce the odds of investing in similar situations again. In Balfour
Beatty’s case many of the relevant lessons have already been learned and
have been integrated into the company analysis process in recent months.
John Kingham, 3rd April 2015
“There’s a fine line between having
done your homework and having
conviction in it and just being
stupidly stubborn. The best
investors figure out how to walk
that line, recognising their mistakes
and moving on when the situation
warrants. All of that is very hard - if
it were easy, everyone would be
good at it.” - Jon Jacobson in The
Art of Value Investing
Sample Issue - April 2015
UK Value InvestorFor Defensive and Income-Focused Value Investors
Page 2
During March the FTSE 100 stayed fairly close to the 7,000 level but by the end of the month had fallen back
to 6,892. That’s only just below where it started the month, at 6,950.
In terms of valuations the story hasn’t changed much, largely because neither the market nor its earnings and
dividends have changed much in the last couple of years. The FTSE 100 currently has a CAPE (Cyclically
Adjusted PE) ratio of 13.2, which is slightly below average for developed equity markets. However, anything
fairly close to mid-teen is a reasonably normal valuation, so despite the record high price levels we are along
way from anything that remotely resembles a boom.
On the other side of the Atlantic the S&P 500 has a CAPE ratio of almost 28, which is more or less where the
FTSE 100 was during the dot-com boom. While the US market has traded at higher valuation multiples, they
have only been higher during the run up to the 1929 crash (and subsequent Great Depression) and the
dot-com boom (and subsequent “lost decade” of returns for its investors).
One reason for the S&P’s high CAPE ratio is its very depressed earnings during the financial crisis of 2008/9.
However, I have edited Professor Shiller’s data (Robert Shiller, who developed the CAPE ratio) to effectively
erase the effects of the financial crisis, and still the S&P 500 has a CAPE ratio of almost 24. That would put the
US index almost into my “expensive” category, so without doubt the FTSE 100 is very likely the cheaper of the
two indices. On balance I think the FTSE 100 is likely to outperform the S&P 500 over the next decade.
FTSE 100 valuation and projection
Range of
CAPE values
Estimated probability ofseeing this valuation
2015 FTSE 100
(currently at 6,892)Description
2025 FTSE 100 (after 4%/yrearnings growth)
Above 32 5% Above 17,000 Extremely Expensive Above 25,200
28 - 32 (e.g. yr 2000) 5% 14,900 - 17,000 Very Expensive 22,000 - 25,200
24 - 28 10% 12,700 - 14,900 Expensive 18,900 - 22,000
20 - 24 10% 10,600 - 12,700 Slightly Expensive 15,700 - 18,900
14 - 20 25% 7,400 - 10,600 Normal 11,000 - 15,700
12 - 14 10% 6,400 - 7,400 Slightly Cheap 9,400 - 11,000
10 - 12 10% 5,300 - 6,400 Cheap 7,900 - 9,400
8 - 10 (e.g. yr 2009) 10% 4,200 - 5,300 Very Cheap 6,300 - 7,900
Below 8 5% Below 4,200 Extremely Cheap Below 6,300
Valuing the market: Stock market valuations change over time but they tend to stay within a range that is centred around their
intrinsic value. Investors can take advantage of this tendency as it implies that markets are more likely to go up when valuations
are far below intrinsic value and more likely to go down when far above.
500
1,000
2,000
4,000
8,000
16,000
32,000
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2012 2013
F
T
S
E
1
0
0
Year
FTSE 100 CAPE Valuation "Heap Map"
28 - 32 24 - 28 20 - 24 14 - 20 12 - 14 10 - 12 8 - 10 FTSE 100
Page 3
Model portfolio review
Last month’s sell decision
On March 6th I added XXXXXXXXXX shares to the model portfolio at XXXXXp per share, for a total
consideration of £2,979.82 after fees, which was about 3.8% of the portfolio’s total. I also added 13,500
shares to the income portfolio at the same price (the income portfolio review has now moved to the back
pages).
Performance review
This month I’ve added another goal for the model portfolio which is to produce annualised total returns of
more than 5% above inflation over any 5-year period. Whether or not that’s possible remains to be seen, but
I think an absolute return goal like that is a useful addition to just focusing on “beating the market”. As we’ve
seen over the last 15 years, it was possible for a portfolio to have zero capital gains and still beat the FTSE 100
during that period. So while I think “beating the market” is a good goal in bull markets, beating an absolute
rate of return in sideways or bear markets may be a more productive goal.
So far the model portfolio has only been running for four years, but in that time its annualised total return
has been 10.7% per year. Inflation has run at 1.9% a year so real returns have been 8.8%, well above my
target. The portfolio’s FTSE All-Share tracker benchmark has returned 8.6% a year for a real annual return of
6.7%.
Holdings review
As usual there was a lot of volatility at the individual company level. The biggest gainers were Hill & Smith (up
19%) and XXXXXXXXXX (up 13%) while the biggest losers were XXXXX (down 29%) and Serco (down 27%). It
always amazes me that so much volatility at the company usually results in so little volatility at the portfolio
level (down just 2% during the month). However, beyond price fluctuations there was some materially bad
news from a couple of companies.
Serco dividend suspension and rights issue
Serco’s annual results have confirmed that it is unlikely to pay a dividend in 2015 at all. In addition a major
rights issue is currently underway. As usual I will be selling the nil paid rights rather than taking them up. It is
also extremely likely that I will be removing Serco from the portfolio in the next few months.
Balfour Beatty dividend suspension
Balfour Beatty’s new CEO has decided to suspend the dividend for two payments (the final payment of 2014
and the interim payment of 2015) in order to defend the balance sheet while the company works through its
turnaround program. Obviously this is not a good outcome. However, rather than covering the reasons why
this has happened here, I have detailed them in this month’s sell analysis which covers this month’s sale of
Balfour. Briefly, I think the company’s problems were caused by:
! A reliance on large, multi-year contracts which are won through a process of competitive tendering
! Too many large acquisitions which led to an overly complex organisation that was poorly integrated
! Too much debt for a cyclical company that relies on continually replacing large contracts
! Excessively large pension obligations
Reviewing your portfolio: In order to keep a portfolio on track it’s important to take time to review its performance against a
relevant benchmark. There may also have been events during the month where action is be required, such as new annual or interim
reports which need reviewing, or dealing with corporate actions such as mergers, acquisitions or rights issues.
Page 4
Model portfolio performance
UK Revenue 45.5% International Revenue 54.5%
Note that the “average investor” and “bad investor” under-perform the market by 3% and 6% per year respectively due to
overtrading, buying high and selling low. These figures are based on research cited by Barclays and the book, Monkey with a Pin.
Cyclical Sectors 51.3% Defensive Sectors 48.7%
Performance Model Portfolio (A)FTSE All-Share Tracker
Trust (B)
Difference
(A) - (B)
Total return over 1 year 5.7% 6.4% -1.7%
Total return over 3 years 45.9% 37.2% 8.7%
Total return from inception (March 2011) 51.2% 40.2% 11.0%
Annualised return from inception 10.7% 8.6% 2.0%
Current cash value £75,612 £70,102 £5,510
Historic dividend yield 3.7% 3.9% -0.3%
3 year Beta (a measure of risk) 0.55 1 -0.45
Sharpe ratio (a measure of risk adjusted return) 1.05 1 0.05
This virtual portfolio represents the portfolio of a typical investor who is still in the capital accumulation phase. It started with
£50,000 in March 2011 and reinvests all dividends to generate additional growth.
£40,000
£45,000
£50,000
£55,000
£60,000
£65,000
£70,000
£75,000
£80,000
Model Portfolio Total Return FTSE All-Share Tracker Total Return
Average Investor (-3%/yr) Bad Investor (-6%/yr)
Size Allocation
Large Cap, 46%
Mid Cap, 41%
Small Cap, 13%
Industry Allocation
Industrials, 28%
Financials, 20%
Consumer Services,
17%
Consumer Goods, 12%
Utilities, 6%
Oil & Gas, 6%
Basic Materials, 5%
Health Care, 4%
Telecommunications,
3%
The portfolio should have at least 50% of its underlying revenues coming from international markets and at be least 50% invested
in defensive sector companies. If these limits are breached I will try to bring them back into line with the next buy or sell trade.
