Artful Investing

Tyro. Like all the best words it's short, rarely heard and easily defined:

tyro
Tyro \Ty"ro\, n.; pl. Tyros. [L. tiro a newly levied soldier, a beginner.]
A beginner in learning; one who is in the rudiments of any branch of study; a person imperfectly acquainted with a subject; a novice. [Written also tiro.]
(Webster's)

On July 29th, 2002, almost two years to the day, I made my first serious investment in equities. For £1,999.78 I acquired shares in McCarthy and Stone, the retirement housebuilder at 275p. My wallet was persuaded to party by the company's low valuation against fundamentals and share price momentum. McCarthy was a company enjoying pituitary-case growth in a niche market they conquered. So far, so good. Impressive results nudged the share price higher beyond three pounds. The earnings outlook confirmed the industry's future was a hot topic but the company's markets remained strong:

The home-owning retirement community, which is now more affluent and more numerous, is the market we serve.

The rate of house price increases over the last year has been the subject of much public debate, as is the high levels of household and mortgage debt, but with low interest rates, affordability within the general housing market remains sound.

McCarthy & Stone has started the new financial year in excellent health. We are enjoying much higher levels of enquiries, visitors and net reservations compared to last year and have a record forward sales position. This is extremely encouraging. We have a land bank that will deliver us profitable growth and a balance sheet that can finance it.

Given the present market conditions, the Group can look forward with confidence to delivering increased value for shareholders and sustainable long term growth.

As a tyro, I suffered the delusion I was some prescient pundit that could better predict McCarthy and Stone's fortunes than the company insiders themselves. In my own arrogance I failed to ascribe greater relevance to the company's report of a stronger market, higher levels of net reservations and record forward sales position, arrogantly unable to ignore the public debate on future house prices on which I had formed my own judgement - the industry's earnings were facing a steep decline. I was in no place to claim to know the industry better than McCarthy executives, or the management at any other housebuilder, who were all extremely bullish.

I hastily sold McCarthy and Stone for 313p on November 27th, 2002. McCarthy continued to deliver growth to it's shareholders without me. The business was so desirable it's co-founder, John McCarthy attempted to buy the company back in the summer of 2003 and the share price progressed past five pounds.

Luck was with me during my shareholding, the price not once fell below my exit point, despite my error I'd made a profit. My mistake was convincing myself I was a corporate clairvoyant, that with good use of nose and nous I could foresee the fortune of industries I had no inside experience or knowledge of.

Did I learn from this error? Not before I'd diagnosed it. That came in 2003, after losing all my gains from McCarthy and Stone in AIM Group, incurring my maiden loss in stock market investing.

Don't second guess the market, trust your company's management to inform you. Tea-leaves are for mugs.

The Artful Dodger

Since the last portfolio report Dana Petroleum is sitting at it's highest price since purchase. My second-largest holding, Chaucer, has disappointed by dropping back slightly, Mayborn has edged upwards toward break-even and Ben Bailey has appreciated a fraction.

In addition I've received dividends from Chaucer and Mayborn, improving the cash count. An important part of an investment strategy is to decide what to do with these payments - I'll be reinvesting them in my next purchase, the first step of what should become a positive feedback cycle - dividends being used to buy more shares which produce more dividends etc.

at June 27:
Ben Bailey, 1281 shares on 20/02/03 at 178p (395p, £5059.95)
Ben Bailey, 890 shares on 21/06/04 at 390p (395p, £3515.50)
Chaucer Holdings, 8092 shares on 06/10/03 at 42.88p (47.5p, £3843.70)
Chaucer Holdings, 4075 shares on 06/04/2004 at 54.75p (47.5p, £1935.62)
Dana Petroleum, 1551 shares on 20/11/03 at 223.75p (305p, £4730.55)
Mayborn Group, 1406 shares on 15/03/04 at 282p (257p, £3613.42)
Cash holdings: £158.97
Total: £22,857.71


at close of market today:

Ben Bailey, 1281 shares on 20/02/03 at 178p (400p, £5124.00)
Ben Bailey, 890 shares on 21/06/04 at 390p (400p, £3560.00)
Chaucer Holdings, 8092 shares on 06/10/03 at 42.88p (45p, £3641.40)
Chaucer Holdings, 4075 shares on 06/04/2004 at 54.75p (45p, £1833.75)
Dana Petroleum, 1551 shares on 20/11/03 at 223.75p (313p, £4854.63)
Mayborn Group, 1406 shares on 15/03/04 at 282p (271p, £3810.26)
Cash holdings: £323.22

