Tesla has caught my eye today. It has become the world’s most valuable carmaker despite never having made a profit. Tesla overtook Toyota (pun intended – sorry) with a valuation of $209 billion, earned partly on the back of growth in sales the company’s range of electric cars, and partly on the back of Elon Musk’s showmanship / marijuana smoking.
It seems a bit mad, doesn’t it?
Growth businesses with high valuations and not profit are nothing new, of course – they are not uncommon in the gambling industry where I work – but when you consider the sheer scale of the numbers involved, it all feels a bit wrong.
After some quick googling I found a really interesting article about valuable but loss-making companies on cnbc.com. It would seem that of the companies publicly listed in the USA in 2019, 76% were unprofitable in the preceding year before the initial IPO. The last time this figure was higher was in 2000, the year of the dot.com bubble bursting.
Time will tell about Tesla of course, but could some troubled times be on the way for the stock markets? If we’ve got a lot of over-valued companies out there, it feels like there may well be some kind of correction on its way. Might be time to buckle up and enjoy the ride!
Over the past week I’ve been doing some number crunching in an effort to find some good stock market investments (you can read here Part 1 of “Appraising The Stock Market”). This means I’ve selected another cliched image for the blog! Also, and more importantly, even though I am only an amateur investor I do kind of feel that with a bit of number work, and a dollop of common sense, it is possible to make sensible investment decisions that won’t come back to bite me on the bottom.
As I detailed in Part 1, I spent some time applying a bit of logic to the FTSE 100 Index and split it into sectors that made sense to me, before then trying to estimate – in very broad terms – how those sectors might fare in the near future, bearing in mind we’re on the cusp of recession.
The next step was to dig a bit deeper into the sectors of interest and see what the analysis spits out at me… So here goes nothing…
Rationale For My Fundamentals Analysis Approach
My guiding principal is that I want to be investing in companies that make money. It might sound like an obvious thing to say, but we know that some companies don’t make a penny yet still cost a lot to invest in. This is because market capitalisation of companies is based on future value, of course, and so share prices in some companies can be high, even if not a penny has been made in profit thus far.
That kind of investment is not for me though as it represents too much risk. I want some proven cash generation. As such, I’ve chosen to focus on fundamentals around earning and efficiency:
EPS (Earnings Per Share)
ROCE (Return On Capital Employed)
Revenue increase from 2018 > 2019
Increase In Cash
Each measure on its own has its plus points and negatives, but used together I believe they can give me a fairly accurate broad picture of where a company is at now, which itself is the springboard for a deeper dive – namely, Discounted Cashflow Analysis. But more on that another time.
What Does My Analysis Tell Me?
Here is an example of data I looked at for the Banking Sector:
So, it is worth clarifying that this is only a small sample. And yes, this data only scratches the surface. However, at first glance Lloyds Banking Group leap out as a company that might be of interest. The share price has dropped by 48% in the past 12 months, more than some peers, yet it appears – at first glance – to have a bit more momentum than sector rivals. Lloyds have increased their cash position of lat e, too, which I find reassuring. I have also represented this increase as a percentage of 2019 revenue to see how much of the annual revenue growth has ended up as cash. 6% is on the high side, by my reckoning.
The downside to investing in Lloyds is that banks were ordered to cancel dividends in the short-term by the Bank of England, but that won’t last forever. It might not belong in a ‘sexy’ sector, but Lloyds Banking Group is definitely of interest to me (currently trading at around 30p).
Two More Companies I Like The Look Of
I’m also potentially sweet on two other companies. First up is Hikma Pharmaceuticals. My biggest worry here would be that I’ve already missed the boat, as the share price has improved 57% over the past 12 months. However, if the aim is to invest over the long-term in solid, well-run businesses that generate cash then this looks a decent investment. Here are the numbers:
This makes for impressive reading. Hikma Pharmaceuticals (trading around 2,502 as I type) has gone on my shortlist.
Finally, for now, I also think ITV might be worth a look:
The ITV share price has plunged 26% in the past year, with the Covid-19 crisis not helping in that regard. However, before Covid-19 they managed to increase revenue in a competitive operating environment, while also managing to increase cash by more than their increase in annual revenue. This to me suggests ITV is a well-run business (which is backed up by ROCE, which looks strong compared to leading peers). ITV is trading at around 81p at the moment – it might well be worth a dabble.
The three companies above are only potential investments for now, but I feel like I’ve got a sound basis for moving forward with some even more detailed analysis. Of course, what my sector analysis also tells me is that I don’t need to concentrate only on the FTSE 100 – there could well be some similar firms lurking in the FTSE 250, or AIM, that could be of investment interest.
As part of my attempt to be the next Warren Buffet, this week I undertook an appraisal of my stock market portfolio. Unfortunately, I am around $72 billion behind Buffett at the moment, although it is worth pointing out that, in truth, I do have my sights set a little lower than that.
I have made a modest but positive return of 2.4% in the past 12 months. I’ll take that, bearing in mind declines over the same period in both the FTSE 100 and FTSE 250 indexes of -16% and -1.7% respectively. Strictly speaking, the time and effort made is not worth the profit I’ve made – especially when I could have chucked it into the bank and earned up to 1.5% risk free in a ‘high interest [insert joke here]’ account. However, there has been a lot of learning over the past year, and as the old adage goes “you’ve got to be in it to win it”.
My next task is to use my learning experience to best advantage.