���������������� ������������������������������ ������������ ����� ������������������������ �
���� ����� ���� ��� ����� �����������
������������
�� ������
!������"#
$��%��
���
$��%��
&����'�( � ��)����� *+�,����
���������
����
���������
�����������������
" -."/ ��)����)�������' 000 ,1���"## ���������������� 000 000 2.3/ 4#.5 "-.-/ 54/ 63/ #.# 73/ 7 000 #89""94#"-
4 4.-/ ��)����)�������' 000 ,1���46#(����:��;���<���� �����=�
�����)����000 000 3.3/ "3.# 44.4/ 7-/ 45/ -.6 "5/ 4- 000 #89#-94#"3
- -.8/ ��)����)�������' 000 ,1���46# ��;;������ ���� 000 000 3.#/ "6.8 "".4/ 52/ "-/ -.3 58/ �9> 000 "29#594#""
3 3.-/ ��)����)�������' 000 ,1���46# ,������������ ���� 000 000 3.#/ 46.2 "7.5/ 52/ 42/ #.# 6#/ 7 000 #69#594#"3
6 4.2/ ��)����)�������' 000 ,1���"## ������ 000 000 6.#/ 5.- "4."/ 8"/ "7/ 4.# "/ �9> 000 "49#594#""
8 -.5/ ��)����)�������' 000 ������ �; ����� 000 000 3."/ "6.8 5.-/ 7-/ 45/ ".- 6/ 2 000 #29#-94#"6
7 ".5/ ��)����)�������' 000 ,1���"## $��<������=������������ 000 000 6.-/ "#.2 8.#/ 85/ "4/ 3.8 22/ 46 000 "#9#794#"4
5 -.7/ ��)����)�������' 000 ,1���46# $��������������� 000 000 3.6/ "-.7 7.8/ 77/ ""/ -.6 "##/ "8 000 #89""94#"3
"" -."/ ��)����)�������' 000 ,1���"## ?���� 000 000 6.#/ "#.- 8.-/ 85/ "4/ �9> 6/ 5 000 #89#894#"3
"- -.-/ ��)����)�������' 000 ,1���"## 1�)���� 000 000 3.4/ 4"." 5.8/ 77/ "8/ -.4 ""/ 47 000 #59#594#"-
"2 ".7/ ��)����)�������' 000 ,1���"## ,����=�������������� 000 000 2."/ 7.5 8.#/ 85/ 5/ 3.6 27/ 47 000 ""9#294#"4
"5 ".7/ ��)����)�������' 000 ,1���"## ,����=�������������� 000 000 8."/ "".# 8.6/ 7-/ 8/ 6.4 "##/ "2 000 #89#694#"-
4# -.3/ ��)����)�������' 000 ,1���46# ���������������� 000 000 6.-/ ""." 2.-/ 8"/ "8/ ".6 4"/ "7 000 #79#494#"-
4" 4.3/ ��)����)�������' 000 ,1���"## ��)����1���������������� 000 000 6.#/ "4.5 2.-/ 54/ 8/ ".4 "4/ �9> 000 #49#294#""
4- -.2/ ��)����)�������' 000 ,1���"## ��������' 000 000 6.7/ "2.6 7."/ 7-/ "#/ 6.- 58/ �9> 000 #"9""94#""
48 3.6/ ��)����)�������' 000 ,1���46# $��������������� 000 000 ".3/ 44.5 "7.4/ 54/ 43/ #.2 74/ �9> 000 "29#-94#""
-4 4.5/ ��)����)�������' 000 ������ �; ����������1����;������ 000 000 2.#/ "#.6 -.-/ 28/ "2/ #.# 27/ �9> 000 "-9#694#""
3- -.5/ ��)����)�������' 000 ,1���"##����������$�����=������
���������000 000 4.3/ 45.8 "".6/ 77/ 4"/ ".6 8/ 48 000 #89#494#"3
36 3.2/ ��)����)�������' 000 ,1���46# ��;;������ ���� 000 000 -.#/ 4#.7 7.2/ 85/ "7/ ".5 6#/ "8 000 #69#794#"-
64 3.3/ ��)����)�������' 000 ,1���46# ,������������� 000 000 4.-/ 4".6 5."/ 54/ "4/ #.7 58/ "2 000 #29""94#"4
2" 3."/ ��)����)�������' 000 ,1���"##���������������=�
?����������'000 000 6.4/ "2.5 ".2/ 8"/ "7/ 3.2 2/ 46 000 #59#"94#"6
2- ".#/ ��)����)�������' 000 ������ �; >����;����=������� 000 000 4.#/ 7.# -.5/ 28/ "#/ -.4 "6/ �9> 000 "79#394#""
84 -.3/ ��)����)�������' 000 ,1���46# ,������������ ���� 000 000 3.6/ 7.7 4.8/ 6#/ "3/ 4.3 6#/ �9> 000 #69#594#""
8- 3.2/ ��)����)�������' 000 ������ �; ��������������������� 000 000 4.2/ 4#.4 8.6/ 77/ "#/ -.6 32/ 47 000 #89#294#"-
87 4.4/ ��)����)�������' 000 ,1���"## ������ 000 000 3.5/ 7." 8.#/ 63/ ""/ 4.4 "/ "8 000 #89#594#"4
77 4.5/ ��)����)�������' 000 ,1���"## (���=�$������������ 000 000 6.8/ 5." �#.6/ 2-/ "#/ 3.8 4#/ �9> 000 #39#-94#""
"#5 ".2/ ��)����)�������' 000 ,1���"## ���������������� 000 000 #.6/ 7.6 �"4.4/ 34/ "-/ "." --/ 6 000 #59#"94#"4
""" 6.2/ ��)����)�������' 000 ,1���"## >����;����=������� 000 000 -.5/ "6.2 4.7/ 86/ 5/ 4.5 4"/ �9> 000 4"9#294#""
"4" ".-/ ��)����)�������' 000 ,1���46# ��;;������ ���� 000 000 4.4/ "3." �3.5/ 86/ 7/ �88.5 37/ "# 000 #89#694#"3
"-4 -."/ ��)����)�������' 000 ,1���46# ����������=��������� 000 000 4.-/ "#.4 �#.7/ 2-/ 7/ 7.5 37/ �9> 000 #59#794#""
6."/ ���
Page 6
Latest annual results
10th March - Hill & Smith Holdings PLC (Purchase date: 7th June 2013)
“An international group with leading positions in the design, manufacture and supply of infrastructureproducts and galvanizing services to global markets. […] facilities principally in the UK, France, USA,Thailand, Sweden, India and Australia.” (www.hsholdings.co.uk)
Revenue
Up 2%
10 Year average earnings
Up 10%
Dividend per share
Up 13%
Debt Ratio
3.5 (cyclical max 4)
Pension Ratio
2.9 (max 10)
Does it still pass the buy tests?
Yes
Quotes from the annual results
2014 has been another good year for the Group resulting in record revenue generation and profitability.Following a good first half performance, trading conditions in many of our end markets continued to improvethroughout the second half which, together with the implementation of strategic initiatives to increase returns,have delivered strong year on year profit growth. Infrastructure Products performed ahead of our expectationswith both Roads and Utilities increasing year on year profitability. A strong performance from Galvanizing in theUSA and UK more than offset any weakness in France.
In December 2014, the Department for Transport published their long awaited Road Investment Strategy (‘RIS’).Recognising that the UK has suffered from insufficient and inconsistent investment, the transformationalinvestment plan sets out the short and longer term vision for the UK strategic road network. The RIS aims toprovide certainty of road investment funding over the period 2015/16 to 2020/21, improve connectivity andcondition of the existing network and, importantly, increase capacity, with projects that will deliver 1,300additional lane miles. The focus of the drive to add capacity will be additional ‘Smart’, or managed motorways,which is at the core of the Group’s product offering in the UK.
In France […] the marketplace remains very competitive due to over capacity and subdued demand. OurScandinavian business enjoyed another successful year despite adverse movements in exchange ratesimpacting local trading margins on products purchased from the UK. Sales of Zoneguard to local distributors inthe USA demonstrated increased levels of acceptance of our product in key states. Australia started to gainsome traction with a key customer and improved its profitability year on year. In India, the market remainsuncertain following national elections in the first half and performance was below the exceptional first full year ofoperation in 2013.
Overall, although some markets remain challenging, 2015 is again expected to be a year of good growth. Beyond2015, the prospects for our infrastructure and galvanizing businesses are encouraging and we are wellpositioned to continue to deliver sustainable growth and shareholder value.
0
50
100
150
200
250
300
350
400
450
500
0
5
10
15
20
25
30
35
40
45
50
2006 2007 2008 2009 2010 2011 2012 2013 2014
£
M
i
l
l
i
o
n
s
P
e
n
c
e
p
e
r
s
h
a
r
e
Adj.Earnings (left axis) Dividends (left axis) Revenue (right axis)
Page 7
Latest annual results
25th March - Balfour Beatty PLC (Purchase date: 9th August 2011)
“For more than 100 years we have created and cared for the vital assets that enable societies andeconomies to grow: road and rail; airports, seaports, tunnels and bridges; health and educationfacilities; heat, light, power and water; places to live and places to work” (www.balfourbeatty.com)
Revenue
Up 2%
10 Year average earnings
Down 12%
Dividend per share
Down 60%
Debt Ratio
6.9 (cyclical max 4)
Pension Ratio
23.2 (max 10)
Does it still pass the buy tests?
No
Quotes from the annual results
Balfour Beatty’s underlying performance has been declining since 2010, with the sharpest and most noticeabledecline occurring over the last 12 months. This has been caused not only by the significant operational issuesimpacting Construction Services UK over the last two years, but also because the cost base of the Group is toohigh and there have been significant working capital outflows since 2009. This trajectory has made it imperativeto identify and address the key issues rapidly, in order to begin at once to restore the Group to strength.
Over the last few months, independent reviews have been underway on operations that account for 70% of theGroup by turnover and the remainder should be underway by the end of the summer. Already it is clear from theoutputs – as well as from wide-ranging discussions with senior operational leaders – that the root cause lies inthe Group’s rapid fourfold revenue expansion since 2000, largely by acquisitions which were insufficientlyintegrated. This resulted in an overly complex, devolved organisation with poor controls and weak disciplines incost control and project bidding. Following a major industry downturn, the UK construction business wasextensively restructured in successive waves and began to exhibit serious project issues which, together withother factors, resulted in substantial operating losses for the Group.
The Group retains many core strengths: a strong brand and reputation underpinned by market-leading andinnovative engineering capability, deep customer relationships […] and the commitment of a talented anddedicated workforce. The business model also balances Construction Services and Support Services with asuccessful Investments business which will continue to create significant value.