Total: £23,146.86

The next week could be crucial for my portfolio, with Ben Bailey announcing interim results. I've promised myself I will be out of bed for the 7 a.m. announcement and not sleep in as I did for March's finals. High profits and a positive outlook statement could see Ben Bailey rise quickly from the 400p level it occupies today. If my target price is met, I will sell and look for a new home for the funds. At today's prices, that could be Mayborn plc. 'Could' being the key word in this paragraph, you can never rely on the stock market delivering anything.

The Artful Dodger

A mail I received privately asked for clarification of my 30% margin of safety requirement and if it is philosophy or dogma. Would I steadfastly refuse to buy a stock that offered a twenty-nine percent appreciation to fair value and risk missing a significant gain? Is that thirty percent a rule of thumb/ballpark figure or a rule?

A recent second viewing of Woody Allen's Annie Hall reminded me of my own insistence for thirty percent from shares. Annie (Diane Keaton) and Alvy (Woody) have met at the cinema but the film, some Bergman effort (the kind of thing people watch to make them feel intelligent and discerning), has just started:

Alvy Singer: Forget it, I can't go in.
Annie: Two minutes Alvy..
Alvy: I can't do it, I can't go in in the middle.
Annie: In the middle? We'll only miss the titles, they're in Swedish!
Alvy: I'm sorry, I've got to see a picture exactly from the start to the finish - because I'm anal.

Alvy's insistence that he can't miss the first two minutes appears unreasonable, overly-fastidious and 'anal' - his slavish adherence to the rule has ruined their evening. Does 'thirty percent' condemn me to missing profitable opportunities that offer twenty-seven, twenty-eight or twenty-nine percent wins?

Yes.

But 'thirty-percent' greatly increases my chances of avoiding a loss. That extra percent or two in my margin of safety ratchets down the probability of loss disproportionately, who knows how much but possibly five or ten percent. The expected gain increases with the margin and those extra fractions compound handsomely on successful reinvestment.

Why thirty percent? I can only say it's a number that feels right for me. At thirty percent I can relax, confident my holdings are undervalued and will deliver a significant return. Any less and the capital at stake would be at greater risk and holding more stressful. Find a margin of safety that feels right for you and stick to it with discipline. Don't go in in the middle, you could be missing a lot more than you think.

The Artful Dodger

My recent absence was due to Blogger upgrading their post software, a browser upgrade was required for the two to talk. Complications arose as this left me without a java plugin, without which I was unable to get streaming share prices from MoneyAM. With both problems fixed, Artful Investing will be appearing regularly again.

Of my four holdings, Ben Bailey and Mayborn have advanced slightly but Chaucer has fallen back. Dana Petroleum advanced to a high for the year on yesterday's news that Wintershall, a German oil and gas company, will shoulder the costs of seismic appraisal work offshore Mauritania in exchange for a 38.5% share of any oil discovery:

Operations have now commenced to acquire a 1,800 square kilometre 3D seismic survey in Block 8. The survey is being performed by PGS Exploration (UK) Limited using the high capacity 3D vessel M/V American Explorer and is expected to take approximately 60 days to complete. The objective of the survey is to identify drilling targets within a number of very large carbonate reef prospects highlighted by the existing 2D seismic data.

Dana have traded off possible upside from a discovery in 'Block 8' for the safety Wintershall bring in bankrolling the geological investigation. Wintershall are betting on the basis of the early seismic data that there is a sufficient possibility of paydirt.

The announcement shows the confidence oil companies outwith Dana have in the Mauritanian acreage. This is starting to be shared on the stock market with Dana shares marked up three percent on the news. Dana is yet to report the status of it's appraisal drilling campaign in Indonesia, with luck shareholders will enjoy more good news in the forthcoming few weeks.

The Artful Dodger

I'm not alone in seeing value in the Lloyd's insurance sector. Warren Buffett, the billionaire investor controls a 25% stake in Capital Insurance Holdings via Berkshire Hathaway, the company he runs.