My Methodology: Digging Into The FTSE 100
As such, I’ve taken a look at the FTSE 100 Index and delved into each company. For starters I have:
taken the current price (as of May 29th 2020)
Looked at the share price of the same company 12 months ago
Identified the difference in % terms for each company share price
This first task has been instructive in itself. Some companies leap out for the change in share price over the last year. The biggest riser is Polymetal International, a mining company that has grown 98%. Following close behind are the gambling company Flutter Entertainment (86%) and online shopping firm Ocado (83%).
At the bottom of the scale is the cruise ship operator Carnival with a -73% drop. No surprise there given that Covid-19 has decimated the travel industry. Rolls Royce and Centrica are close behind at -69% and -61% respectively.
Next Steps: Segmenting the FTSE 100
The whole idea of putting a value to a business is that the value should reflect future earnings potential. The more likely the business is to make money – based on the evidence available to us – the higher the value of the business. This simple approach helps to explain the 12-month Carnival nosedive: the evidence points to them not earning very much, comparatively to the recent past, in the near future.
Some of this evidence is based around key financial metrics, but it seems to me that the key to beating the stock market longer term is to look at factors that perhaps the general herd are not paying attention to. So, while the financial fundamentals are important, I’d rather try and look at broader societal, economic and consumer trends first, and see how these might be reflected in current stock market trends, and then understand the fundamentals for any potential individual companies second.
In practice, I have segmented the FTSE 100 Index companies into broad sectors, then added up the before and after share prices for each constituent company in each sector. This gives us a rough and ready guide to growth or otherwise over the past year. I’ve used my own categorisation, rather than what ‘official’ sources might say. Just because I can.
Yes, I know… Adding all share prices together is not the way a lot of people would approach this. But I shall return to this below.
Segmented FTSE Constituent Companies
My segments look as follows:
This paints a slightly different picture of the FTSE 100 Index. The bare facts are that, if you owned one single share in each company 12 months ago, over that time the value would have risen by 3,836 pence, or £38.36. This is a rise of 2%. Hardly enough to set the pulse racing, but equally, not the same as a -16% drop for the FTSE 100 Index either.
The sector changes are interesting too.
There are four definite growth areas: ‘Building Things’, ‘Data’, ‘Lifestyle Choice’, and ‘Science & Tech’. These should be self-explanatory, but it would seem in the past 12 months the people of Britain have thrown up a lot of new buildings (which is a famous indicator of recession, unless I am misremembering that?), begun to fully understand the value of science and data, while smoking, gambling, drinking and wearing Burberry.
Of these four categories, Data seems far and away the most interesting to me. If we are on the cusp of a recession, I’m not sure there will be much demand for houses. I do however believe that Data – and our exploitation of it as a society – is only going to develop further, so this is a sector that I would expect to continue growing apace. I know that is hardly revelatory, but some things seem so obvious at times that it pays to say it out loud so that you don’t forget.
I do also feel like the companies in the Lifestyle Choices sector won’t be going anywhere soon. People may spend less on treating themselves though, which has to be a consideration when assessing future value.
As for Science & Tech, on a very broad basis you have got to think that in times of hardship and financial pressure, innovation will be of increased importance. It can’t be a surprise that the iPhone debuted in 2007 and went onto plough through the worst recession in living memory, making Apple the most valuable company in the world.
The Falling FTSE 100 Segments
Without digging deeper, it kind of feels like Banking (which is constituted of four companies) has gone too far the wrong way. The market might have overreacted to pressure placed on them of late, but I could be wrong of course – this is something I shall have to dig into.
Media and Comms seems a bit funny. I am not sure why that has fallen so much at first glance – I am presuming it is because the sector is ultra-competitive – but it warrants a bit of a deeper dive.
Travel is no surprise. Indeed, I am surprised it has not fallen lower.
The Middling FTSE 100 Segments
Insurance is worth a second look, bearing in mind that is an industry that will never, ever die (I need to look for dividend potential there, I would say).
Shopping is another surprise, as I would have expected this to be slightly lower. That said, I have lumped in the supermarkets into this category so that means Ocado (which perhaps, arguably could belong in Science & Tech, or even data) is boosting it. And yes – I know Ocado are an online supermarket! Some of these companies can straddle more than one sector though, depending on the view you take.
Finally, Magic Money Tree companies will be left alone. These are companies that invest money to make money, which has always given me this nagging feeling that they are part of some highly elaborate Ponzi scheme… Is it a bit strange the FTSE 100 Index can include companies whose business it is to invest in the FTSE 100 Index?
Anyway, I digress.
Natural resources is a peculiar one. Why would it decline by 6% year on year? I need to look at that more as it instinctively feels like there has been too much of a downward swing. Like it or not, we need oil and gas (and water) to live our lives. A naive, overly simplistic view: yes. But I am invoking the Occam’s Razor here. The simplest explanations are often the best.
Finally, ‘Make Things’ is essentially B2B and manufacturing. They are basically there to serve other companies, and in a time of recession I would not fancy the challenge of being a link in a supply chain. I’d rather not get involved in this sector.
So, my next steps are to focus on the sectors that might be of interest and from there see if I can dig out some potential investments. I’ll be look at data more closely, as well as the more traditional Insurance, Banking and Natural Resources. Science & Tech will have to be on the radar too.
I shall follow up when I have done some more in-depth research…
P.S. If anybody wants a breakdown of my data, add a comment and I will find a way of getting it to you.