In mid-February 2015 the Group launched its “Build to Last” programme. This is designed to address the Group’sperformance as it affects all stakeholders […] by driving continuous measurable improvement. The initial phaseof Build to Last specifically aims within 24 months to improve operating cash flow by £200 million and achieve£100 million of overhead and procurement cost savings, against 2014 levels
The Board decided not to recommend a final dividend, to ensure balance sheet strength is maintained, butexpects to reinstate the dividend at an appropriate level, by March 2016
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
0
5
10
15
20
25
30
35
40
45
2006 2007 2008 2009 2010 2011 2012 2013 2014
£
M
i
l
l
i
o
n
s
P
e
n
c
e
p
e
r
s
h
a
r
e
Adj.Earnings (left axis) Dividends (left axis) Revenue (right axis)
Page 8
“Our business finances, develops, manages and maintains essential assets, including buildings andinfrastructure by integrating local supply chains.” (www.balfourbeatty.com)
OverviewBalfour Beatty is involved in the full lifecycle of infrastructure assets such as roads, bridges and buildings,
from financing to design, construction and maintenance. It operates primarily in the UK and US and has been
in business for more than a century.
When I added Balfour to the model portfolio it was still performing well. However, it was facing some
headwinds in the UK and US infrastructure markets due to recession-like conditions and government
spending cuts in both economies. I thought the company stood a reasonable chance of getting through this
period without major problems, and for a couple of years that was true. Eventually though the company
became more risky and existing risks, which I hadn’t spotted, began to have a serious impact.
In the latest annual results announced this month the new CEO suspended the dividend for two payments,
although it could turn out to be longer. No rights issue has been announced yet but the company’s fortunes
have taken a serious turn for the worse, as has its ranking on the stock screen. Rather than wait for a potential
turnaround at some point in the future I have decided to sell Balfour now, extract any relevant lessons and
apply them to future investments.
Selling: Balfour Beatty PLC (BBY)
Maintaining your portfolio: As companies grow (or shrink) and as their share prices go up (or down) the features and relative
attractiveness of the investment change. If a company’s share price increases faster than its earnings or dividends, or if a company
falls into long-term decline, it may be time to sell and replace it with something that appears to offer better value for money.
Purchase price and date
254p on 09/08/11
Current price
240p on 01/04/15
Holding period
3 Year 8 months
Capital gain (net of fees)
-6.3%
Dividend income
18.6%
Annualised rate of return
3.5% per year
Page 9
The impact of the financial crisis is clearly visible in the company’s post-2007 earnings. However, the general
upward trend was maintained with both revenues and dividends apparently unaffected by the recession.
So given that positive picture I added 950 shares to the model portfolio on August 9th 2011 at a price of 254p
per share. That came to £2,434 after stamp duty and fees, which was 5.1% of the portfolio (the portfolio was
worth just £47,280 at the time). 5.1% is a much bigger allocation than I would use today and that’s because
in 2011 I was targeting 20 holdings rather than 30. Eventually, in early 2012 if I recall correctly, I changed from
20 holdings to 30 to diversify the portfolio further in order to reduce risk.
Holding: A bumpy and ultimately disappointing three years
For the first year or so Balfour continued to perform well against a difficult economic environment. But by
the third quarter of 2012 things began to change. The company announced that profitability would be below
previous expectations and that its construction services unit would face a tough 2013. The shares dropped
by about 20%, although they soon recovered most of that.
2013 continued that less positive trend. In the 2012 annual results, published in March 2013, the CEO spoke
mostly of resilience in tough times and of growth when the recovery came, but revenues and profits declined.
The full-year dividend was still increased by 2% despite those declines. In April 2013 the company announced
that it was launching an immediate action plan in the face of increasing weakness in UK construction, and
further negative announcements were made during the rest of the year.
In 2014 things just got worse. The 2013 annual results were very bad, with underlying profits down by around
30%. This time it was a combination of poor results from both the professional services and construction
services businesses, with the key problem continuing to be the decline of the UK construction market. As is
often the case when companies run into significant problems, Balfour turned primarily to cost cutting,
disposal of underperforming and non-core businesses, and internal restructuring and refocusing in order to
turn the situation around.
Buying: An established business with a solid track record
In 2011 Balfour appeared to be having an impressive run of success. It had a Growth Rate over 10 years of
12.1% and had increased the dividend in every one of those years. It didn’t have a great deal of debt (just
£44m of operational borrowings, which gave it a Debt Ratio of 0.3) and it had about half of its business
operating on either side of the Atlantic, which seemed to give it some degree of protection from declines in
either the US or UK markets.
Here are Balfour Beatty’s financial results up to the 2010 annual report, which was the latest at the time:
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
0
5
10
15
20
25
30
35
40
45
2002 2003 2004 2005 2006 2007 2008 2009 2010
£
M
i
l
l
i
o
n
s
P
e
n
c
e
p
e
r
s
h
a
r
e
Balfour Beatty Financial Results to 2010
Adj.Earnings (left axis) Dividends (left axis) Revenue (right axis)
Page 10
In its 2014 Q1 statement the company announced the CEO’s departure and the possible sale of Parsons
Brinkerhoff (a professional services consultancy focused on infrastructure), which had only recently been
acquired in 2009 for £382m. Parsons was eventually sold in September 2014 for £812m and up to £200m of
that was earmarked for a shareholder return. At the half-year results the story was the same with the
dividend held fast and profits down by more than 50%. By this point the construction services business was
solidly loss-making, losing almost £70m at the operating level in the first 6 months of the year. In September
the dividend was put under “review” and the Chairman stated his intention to leave once a new CEO had
been found. All in all 2014 was a very bad year.
In 2015 the company found a new CEO (Leo Quinn, previously at QinetiQ) who immediately launched a new
transformation program with the goal of reducing costs by £100m and improving cash generation by £200m
over 2 years. At this point the dividend was suspended for two payments, with the expectation that it will be
reinstated in March 2016. Here are Balfour’s most recent results:
All in all then Balfour Beatty was not a great investment. I realise that some problems are inevitable and that
my investment strategy is primarily a value investment strategy, albeit a defensive value strategy. So buying
companies with minor problems is almost a prerequisite for buying them at attractive prices. But Balfour’s
problems are far more than minor. So my question is:
Was there anything that could have been done to avoid this situation, without being so cautious as to miss
out on other potentially attractive opportunities?
Learning the right lessons: Acquisitions, pensions and debts
Since 2011 I have introduced many improvements to the investment strategy with the goal of increasing
returns and reducing risk. This includes things like lowering the amount of debt that is acceptable, looking at
the size of a company’s defined benefit pension obligations, asking questions about how focused the
company is, how cyclical it is, whether it depends on large contracts, how much is spends on capex, how
much it has spent on acquisitions and what sort of competitive advantages it might have.
In relation to Balfour, several of these new checks would have made me more cautious about investing, but
one in particular would have ruled it out from the start.
Lesson 1. Be wary of companies that need to repeatedly replace large contracts
This was a lesson I learned recently after Serco ran into serious trouble; it is already part of the new company
analysis checklist. Companies that need to repeatedly replace large projects or contracts carry a lot of risk
from either not replacing the contract (which of course would reduce revenues and profits, sometimes
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
0
5
10
15
20
25
30
35
40
45
2006 2007 2008 2009 2010 2011 2012 2013 2014
£
M
i
l
l
i
o
n
s
P
e
n
c
e
p
e
r
s
h
a
r
e
Balfour Beatty Financial Results to 2014
Adj.Earnings (left axis) Dividends (left axis) Revenue (right axis)
Page 11
dramatically) or bidding too low in order to win a new contract. If a contract is won at too low a price it can
lock the company into wafer thin profits or even losses over a multi-year period. This has definitely effected
Balfour’s UK construction services business. I’m not totally against investing in these sorts of companies but
they should have very low levels of debt; perhaps a Debt Ratio of just 3 rather than the standard 4 for cyclical
sector companies. While debt wasn’t initially a problem for Balfour, it did increase its operational borrowings
every year to a high in 2013 of more than £600m (a Debt Ratio of 3.7), which probably was too high.
Lesson 2. Be wary of companies that make lots of large acquisitions
This is another new check that was added to the company analysis checklist in January 2015 and it would have
provided another warning flag against Balfour. My rule of thumb is that if a company spends more on
acquisitions in a year than it made in post-tax profits, then that is a “large” acquisition expenditure. The more
large acquisitions there are, the more cautious you should be. In Balfour’s case it made large acquisitions in
the 2007, 2008 and 2009 financial years. In total it spent some £800m on acquisitions in those years while
only making adjusted post-tax profits of £430m. The problem with acquisitions is that they usually have to be
integrated, and the bigger they are the more disruptive they can be. The new CEO has highlighted these
acquisitions as a major cause of the company’s current problems. Although they wouldn’t necessarily have
ruled Balfour out as an investment, they would have made it more likely.
Lesson 3. Be wary of companies with large defined benefit pension obligations
Oddly enough this isn’t something that gets talked about much, but I think it has been instrumental in
exacerbating Balfour’s other problems. The rule which I brought in a couple of years ago was that a company
should have defined benefit pension obligations of no more than 10 times its Earnings Power (5-year average
earnings), i.e. a Pension Ratio of less than 10. I focus on the pension obligations rather than whether or not
the plan is in surplus or deficit because a surplus can quickly become a deficit, so a pension surplus is not a
guarantee of safety. Limiting the size of the overall obligations limits the maximum size of any deficit and any
associated deficit funding requirements.
In Balfours case it had pension obligations of £2,795m as at the 2010 annual results compared to 5-year
average earnings of £139m. That gave the company a Pension Ratio of 20 which is, quite frankly, massive.
How does this impact the company? It means the company is at risk of running a huge pension deficit which
the company will have a legal obligation to reduce, by any means necessary. In 2010 Balfour’s pension plans
had a deficit of £440m, more than three times its average earnings. That year it had to pay £81m into the
pension fund to close the gap, only slightly less than the £84 million paid out to shareholders as a dividend.