Capital Insurance plans to acquire smaller listed Lloyd's companies, consolidating their insurance operations to maximise profitability. Capital Insurance plans to raise £125m to achieve this, taking their own market capitalisation to £134m. Investors today speculated SVB and Goshawk were Capital's most likely targets, chasing the shares up 4.4% and 6% respectively. Chaucer advanced 1% on large trading volumes whilst the larger players in the sector remained unimpressed. The financial clout of Capital has caused a nodding appreciation akin to the arrival of a tray of raisined flapjacks at a WI get-together rather than the ecstatic frenzy a quartet of Chippendales would receive.

Ambitions towards a shake-up in the sector began to look less feasible as the day progressed with market commentators revealing the obstacles such action would face:

Previous attempts at merging Lloyd's insurers have been dogged by clashes between strong-willed individuals and the departure of highly skilled underwriters, who can easily take their skills elsewhere.

Lloyd's insurers don't enjoy the same money-savings industrials or banks get through merger, nor do they suffer the conceit prevalent amongst retailers seeking international high street hegemony. Lloyd's insurers thrive operating in niches they have the time and expertise to exploit.

Though today's news from Capital Insurance won't light a firework under the sector, I welcome the publicity the companies are receiving. This area of the market contains some very tempting valuations, a rerating might benefit Chaucer Holdings, my second largest holding after Ben Bailey.

The Artful Dodger

A previous blog was dedicated to the opening chapter of Max Gunther's treatment of investment and speculation, The Zurich Axioms.

After castigating the congregation on risk, the second chapter concerns the deadly sin of avarice, or as to use his terms, greed.

Gunther shows how savvy an author he is by ensuring the key concepts of risk and greed are dissected so early in the book.

Major Axiom II: on greed

Always take your profit too soon
Gunther explains:

Greed is built into the human psyche..get in the habit of selling too soon. And when you've sold, don't torment yourself if the winning continues without you.

This could be couched as 'leave something for the next man' and is a cornerstone of my strategy. It's commonplace on bulletin boards across the internet for investors to chide themselves with 'knowing when to sell is the difficult bit' or comfort themselves with nebulous truism 'no-one went broke taking a profit'. To me always take your profit too soon and leave something for the next man demand the investor sells while some reasons to hold on remain. It's a delicate point and needs careful consideration before its merit becomes clear. It helps to understand that shares are traded on a market that matches buyers to sellers. A buyer (the next man) needs good reason to enter the market to make a bargain. The next man must exist to allow you to get out - leave something to tempt him in. In my investments this is anything above what I consider to be fair value. I also leave momentum for the next man, the share having risen to fair value, he buys on the assumption it can continue. I leave the next man with the improved sentiment on the stock's future. The sooner a profit is taken, the more is left for the next man.

Minor Axiom III

Decide in advance what gain you want from a venture and when you get it, get out

What is enough? As we've seen, greed is the main reason why this question is so hard to answer. However much one has, one wants more. That is the way humans are made

I'm with Gunther on Major Axiom II but we diverge here. My strategy involves establishing an exit price on entry but continually updating that exit price as the situation changes. For example, my original exit price for Dana Petroleum was 326p, adjusted to 318p following the final results but now adjusted higher to reflect favourable circumstances in the industry. Fair prices are moving targets, don't slavishly stick to the one set initially. A farmer has his eye on a summer harvest when he plants fruit but won't do so until it's ripe.

Consider a company bought at a P/E of ten with thirteen calculated to be fair value. If that company's earnings rise, multiply this amount by thirteen to give the new target price - don't leave too much for the next man.

The Artful Dodger

On April 13th, Dana Petroleum, the oil explorer and producer announced appraisal drilling offshore Indonesia:

Two wells will be drilled to test for the presence of a western extension of the Ujung Pangkah gas field. If successful, the wells will also be flow tested to provide additional production performance information ahead of finalising the Ujung Pangkah development well locations. The opportunity may also be taken to test the productivity of the Ujung Pangkah oil rim, directly underlying the gas accumulation, where approximately 450 million barrels are mapped in place. Each well is expected to take around one month to complete, excluding any well testing operations.