Over the last 10 years Balfour has paid more than £500m into the pension fund and yet it still runs a deficit
and the obligations just keep growing (they currently stand at £3,518m). With the dividend now suspended
and £85m of the £200m windfall from Parsons Brinkerhoff going into the pension fund, it seems to me that
Balfour is a company run primarily in the interests of its enormous pension scheme rather than its
shareholders. That is entirely as it should be given the company’s legal obligations to the fund’s beneficiaries,
but it does illustrate the reasons why I introduced the Pension Ratio in the first place.
Selling: Losses, suspended dividends and a potentially difficult turnaround ahead
The turnaround is expected to take at least a couple of years, although of course how well it goes and what
happens to the share price in that time is anybody’s guess. However, given the resilience of the share price
in the face of this bad news I will be taking this opportunity to offload Balfour and search instead for a less
risky and less financially obligated company. As usual I will sell the entire holding a few days after this issue
is published.
IMPORTANT NOTICE: This analysis is for information only. It is an example of how one investor applies a checklist approachto analysing a company and it should not be construed as investment advice and should not be relied upon in isolation beforeinvesting. You should always perform your own analysis and factual verification before making investment decisions. If youneed advice you should seek a financial advisor. See the important notes on the last page.
Holdings with a lower stock screen rank Reason for not selling
None There were no holdings with a lower stock screen rank than Balfour Beatty
Page 12
Questions and Answers
Readers ask questions on a range of topics every month. Here are the most interesting and/or frequent:
Q: Why are some companies that I’m interested in missing from the stock screen?
A: Not every company listed on the London Stock Exchange makes it into the stock screen. It uses the
following filter before ranking the remaining stocks.
Only include stocks that:
! Are part of the FTSE All-Share index (i.e. not AIM and not FTSE Fledgling)
! Have a non-zero dividend in every one of the last 10 years (i.e. paid a dividend every year)
! Have a 10-year dividend cover of more than 1 (i.e. 10-year total profits more than total dividends)
! Are a “normal” trading business rather than an investment trust (either equity or real estate)
Defensive Sectors
! Aerospace & Defense
! Beverages
! Electricity
! Fixed Line Telecommunications
! Food & Drug Retailers
! Food Producers Gas
! Water & Multi-utilities
! General Retailers
! Health Care Equipment & Services
! Mobile Telecommunications
! Non-life Insurance
! Personal Goods
! Pharmaceuticals & Biotechnology
! Tobacco
Cyclical Sectors
! Automobiles & Parts
! Banks
! Chemicals
! Construction & Materials
! Electronic & Electrical Equipment
! Financial Services
! Forestry & Paper
! General Industrials
! Household Goods & Home Construction
! Industrial Engineering
! Industrial Metals & Mining
! Industrial Transportation
! Leisure Goods
! Life Insurance
! Media
! Mining
! Oil & Gas Producers
! Oil Equipment, Services & Distribution
! Real Estate Investment & Services
! Software & Computer Services
! Support Services
! Technology Hardware & Equipment
! Travel & Leisure
Defensive and Cyclical sectors
The model portfolio aims to be at least 50% invested in defensive FTSE Sectors as defined in the Capita
Dividend Monitor. The definitions are repeated here in case you want to follow a similar policy:
��������������������� �������������������� ������������ ����� ������������������������ �
��� ���� ���� ���� ������������
�������������
��������
���������
��� ���
����
��� ���
!"���� �#��
�����
�����
����$%�
�� ���
� �"�%������%��� &&& '(������ ����)���%"���� &&& &&& *+,- .�+/ �0+0- /.- 1,- �+� 2.,/
. �"�%������%��� &&& '(���.1� #����3"�4���5��������%�6���%����"��� &&& &&& ,+,- �,+� ..+.- 70- ./- 0+1 20�*
0 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& ,+�- �1+8 ��+.- /*- �0- 0+, 288
, �"�%������%��� &&& '(���.1� '��������������% &&& &&& ,+�- .1+* �7+/- /*- .*- �+� 2�0.
1 �"�%������%��� &&& '(������ 9��$ &&& &&& 1+�- /+0 �.+�- 8�- �7- .+� 2��50.*
* �"�%������%��� &&& ��������4 :�)���%"���� &&& &&& 1+.- �,+7 *+/- 77- �1- �;< 2.8
8 �"�%������%��� &&& ��������4 9���� &&& &&& ,+�- �1+8 /+0- 70- ./- �+0 20.
7 �"�%������%��� &&& '(������ ��%5�=�����6�9"���"�������% &&& &&& 1+0- ��+* 8+�- 8/- �.- ,+8 2�5,81
/ �"�%������%��� &&& '(���.1� ���������������% &&& &&& ,+1- �0+7 7+8- 77- ��- 0+1 28,
�� �"�%������%��� &&& ��������4 ��"%�������$�����$ &&& &&& 1+/- ��+� ��+/- 8/- 7- ,+* 2,8
�� �"�%������%��� &&& '(������ >��% &&& &&& 1+�- ��+0 8+0- 8/- �.- �;? 2.57,1
�. �"�%������%��� &&& '(���.1� #����3"�4���5��������%�6���%����"��� &&& &&& ,+7- �8+/ �,+1- 70- �.- �+* 2..�
�0 �"�%������%��� &&& '(������ (������ &&& &&& ,+.- .�+� /+8- 77- �8- 0+. 205707
�, �"�%������%��� &&& '(������ 9���� &&& &&& 0+.- .1+0 ��+.- /*- ..- .+8 2/71
�1 �"�%������%��� &&& '(������ '����6���"$���������% &&& &&& *+8- ��+* 7+*- 77- 1- 1+. 21,�
�* �"�%������%��� &&& '(������ '����6���"$���������% &&& &&& *+�- 7+/ 8+�- 8/- /- ,+1 2.5,//
�8 �"�%������%��� &&& '(���.1� '�����:���(�������"������% &&& &&& ,+�- 0*+, .,+1- /.- 0*- ,+0 2.0
�7 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& ,+0- ..+/ /+0- 77- 0,- �+� 2.7
�/ �"�%������%��� &&& '(������ '����6���"$���������% &&& &&& 8+�- ��+� 8+1- 70- 8- 1+. 2,78
.� �"�%������%��� &&& '(���.1� ����)���%"���� &&& &&& 1+0- ��+� *+0- 8�- �8- �+1 2�8/
.� �"�%������%��� &&& '(������ 9������(�������"������% &&& &&& 1+�- �.+/ *+0- /.- 8- �+. 2��5/**
.. �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& .+8- �7+0 ��+7- /.- �,- 1+� 2�,0
.0 �"�%������%��� &&& '(������ ���������� &&& &&& 1+7- �*+1 7+�- 70- ��- 1+0 2�5�/8
., �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& 8+*- ��+0 *+�- 17- 0/- .+8 21,
.1 �"�%������%��� &&& '(������ (������ &&& &&& ,+0- �*+0 �0+7- 81- ��- 1+0 2�5717
.* �"�%������%��� &&& ��������4 �"44�����������% &&& &&& ,+0- 7+0 ,+8- 8�- �0- ,+� 20,
.8 �"�%������%��� &&& '(���.1� ���������������% &&& &&& �+,- ..+/ �7+.- /.- .,- �+* 21,
.7 �"�%������%��� &&& ��������4 ��"%�������$�����$ &&& &&& .+�- �8+/ �0+7- 70- �7- �+/ 2��
./ �"�%������%��� &&& '(���.1� ����)���%"���� &&& &&& 0+.- �0+� *+7- 81- �7- �;< 2�.1
0� �"�%������%��� &&& '(���.1� ����������6�������������3"�4��� &&& &&& 0+.- 8+8 ��+0- 8�- /- ,+� 2*,
0� �"�%������%��� &&& '(���.1� ��"%�������$�����$ &&& &&& .+�- 0�+7 �,+0- ���- 0�- �+. 277
0. �"�%������%��� &&& ��������4 ��"%������(��%4������� &&& &&& *+�- ��+1 0+0- *8- �*- �+� 27
00 �"�%������%��� &&& '(���.1� ����)���%"���� &&& &&& .+7- .1+0 ��+�- 77- �*- �;< 2��,
0, �"�%������%��� &&& '(������ ��"%�������$�����$ &&& &&& .+*- �7+, �7+.- 70- ��- 0+8 2.7�
01 �"�%������%��� &&& '(������ �"44�����������% &&& &&& �+7- ..+* �8+8- 77- �*- .+. 2.07
0* �"�%������%��� &&& '(���.1� ��)� ����6����4"�����������% &&& &&& .+7- �/+7 ��+,- 77- �.- �+0 21/
08 �"�%������%��� &&& '(���.1� ��)� ����6����4"�����������% &&& &&& �+7- .8+. .�+1- /.- �/- �+� 2,.
07 �"�%������%��� &&& '(���.1� ��������% &&& &&& .+,- ./+7 �0+�- /.- .0- �+� 28�
0/ �"�%������%��� &&& '(���.1� ����)���%"���� &&& &&& ,+*- �0+7 1+*- 81- ��- �;< 2�8/
,� �"�%������%��� &&& ��������4 �"44�����������% &&& &&& .+,- .�+0 �.+0- /.- ��- 0+/ 2.�
,� �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& .+*- �*+7 8+�- 8/- �/- �+. 270
,. �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& .+0- ,8+� �/+,- ���- 0/- �+* 201
,0 �"�%������%��� &&& '(������ @�"%����������%�6�@������%��"���� &&& &&& .+,- ./+8 ��+1- 77- .�- �+1 2�58�7
,, �"�%������%��� &&& '(������ #���6���%�����"���% &&& &&& .+.- /+0 7+�- 8/- �.- 0+0 205..1
,1 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& 0+�- .�+7 7+*- 8/- �7- �+/ 28�
,* �"�%������%��� &&& '(���.1� ����)���%"���� &&& &&& .+*- �*+0 /+,- 81- �,- �;< 2�*8
,8 �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& .+0- 0�+� ��+,- ���- �/- �+� 2,/
,7 �"�%������%��� &&& '(������ 9��$ &&& &&& �+7- ��+0 �,+.- 17- �0- �+� 2811
,/ �"�%������%��� &&& '(���.1� ?���%4����6���)�%� &&& &&& 0+1- .�+1 /+8- 8/- �0- 8+8 2�77
1� �"�%������%��� &&& '(���.1� #����3"�4���5��������%�6���%����"��� &&& &&& .+8- /+0 ��+7- 81- /- .+0 2�0�
1� �"�%������%��� &&& '(���.1� #���6���%�����"���% &&& &&& �+,- 8+/ �0+*- 1,- /- ,+0 21�*
1. �"�%������%��� &&& '(���.1� '��������"���% &&& &&& .+0- .�+1 /+�- /.- �.- �+7 20*
10 �"�%������%��� &&& '(������ �"44�����������% &&& &&& .+�- .7+* �*+7- /.- �,- ,+. 2�8*
1, �"�%������%��� &&& '(������ ��������"�����%�6�>���������$ &&& &&& 0+7- �*+� �+,- 81- .0- �+7 205/.7
11 �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& 7+*- ,+, ,+/- 1�- .�- .+� 2.�/
1* �"�%������%��� &&& '(���.1� ?���%4����6���)�%� &&& &&& .+*- ..+. ��+8- 8�- �7- .+8 2*,
18 �"�%������%��� &&& '(������ >�����$�% &&& &&& .+7- .,+8 8+/- 77- �,- ,+0 2.5.80
17 �"�%������%��� &&& '(���.1� ���������������% &&& &&& 0+�- �,+, 0+�- 8�- �1- �+1 28.
1/ �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& 0+0- �1+, �+,- 77- ��- 0+/ 2�70
*� �"�%������%��� &&& '(���.1� ��"%�������$�����$ &&& &&& .+/- ..+, *+�- 70- �8- �+. 2.��
*� �"�%������%��� &&& '(������ ��������"�����%�6�>���������$ &&& &&& 1+.- �*+/ �+*- 8�- �7- ,+* 2,5�1�
*. �"�%������%��� &&& '(������ �"44�����������% &&& &&& .+*- 0�+* ��+1- /.- �0- 8+* 2.*.
*0 �"�%������%��� &&& ��������4 ?���%4����6���)�%� &&& &&& .+�- 7+� 0+/- *8- ��- 0+. 2,/
*, �"�%������%��� &&& ��������4 ��)� ����6����4"�����������% &&& &&& �+7- 07+/ ..+,- ���- �1- .+1 2�,
*1 �"�%������%��� &&& '(������ ���������������% &&& &&& .+�- .8+/ ��+.- 70- ,�- �+8 2,8�
** �"�%������%��� &&& '(���.1� ��������% &&& &&& .+,- 00+� �8+7- 70- �8- �+, 2�*.
*8 �"�%������%��� &&& '(������ (������6�:��%"�� &&& &&& .+0- 0*+8 �0+8- /*- �0- 0+* 2881
*7 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& 0+7- �1+* 8+.- 70- 7- 0+� 20�
*/ �"�%������%��� &&& '(������ �"44�����������% &&& &&& .+,- ./+7 �7+.- 77- ��- ,+. 2�18
8� �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& 1+,- ��+. 1+�- 8�- 8- ,+1 2�,1
8� �"�%������%��� &&& ��������4 ��)� ����6����4"�����������% &&& &&& .+7- 7+* 0+*- 17- �/- �+� 2�0
8. �"�%������%��� &&& '(���.1� '��������������% &&& &&& ,+1- 7+7 .+8- 1�- �,- .+, 2/�
80 �"�%������%��� &&& ��������4 ��"%�������$�����$ &&& &&& .+*- .�+. 8+1- 77- ��- 0+1 20�
8, �"�%������%��� &&& '(���.1� ��"%�������$�����$ &&& &&& �+/- 0.+7 ��+�- /*- �8- �+/ 2/*
81 �"�%������%��� &&& '(���.1� '��������������% &&& &&& ,+.- ��+, ,+�- 8�- �0- 1+* 2�0/
8* �"�%������%��� &&& '(���.1� ���������� &&& &&& 0+0- 1+* 1+8- 1�- �,- �+8 2�78
88 �"�%������%��� &&& '(���.1� 9��$ &&& &&& 8+,- 1+� ,+8- *8- 0- 07+0 2.*1
87 �"�%������%��� &&& '(������ 9��$ &&& &&& ,+/- 7+� 8+�- 1,- ��- .+. 285,*.
8/ �"�%������%��� &&& '(������ ���%��������% &&& &&& �+7- 08+. �8+,- 70- .8- �+1 2.*/
7� �"�%������%��� &&& '(������ #���6���%�����"���% &&& &&& 1+*- /+* 0+�- *0- /- .+� 2�,5�./
7� �"�%������%��� &&& '(������ '��������������% &&& &&& 0+/- 0.+. �/+�- 70- /- �+� 2.,�
��������������������� �������������������� ������������ ����� ������������������������ �
��� ���� ���� ���� ������������
�������������
��������
���������
��� ���
����
��� ���
!"���� �#��
�����
�����
����$%�
�� ���
7. �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& .+�- ,�+8 �1+*- /.- �,- �+� 2./
70 �"�%������%��� &&& '(������ ���������"%�����% &&& &&& 0+*- �1+0 1+1- *8- ��- .+/ 20,0
7, �"�%������%��� &&& '(���.1� >�����$�% &&& &&& .+7- .,+8 /+.- 8/- �.- *+8 271
71 �"�%������%��� &&& '(���.1� ����������6�������������3"�4��� &&& &&& .+,- 0�+1 ��+�- 70- �8- �+� 2,�
7* �"�%������%��� &&& '(���.1� ���%��������% &&& &&& �+*- 1.+. �0+1- /.- .0- �+8 2..
78 �"�%������%��� &&& '(���.1� >�����$�% &&& &&& .+�- 00+, /+.- /*- �*- �+* 2.*
77 �"�%������%��� &&& '(������ #���6���%�����"���% &&& &&& 1+8- /+� �+1- *0- ��- ,+8 285./�
7/ �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& .+8- 00+* �/+�- 8�- �*- �+� 28,
/� �"�%������%��� &&& '(���.1� ���������������% &&& &&& .+8- .*+/ ��+7- 8�- 0,- �+� 27�
/� �"�%������%��� &&& '(���.1� ��)� ����6����4"�����������% &&& &&& �+8- 0*+� �.+0- 70- �8- �+� 2./
/. �"�%������%��� &&& ��������4 ��"%������(��%4������� &&& &&& ,+,- ..+� 1+0- *0- �8- �+� 2�0
/0 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& 1+*- �0+� .+*- ,.- �0- 0+* 217
/, �"�%������%��� &&& ��������4 ��"%�������$�����$ &&& &&& 0+8- �0+� 1+�- *0- ��- 0+0 2.1
/1 �"�%������%��� &&& ��������4 '��������������% &&& &&& 0+�- .8+� ��+�- 70- ��- 0+. 2��
/* �"�%������%��� &&& '(���.1� ?���%4����6���)�%� &&& &&& �+8- ..+7 �0+0- 8/- �.- �+, 270
/8 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& ,+�- �8+, ,+*- 8/- 7- 0+� 2,�
/7 �"�%������%��� &&& ��������4 '��������"���% &&& &&& 0+�- .�+7 ��+�- *8- ��- �+0 20.
// �"�%������%��� &&& '(���.1� '��������������% &&& &&& ,+.- �7+1 *+7- *0- �.- 0+7 2.�7
��� �"�%������%��� &&& '(������ ��%5�=�����6�9"���"�������% &&& &&& ,+/- �1+* 1+*- 81- 1- �.+, 2.5�/0
��� �"�%������%��� &&& ��������4 9���� &&& &&& 7+�- *+* ,+0- 17- 1- .+0 2�8
��. �"�%������%��� &&& ��������4 �"44�����������% &&& &&& 1+8- ��+. ,+8- 8�- ��1- 0+, 200
��0 �"�%������%��� &&& '(���.1� ��"%������(��%4������� &&& &&& �+8- .8+8 �0+�- ���- 7- .+8 20�
��, �"�%������%��� &&& '(���.1� ���%��������% &&& &&& .+0- .0+/ /+7- 70- ��- �+* 28*
��1 �"�%������%��� &&& '(���.1� ��)� ����6����4"�����������% &&& &&& �+*- 0/+0 .0+0- 81- ,,- .+, 280
��* �"�%������%��� &&& ��������4 '��������"���% &&& &&& �+1- /+� �.+.- *8- ��- �+* 20*
��8 �"�%������%��� &&& '(���.1� ����������6�������������3"�4��� &&& &&& .+.- .*+, ��+�- 8/- �0- �+0 2�..
��7 �"�%������%��� &&& '(������ 9���� &&& &&& .+1- .*+1 �.+.- /.- 8- 0+8 2�5.�,
��/ �"�%������%��� &&& '(������ ����)���%"���� &&& &&& �+1- 7+1 �.+.- ,.- �0- �+� 2.�7
��� �"�%������%��� &&& ��������4 '��������"���% &&& &&& .+,- �8+. 8+7- 8/- /- ,+/ 27
��� �"�%������%��� &&& '(������ ?���%4����6���)�%� &&& &&& 0+/- �1+* .+7- 81- /- .+/ 2�5�1.