With results expected imminently prudence demands I revisit my own appraisal, a fair price for Dana shares. Dana is a company with exciting exploration prospects in Indonesia, Mauritania and Kenya. The expensive exploration activity is bankrolled by strong cashflow from the company's oil producing fields in the North Sea. Very little debt remains on the balance sheet and with 2003's earnings per share of 26.5p, I was happy to apply a P/E of 12 to give fair value of 318p. However, since the final results Dana has enjoyed exceptional operating conditions due to the strong price of crude oil on the energy markets. If production is maintained around the 17,000 barrels per day level this will further improve earnings and advance my exit price. But while the newsflow is thin all that can be done is monitor the industry and try to estimate the effects of this strong oil price. Returning to exploration, a failure in Indonesia would be Dana's second miss of 2004, the Pelican prospect off Mauritania finding a column of gas with the commercial value of a caveman's fart. Another disappointment and opportunities would be less in number and promise. Dana's business is discovering new energy assets, when will this happen?

Meanwhile, I'll be keeping my ear to the ground waiting for the 'Drilling Report' to hit the regulatory newswire.

The Artful Dodger

A quick look at my portfolio shows Ben Bailey as comfortably the largest holding. 'Comfortable' because though it is nearly twice the size of the Mayborn exposure, Ben Bailey still trades at a cheap rating of 5.2 times previous full year earnings and 4.1 times expected earnings. Moreover, the company's trading statement from June 28 vindicated the decision of a few days previous to increase my stake:

Market conditions remain positive, with reservations for the whole of 2004 being 18 per cent. ahead of the corresponding period of 2003, which represents 90 per cent. of the Company's expected full year volume output. Selling prices for reservations taken for the year to date show an increase of 19 per cent. per square foot over what was achieved in the whole of 2003. These factors give the Board confidence that results in 2004 will show further significant growth.

Ben Bailey has produced smaller homes recently, so this increase in price per square foot is not as indicative of profits as you might like. Still, the trading and sentiment are positive overall.

I expect interim results early August that will hopefully be met with an increase in share price closer to fair value, which, based on today's information, I feel is around 540p. However, with recent interest rate increases and the state of the UK housing market, which I believe to be grossly overheating, I'm keen to take my money off the table.

So, fingers crossed for Ben Bailey and early August. If I do manage a sale (my first since beginning the blog) I'll naturally need a new home for the cash. I hope to discuss potential targets with you soon.

The Artful Dodger

The 'crisis play'. An investment colloquialism, meaning a speculative investment in a company in serious danger of bankruptcy. On Friday Jarvis, the rail maintenance and construction group joined the stock market's equivalent of death row, with a terrifying announcement on trading. Jarvis' balance sheet needs the Heimlich manoeuvre and a cash transfusion.

Not only has Jarvis let down its shareholders, it has failed customers, partners and most tragically the public. Separate to informing the market of discussions with its lenders regarding appropriate financing arrangements for the group in future Jarvis accepted blame for the death of a child that fell onto a length of track that the company had failed to secure. Back in April, Jarvis finally admitted responsibility for the Potter's Bar derailment, after months of claims that the disaster which resulted in seven deaths was caused by sabotage. Jarvis' incompetence does not stop at rail maintenance. Accounting shenanigans required the company to hold back payments in the construction division in an effort to boost profits. Jarvis is imbroiled in a number of disputes with partners and suppliers over payments and terms. Elizabeth Taylor has more chance of recovering her looks than Jarvis does of regaining any repute amongst industry or the public.

This litany of failure will consign Jarvis to nothing more than a case study in business failure. The company is the antithesis of public relations. Past performance awards any potential customer an immediate excuse for not dealing with the company and no possible white knight would sully their reputation trying to save a company with blood on its hands.

The banks are in charge at Jarvis now and a turnaround by management looks fanciful, with the board fully committed just to keep the company afloat. But there is the chance Jarvis might survive the financial earthquake underneath it. This possibility will attract some, who judge the market valuation of Jarvis to imply impending bankruptcy, to speculate on a revival. Such an escape would return several times the initial investment but the return on failure is a wipe-out. This is the appeal of the crisis play.

Jarvis is several accidents that have already happened. There is no investment case for Jarvis, it is on the brink of extinction. Any money that can be made can only be done so at very high risk. This is true of all crisis plays and why I always stay well clear. Adrenaline has no place in investing.

The Artful Dodger