��. �"�%������%��� &&& '(���.1� ���������"%�����% &&& &&& .+,- .0+8 �.+1- 8/- /- ,+/ 21*
��0 �"�%������%��� &&& '(������ :�)���%"���� &&& &&& .+.- ./+, ��+8- 81- �7- �;< 2�5*,8
��, �"�%������%��� &&& '(���.1� #����3"�4���5��������%�6���%����"��� &&& &&& ,+�- �,+. 8+.- 8�- *- .+, 21/
��1 �"�%������%��� &&& '(���.1� ����������6�������������3"�4��� &&& &&& �+*- ,�+� /+/- ���- �1- �+0 27.
��* �"�%������%��� &&& '(���.1� '��������"���% &&& &&& ,+*- �0+� 0+,- *0- ��- 0+. 2.,*
��8 �"�%������%��� &&& '(���.1� ��%��"�����6�9�������% &&& &&& ,+1- �1+/ .+�- *0- �,- 8+0 2,,
��7 �"�%������%��� &&& '(������ :�)���%"���� &&& &&& ,+�- .0+, ��+8- 17- �*- �;< 27,7
��/ �"�%������%��� &&& ��������4 '�����:���(�������"������% &&& &&& 1+,- �1+0 1+*- 1,- �0- .+, 201
�.� �"�%������%��� &&& '(���.1� ��%5�=�����6�9"���"�������% &&& &&& 0+8- .,+* 8+0- 77- ,- .�+� 2�,�
�.� �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& .+.- �,+� ,+/- 81- 7- 88+/ 2��
�.. �"�%������%��� &&& ��������4 ����������6�������������3"�4��� &&& &&& .+�- 00+7 �8+�- 70- �.- �+8 2��
�.0 �"�%������%��� &&& '(���.1� '����6���"$���������% &&& &&& .+.- ./+� 1+1- 70- �7- �+� 20/
�., �"�%������%��� &&& '(������ >��% &&& &&& 1+,- ��+* �+,- *8- /- �;? 2/508�
�.1 �"�%������%��� &&& '(������ @������������3"�4����6��������% &&& &&& �+*- ./+* ��+,- 70- �*- .+8 2,��
�.* �"�%������%��� &&& '(������ ��)� ����6����4"�����������% &&& &&& .+*- .8+0 8+.- 70- ��- .+1 2.08
�.8 �"�%������%��� &&& ��������4 9���� &&& &&& 0+�- �*+7 ,+,- 8/- /- 1+7 2��
�.7 �"�%������%��� &&& '(������ ���%��������% &&& &&& 0+.- .,+. 1+�- 8�- �1- .+8 20517,
�./ �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& ,+/- �*+. �+�- 1,- �.- .+� 28�
�0� �"�%������%��� &&& ��������4 ��%��"�����6�9�������% &&& &&& 0+,- ��+. 1+1- ,*- �,- �+1 2.,
�0� �"�%������%��� &&& ��������4 ��"%������(��%4������� &&& &&& .+8- �/+, �+0- 8/- �.- �+� 2.�
�0. �"�%������%��� &&& '(���.1� ��%��"�����6�9�������% &&& &&& .+0- ��+. �+7- *0- 7- 7+/ 2��7
�00 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& .+8- .,+� /+8- 8/- 7- 0+. 2..
�0, �"�%������%��� &&& '(���.1� ��%��"�����6�9�������% &&& &&& .+8- �0+* �+*- 81- /- 1+. 20*
�01 �"�%������%��� &&& '(������ �"44�����������% &&& &&& �+/- 0,+1 7+7- ���- ��- ,+7 2.�,
�0* �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+*- 0�+� ��+8- 81- /- /+* 2�11
�08 �"�%������%��� &&& '(������ ���������������% &&& &&& 0+.- �1+0 �+,- *8- ��- 0+/ 21,,
�07 �"�%������%��� &&& '(���.1� 9���� &&& &&& .+�- .*+� 1+1- 81- �8- �+8 2*1
�0/ �"�%������%��� &&& '(���.1� 9������(�������"������% &&& &&& 0+0- .*+7 ��+.- 8�- /- *+. 2�/�
�,� �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& 0+,- �1+8 ,+.- 8/- ,- �,+, 2��1
�,� �"�%������%��� &&& ��������4 ���������������% &&& &&& ,+1- *+* �7+�- 00- /- *+� 20*
�,. �"�%������%��� &&& '(���.1� 9���� &&& &&& ,+0- �,+. �+0- 17- �.- 1+1 2��0
�,0 �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+�- ��+0 �,+�- 1�- ��- �+1 2�/8
�,, �"�%������%��� &&& '(������ :�)���%"���� &&& &&& 0+8- .,+/ 1+.- 8�- ��- �;< 2,81
�,1 �"�%������%��� &&& '(���.1� '��������������% &&& &&& .+�- *+/ ��+/- *8- �.- ��.+7 2/1
�,* �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& 0+*- �*+. .+0- 17- �.- 1+/ 211
�,8 �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+�- ..+, 0+�- *8- �,- *8+. 2���
�,7 �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& ,+,- /+8 �+8- *8- 0- �*+� 271
�,/ �"�%������%��� &&& '(������ :�)���%"���� &&& &&& .+1- ,8+* �1+.- 8/- �0- �;< 2��8
�1� �"�%������%��� &&& ��������4 9���� &&& &&& 0+7- �0+/ �+7- 8�- 8- �+� 28
�1� �"�%������%��� &&& '(������ ��������"�����%�6�>���������$ &&& &&& �+*- 11+1 .�+8- 77- /- 0+� 271
�1. �"�%������%��� &&& '(������ (������$ �@��� ����6��3"�4��� &&& &&& �+*- �,1+0 ..+0- 77- /- �+� 2�11
�10 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& �+,- .0+� �+1- 17- .,- �+, 2�8
�1, �"�%������%��� &&& '(������ ��������% &&& &&& �+7- 0�+, ��+,- 8/- ��- 0+1 2.8,
�11 �"�%������%��� &&& '(���.1� ����������6�������������3"�4��� &&& &&& �+8- ,0+, ��+8- 81- �8- �+� 21*
�1* �"�%������%��� &&& '(���.1� '��������"���% &&& &&& ,+7- �.+� �+1- 17- 8- ,+8 2,,
�18 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& �+/- 0.+� ��+*- 8/- 7- 7+� 2�0�
�17 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& 1+�- ,+� 7+,- ,.- *- ,+� 2�0
�1/ �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& �+8- .�+. 0+7- 17- ..- �+1 28.
�*� �"�%������%��� &&& '(���.1� ��������% &&& &&& �+7- .*+/ ��+7- 8�- ��- �+� 2*7
�*� �"�%������%��� &&& '(������ (������6�:��%"�� &&& &&& �+0- ,/+7 �0+0- /.- /- �+8 2.,/
�*. �"�%������%��� &&& '(������ ��%5�=�����6�9"���"�������% &&& &&& 0+/- .0+� .+/- 8/- 0- �/+1 2.0*
��������������������� �������������������� ������������ ����� ������������������������ �
��� ���� ���� ���� ������������
�������������
��������
���������
��� ���
����
��� ���
!"���� �#��
�����
�����
����$%�
�� ���
�*0 �"�%������%��� &&& '(������ :�)���%"���� &&& &&& 0+,- �.+1 *+,- ,*- /- �;< 2�5�,.
�*, �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+,- �0+7 �+7- *8- 8- �0�+/ 20�8
�*1 �"�%������%��� &&& '(���.1� ��"%�������$�����$ &&& &&& .+/- 01+, �,+/- 81- ,- 0+� 2��0
�** '(������ *57/� �1+* 0+1- �,+, �+/- 1,- ��-
�*8 �"�%������%��� &&& '(���.1� '��������������% &&& &&& .+1- ./+0 0+�- 8�- �,- 00+, 2./
�*7 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& ,+.- �.+1 .+�- 17- *- *+7 2*
�*/ �"�%������%��� &&& ��������4 ����������6�������������3"�4��� &&& &&& .+.- .7+, .�+/- *0- �.- �+� 2�,
�8� �"�%������%��� &&& ��������4 �"44�����������% &&& &&& ,+.- �.+* 7+�- 1,- 8- 0+8 2�1
�8� �"�%������%��� &&& '(���.1� ��"%�������$�����$ &&& &&& .+�- .1+0 *+,- 81- ��- �+� 2*1
�8. �"�%������%��� &&& '(������ ?���%4����6���)�%� &&& &&& .+1- .,+� /+0- 8�- *- 0+0 2.�7
�80 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& �+7- ,0+* ��+,- 8/- ��- *+� 2*,
�8, �"�%������%��� &&& '(���.1� @������������3"�4����6��������% &&& &&& �+�- 18+7 �,+.- /*- 1- *+0 2./
�81 �"�%������%��� &&& ��������4 9���� &&& &&& .+�- ,,+* *+�- 70- �0- �- 21
�8* �"�%������%��� &&& ��������4 9��$ &&& &&& ��+0- /+* ��+�- ,.- ,- �+� 2�.
�88 �"�%������%��� &&& ��������4 9���� &&& &&& 0+1- .�+/ ,+8- 17- ��- ,+* 2/
�87 �"�%������%��� &&& '(������ 9��$ &&& &&& �+7- 08+7 0�+,- 8/- 8- �+� 2�88
�8/ �"�%������%��� &&& ��������4 �"44�����������% &&& &&& �+/- .8+� ,+7- 8�- �,- �+� 2�*
�7� �"�%������%��� &&& ��������4 (������6�:��%"�� &&& &&& �+1- 0�+* /+�- /*- 1- *+0 2.0
�7� �"�%������%��� &&& '(������ �"44�����������% &&& &&& 0+�- .0+0 1+/- 8�- 1- ��+� 2.�,
�7. �"�%������%��� &&& '(���.1� 9���� &&& &&& 0+,- .0+1 *+0- 8�- 1- 1+� 2�*.
�70 �"�%������%��� &&& '(������ (������6�:��%"�� &&& &&& �+7- 0.+. *+�- 8�- �/- ,+7 2..8
�7, �"�%������%��� &&& '(���.1� ��"%������(��%4������� &&& &&& 0+�- �/+8 ,+1- *8- 8- 1+8 2/�
�71 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& 0+7- /+� ,+0- 17- ,- *+1 28
�7* �"�%������%��� &&& ��������4 ��%��"�����6�9�������% &&& &&& ,+8- ��+8 �+0- 1,- ,- 8+� 2�*
�78 �"�%������%��� &&& '(������ '��������"���% &&& &&& �+.- ,�+1 /+/- /*- 8- �+1 2*,*
�77 �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+.- .7+� 0+0- *0- �,- �+� 2./
�7/ �"�%������%��� &&& '(������ ���������������% &&& &&& .+*- �/+8 1+,- *8- *- �+* 218,
�/� �"�%������%��� &&& ��������4 �"44�����������% &&& &&& .+8- /+� *+.- *8- 1- 1+7 2�/
�/� �"�%������%��� &&& '(������ >��% &&& &&& .+8- ��+, ..+7- 17- ,- �;? 2�5/.1
�/. �"�%������%��� &&& '(������ ?���%4����6���)�%� &&& &&& �+/- .0+, 1+�- 8�- ��- ,+. 281.
�/0 �"�%������%��� &&& '(���.1� (������$ �@��� ����6��3"�4��� &&& &&& 0+8- .1+. �+1- 8/- 1- *+8 20,
�/, �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& .+8- 0�+0 1+1- 8/- *- *+8 28�
�/1 �"�%������%��� &&& '(������ �"44�����������% &&& &&& �+�- 8.+0 �*+1- 77- 1- �0+1 271
�/* �"�%������%��� &&& '(������ '�����:���(�������"������% &&& &&& .+1- .0+1 .+*- 8�- ��- *+� 2�5*�8
�/8 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& 0+0- �1+. �+�- *0- 0- �*+0 2.1
�/7 �"�%������%��� &&& '(���.1� @�"%����������%�6�@������%��"���� &&& &&& 0+8- ..+8 ,+�- 8�- 7- 0+, 2,0
�// �"�%������%��� &&& '(���.1� ������%��������%�����6��������% &&& &&& �+,- .,+* .+1- 8�- �0- �+. 2,�
.�� �"�%������%��� &&& '(���.1� ��������"�����%�6�>���������$ &&& &&& �+0- 0/+� ��+�- /.- 1- 0+1 2.1
.�� �"�%������%��� &&& ��������4 �"44�����������% &&& &&& �+8- ./+* �+7- 81- �,- �+1 27
.�. �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& .+�- ./+1 �+*- *8- .,- �+� 2,,
.�0 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& .+�- 0�+* 1+8- 8/- 8- *+7 2/
.�, �"�%������%��� &&& ��������4 9���� &&& &&& ,+.- �8+0 8+1- *8- ,- ,+/ 21
.�1 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& �+/- ��+1 .,+�- *0- �- 8*+0 2�
.�* �"�%������%��� &&& '(���.1� ���������"%�����% &&& &&& 0+�- �7+/ �+�- *0- *- 1+. 2.8,
.�8 �"�%������%��� &&& ��������4 ��������% &&& &&& �+/- �8+, .+7- 8�- *- *+* 2,
.�7 �"�%������%��� &&& ��������4 ����������6�������������3"�4��� &&& &&& �+1- 0,+� �/+,- *8- 8- 8+� 2..
.�/ �"�%������%��� &&& '(������ :�)���%"���� &&& &&& 0+/- �7+0 �+1- 17- *- �;< 21/�
.�� �"�%������%��� &&& '(������ 9���� &&& &&& 0+1- .8+7 0+8- 8�- 1- ,+/ 2,10
.�� �"�%������%��� &&& '(���.1� (������6�:��%"�� &&& &&& .+,- �,+1 *+�- 1,- ,- .+� 2�*.
.�. �"�%������%��� &&& '(������ >�����$�% &&& &&& �+7- 0*+. ��+*- 81- 8- 1+0 2�5/..
.�0 �"�%������%��� &&& '(���.1� �"44�����������% &&& &&& �+7- 0�+, 7+�- 81- /- 0+/ 21,
.�, �"�%������%��� &&& '(������ ��%5�=�����6�9"���"�������% &&& &&& 0+/- �/+0 .+,- *0- 0- �7+8 20.1
.�1 �"�%������%��� &&& '(������ '��������������% &&& &&& .+,- 00+, ��+/- 81- 1- ,/+� 20,0
.�* �"�%������%��� &&& ��������4 ��"%�������$�����$ &&& &&& �+�- 07+� /+0- 77- 1- �+* 2,
.�8 �"�%������%��� &&& ��������4 ���������"%�����% &&& &&& .+,- �*+1 �+8- 17- 8- .+8 2��
.�7 �"�%������%��� &&& '(���.1� ���������"%�����% &&& &&& .+/- 00+8 8+.- 81- 1- ��+� 2/�
.�/ �"�%������%��� &&& '(������ 9���� &&& &&& .+.- 0�+� 1+.- *8- ��- ,+/ 2,�/
..� �"�%������%��� &&& '(���.1� @������������3"�4����6��������% &&& &&& �+8- .8+* 1+/- 8�- 8- *+/ 2,,
..� �"�%������%��� &&& '(���.1� ?���%4����6���)�%� &&& &&& .+,- �*+7 .+,- *0- *- .+� 28,
... �"�%������%��� &&& '(���.1� '��������������% &&& &&& 0+.- 07+/ ,+�- *8- ��- .+. 2*/
..0 �"�%������%��� &&& '(���.1� ��������"�����%�6�>���������$ &&& &&& �+1- 1/+0 .+/- 77- /- .+. 2�1
.., �"�%������%��� &&& '(������ ��%��"�����6�9�������% &&& &&& .+7- �7+/ ,+�- 17- ,- /+* 2,8/
..1 �"�%������%��� &&& ��������4 ��)� ����6����4"�����������% &&& &&& .+.- ..+8 ,+,- ,*- ��- �+� 2��
..* �"�%������%��� &&& ��������4 ������%��������%�����6��������% &&& &&& .+�- �/+� �+7- 17- 8- 0+8 2.�
..8 �"�%������%��� &&& ��������4 �"44�����������% &&& &&& �+.- �,+. *+,- 1,- 1- �+. 2��
..7 �"�%������%��� &&& ��������4 @������������3"�4����6��������% &&& &&& .+�- .0+0 �+/- ,.- /- �+� 2�.
../ �"�%������%��� &&& '(���.1� @�"%����������%�6�@������%��"���� &&& &&& .+*- .8+� �+�- 8�- 8- �+0 2/0
.0� �"�%������%��� &&& '(���.1� ������%��������%�����6��������% &&& &&& �+,- .*+1 1+.- *8- ,- ,+� 280
.0� �"�%������%��� &&& '(���.1� '��������"���% &&& &&& �+8- ./+* �+0- *0- *- ,+1 21�
.0. �"�%������%��� &&& '(���.1� ���������������% &&& &&& �+�- 11+� �+*- 8/- 7- �,+� 20,
.00 �"�%������%��� &&& ��������4 ��%��"�����6�9�������% &&& &&& .+,- 0,+8 �+/- *0- ,- 1+8 2/
.0, �"�%������%��� &&& ��������4 ������%��������%�����6��������% &&& &&& �+8- ..+� �+8- 17- .- �8+* 2.�
.01 �"�%������%��� &&& ��������4 ��%��"�����6�9�������% &&& &&& .+.- ./+* 8+1- ,*- ,- ,+/ 2��
Page 14
Appendix 1: Metrics, maximums and minimumsFinancial metrics on the stock screen
Rank: The company’s rank on the screen, with 1 being the highest rank. The rank is calculated by sorting all of the
companies on the screen by each key factor (Growth, Quality, PE10, PD10, ROCE), creating a rank for each factor and
then adding those individual ranks together.
PE: The price to earnings ratio. This is included just for information and doesn’t form part of the ranking calculation.
Yield: The historic dividend yield. This is included for information only and doesn’t form part of the ranking
calculation. Instead, each company’s rank is based on PD10, the ratio between the current share price and the
average dividend paid over the past 10 years.
PE10: The ratio between the current share price and the company’s average adjusted earnings per share over the
past 10 years. This is used in the rank calculation. (MAXIMUM = 30)
Growth: The company’s Growth Rate. This is used in the rank calculation. It is the average growth of revenues,
earnings and dividends where growth in each is measured as the annualised growth of a 3-year rolling average over
the past 7 years. (MINIMUM = 2%)
Quality: The company’s Growth Quality. This is used in the rank calculation. It is the percentage of times that a profit
has been made, and that revenues, earnings and dividends have increased, measured over the past decade.
(MINIMUM 50%)
ROCE: The company’s median “net” Return on Capital Employed over the last decade. (MINIMUM 7%). Calculated as:
Adjusted profit after tax / (fixed assets + working capital), for non-financial companies
Adjusted profit after tax / shareholder’s equity, for financial companies (banks and insurance companies)
Debt: Debt Ratio – The ratio between a company’s total borrowings (total interest bearing debt) and its Current
Earnings Power (CEP). Provides a rough guide to a company’s ability to carry its debts in good times and bad. This is
“N/A” (not applicable) for banks (where I use a series of ratios defined by banking regulators: Common Equity Tier 1
Ratio for leverage and the Liquidity Coverage Ratio and Net Stable Funding Ratio for liquidity). For insurance
companies the Debt Ratio is “N/K” (not known) as I do not have data on borrowings for insurance companies.
(MAXIMUM = 4 for cyclical sector companies, 5 for defensive sector companies)
Earnings Power: Current Earnings Power (£m). Calculated as 5-year average adjusted profit after tax. Used in the
Debt Ratio and Pension Liability Ratio when reviewing companies for the model portfolio.
Financial metrics used to analyse companies but which are not on the stock screen
Pension Ratio: The ratio between the company’s defined benefit pension liabilities and its Current Earnings Power.
(MAXIMUM = 10)
FCF/Div: 10-yr total free cash flow to 10-year total dividend ratio. Preferred value is above 1, but this is not a hard
rule.
Capex/earnings: 10-yr total capital expenditure to 10-yr total adjusted earnings (post-tax profit) ratio. No hard rule
but below 0.5 is defined as LOW, 0.5 to 1 is MEDIUM, above 1 is HIGH.
Insurance company metrics
Premium to Surplus Ratio: A measure of how cautious an insurance company’s underwriting business is. Calculated
as the ratio between Net Written Premium and Tangible Net Asset Value. (MAXIMUM = 2)
Allocation to Equities: A measure of how cautious an insurance company’s investments are. Calculated as the
percentage of investment assets allocated to equities. (MAXIMUM = 10%)
Combined Ratio: Shows whether or not an insurance company is making a profit on its underwriting business.
Calculated as the sum of Loss Ratio and Expense Ratio. (MAXIMUM = 99%)
Bank metrics
Common Equity Tier 1 Ratio (CET1): A measure of bank leverage. Calculated as the percentage of “high quality”
capital relative to risk-adjusted assets. (MINIMUM 10%)
Liquidity Coverage Ratio (LCR): A measure of bank liquidity. Calculated as the ratio of “high quality” liquid assets
relative to expected net liquidity outflows (i.e. cash outflows) over a 30-day period. (MINIMUM = 100%)
Net Stable Funding Ratio (NSFR): A measure of bank funding stability. Calculated as the ratio between sources of
stable funding and items requiring stable funding. (MINIMUM = 100%)
Page 15
Appendix 2: Strategy overview and stock screen colour-coding
Portfolio managementDeliberate diversification - To reduce the risks that come with each individual company it is generally considered a
good idea to hold a widely diversified portfolio. The model portfolio is diversified in terms of the number of
companies (with a target of 30 equally weighted holdings), the industrial spread of those companies (no more than 2
or 3 from the same Sector) and their geographic spread (no more than 50% of portfolio revenue to be generated in
the UK).
Continuous portfolio improvement - A portfolio is a dynamic entity much like a garden. If left unmanaged (as with a
pure buy-and-hold portfolio) there is a risk that over time it will drift away from its original goal. For example, a high
yield portfolio may become an average yield portfolio if the share prices of all the holdings increase faster than the
dividends.
To avoid this the portfolio is actively managed so that it always contains a majority of high quality companies with
attractively valued shares. Each month a company is either added to or removed from the portfolio based on its
Stock Screen rank and various other factors.
Monthly buy and sell decisions
Buy decisions - The first step in each buy decision is to look through the Stock Screen for the highest ranked stock
which is not already in the portfolio and which meets all the initial criteria (e.g. Debt Ratio under 5, ROCE above 7%).
The second step is to enter the company’s financial results from the past decade into the investment analysis
spreadsheet (available on the website) so that some additional quantitative checks can be carried out (such as
calculating the Pension Ratio, Free Cash Flow to Dividend Ratio or Premium to Surplus Ratio).
If all the financial results look okay then the next step is to review the operational history of the company over the
past decade. This involves reading the opening sections of each annual report, as well as more recent interim and
quarterly results, in order to build up a picture of what the company does and what problems it has faced or is facing.
This analysis is used to answer the YES/NO questions in the investment worksheet (available on the website), which
are then used in combination with the financial results to make a final buy or no-buy decision.
Sell decisions - Sell decisions are based primarily on a company’s stock screen rank, with the lowest ranked
companies most likely to be sold. However, there is a degree of subjectivity involved and it isn’t a purely mechanical
process. For example, companies which are surrounded by a reasonable amount of good news are more likely to be
sold than those which are still unloved, or which are still in the middle of a turnaround strategy.
Stock screen colour coding! Ranking Factors (PE10, Growth, Quality, ROCE) and Yield:
qGreen = Better than FTSE 100
q Light Red = Worse than FTSE 100
qDark Red = Above maximum or below minimum
! Debt Ratio:
qGreen = Below 4 (acceptable for all companies)
q Light Red = Between 4 and 5 (only acceptable for defensive sector companies)
qDark Red = Above 5 (too high for all companies)
! Rank:
qGreen = Above average rank; Amber = Average rank; Dark Red = Below average rank
Page 16
Appendix 3: Model income portfolio
Annual Dividend Income Withdrawn Model PortfolioBasket of Investment
Trusts
CPI Inflation-Linked
”Bond”
2012 £20,250 £20,525 £20,000
2013 £20,856 £20,575 £20,504
2014 £26,512 £21,408 £20,797
2015 Year to date £3,401 £6,857 £5,211
Cumulative income £71,019 £69,365 £66,512
This model income portfolio holds exactly the same shares as the model portfolio and represents the portfolio of a typical investor
who is in the income drawdown phase. It started with £500,000 in March 2011 and pays out all dividends as income. The goal of
the portfolio is to show that equities can produce a dividend income which grows faster than inflation over the medium to
long-term. In the long-term I would also expect the capital value to grow faster than inflation even after dividends are withdrawn.
The income in 2014 is exceptionally large for the Income Portfolio because of a huge one-off special dividend from Vodafone after
the company sold its stake in Verizon.
This chart of capital value is included to show how capital growth should approximately track dividend growth over the years. The
CPI inflation-linked 4% coupon “bond” has a capital value which increases in line with CPI inflation from £500k on 01/01/12. The
model income and investment trust portfolios should produce capital gains which at least match the inflation-linked “bond” over
the long-term.
£-
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
2012 2013 2014 2015 YTD
I
n
c
o
m
e
Dividend Income Withdrawn
Model Income Portfolio Basket of Investment Trusts CPI Inflation-Linked 4% "Bond"
£-
£100,000
£200,000
£300,000
£400,000
£500,000
£600,000
£700,000
2012 2013 2014 2015
V
a
l
u
e
Capital value as at 1st January
Model Income Portfolio Basket of Investment Trusts CPI Inflation-Linked 4% "Bond"
IMPORTANT DISCLAIMER: The author is not registered as an investment adviser or as an independent financialadviser and does not provide individual investment advice. As no advice is provided, neither the author nor this documentare regulated by the Financial Services Authority. This document contains the opinions of the author and should neverbe construed as investment advice; it is for information only. The information contained in this document is not an offeror recommendation to buy or sell or a solicitation of an offer to buy or sell any securities.
The specific needs, investment objectives and financial situation of any particular reader have not been taken intoconsideration and the investments mentioned may not be suitable for any individual. You should not base anyinvestment decision solely on the basis of this document. You should carry out your own independent research andverification of facts and data. If you are unsure of any investment and need advice you should seek professional financialadvice.
The information in this document and any expression of opinion by the author have been obtained from or are based onsources believed to be reliable, but the accuracy or completeness of any such sources or the author’s interpretation ofthem cannot be guaranteed although the author believes the document to be clear, fair and not misleading.
The author receives no compensation from and is not affiliated with any company mentioned in this document.
To the maximum possible extent of the law, the author does not accept any liability whatsoever for losses arising fromthe use of the material or information contained herein.
Please see the full Terms and Conditions and Disclaimer at http://www.ukvalueinvestor.com/terms-and-conditions/
INVESTMENT RISK: The value of shares can fall as well as rise. Dividend payments can fall as well as rise. Anyinformation relating to past performance of an investment or investment service is not necessarily a guide to futureperformance. There is an additional risk of making a loss when you buy shares in certain smaller companies. There is abig difference between the buying price and the selling price of some shares and if you have to sell quickly you may getback much less than you paid. Share prices may go down as well as up and you may not get back the original amountinvested. It may be difficult to sell or realize an investment. You should not buy shares with money you cannot afford tolose.
DISCLOSURE RULES: When content is published about a company and the author has a position or beneficial interestin it, that fact will be disclosed.
In addition to the above disclosure requirement, the author follows additional trading restrictions and guidelines. Theserestrictions require that the author:
· Hold any stocks owned for at least 10 full market business days.
· Cannot write about a stock for 2 business days before and after purchasing or selling the stock.
DISCLOSURE: The author owns shares in all of the companies in the model portfolio and intends to buy shares in anynew model portfolio investments, and sell the shares of any model portfolio holdings which are sold, according to thetrading restrictions noted above.
CONFIDENTIALITY: This document is for the personal use of paid members of UKValueInvestor.com only. Theinformation contained in this document may not be used for any commercial endeavour without explicit written consentfrom the author. Please retain this document for your own exclusive use and treat it as confidential.
© John Kingham. Offices at Bramleys House, Bower Road, Mersham, Kent, TN25 6NJ
Subscribe online at www.ukvalueinvestor.com