Revisiting
Jacko the Stock Exchange Gorilla and the question of benchmarks
And
Stanley Gibbons Group PLC
My first article at this blog discussed the extraordinary stock
picking exploits of Jacko the gorilla. Jacko
lives in Amsterdam's zoo. In January 2000 he was presented with seventy-five
bananas, each of which represented one of the largest 75 stocks traded on the
Amsterdam Stock Exchange. He chose ten and this was his starting portfolio. Every
month since then Jacko picks out one of ten bananas corresponding to his
portfolio and that stock is sold. Then he chooses one banana from another pile
of 65 bananas, corresponding to shares he does not hold, and that is his buy.
Jacko's banana portfolio has beaten the AEX index of large Dutch
companies every year except for 2011. Cumulatively,
Jacko's portfolio has increased in value by 108% compared to a loss of
41% of his benchmark, the AEX (both exclude dividend income). This represents
an average outperformance of 9.4% every year for 14 years. By comparison, star
fund manager Anthony Bolton's Fidelity Special Situations outperformed his
benchmark by 6% a year over a period of 28 years.
In 2013, Jacko's portfolio beat the AEX by 22%. As Jacko's investments are reported daily, neither Jacko
nor his human interface have had the opportunity of cheating. But Jacko's
portfolio exposes the limitations of index benchmarking, which are often
ignored.
Ø Jacko's portfolio is chosen from the 75
largest stocks traded in Amsterdam compared to the 25 largest which makes up
the AEX index. The other stocks are quoted on the
AMX - mid-cap, representing the 26 to 50 largest stocks, and the AScX - small
cap shares, representing the 51 to 75 largest stocks traded in Amsterdam.
Ø Even if these indices were included, they would misrepresent Jacko's choice of stocks, because the
indices themselves have changed radically over the 14 years that Jacko has been
trading.
Number
of constituent companies in the index in both January 2000 and March 2014:
Amsterdam large cap AEX 13 of 25 constituents
Amsterdam mid-cap AMX 3 of 25 constituents
Amsterdam small-cap AScX 0 of 25 constituents
Ø The indices are weighted annually by free float market capitalization for each company. Jacko
gives equal weight to each stock (banana) in his portfolio.
Jacko can beat his benchmark because his portfolio has little to do with the index used as his benchmark.
Our
own indices are also in flux. The FTSE 100 has
gained 160 constituents and lost 160 over the last 14 years and it is rebased
every quarter for market capitalization.
Individual
investors face trading expenses and income and capital gains tax that are excluded from the indices. Benchmarking a portfolio is good practice:
without a benchmark we are like a rudderless dinghy bobbing along at sea, with
no idea and no control over where we will eventually land. Fund managers require
a generally accepted yardstick in the public domain, usually an index, but that
doesn't mean this is the right yardstick for an individual.
Financially
speaking, individual investors have messy lives. We
spend large sums on weddings, houses, divorces, our children's education and
our own businesses. We save as best we can, if we're fortunate we receive
bonuses and inheritances, and by downsizing our homes we release capital to
invest. We invest when we can and disinvest when we have to; at bottom our financial
objectives have nothing to do with the vagaries of any market index.
Benchmarking
should reflect our goals. For a young professional,
who wants to buy a first home, the most appropriate benchmark might be to
accumulate X thousand pounds within Y years as a deposit. This he or she must achieve through savings
and capital gains. For the self-employed homeowner, who wants to secure his
retirement, the benchmark might be a Self Invested Pension Plan that, with
current annuity rates, will provide an income of at least X pounds a year from
the age of 65. And for someone nearing retirement, who wants an income
to keep pace with inflation, the most relevant benchmark will be based on the
income generated by his or her investments and not the asset value of his portfolio. Our
benchmarks change as our lives and circumstances change. And
by being specifically related to our financial objectives our personal
benchmarks point us to the financial assets that best suit our needs.
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Stanley Gibbons Group PLC (AIM stock)
British Guiana 1 cent magenta,
1856, courtesy Wikipedia
Stanley Gibbons (SGI), well known for its philatelic business, has a growing and profitable
business in other collectibles as well - First Day covers, rare coins, medals
and memorabilia. While sales from the London, Jersey, Singapore and Hong
Kong offices, including email campaigns and auctions, contribute the
bulk of revenue and earnings, the company is working hard to develop its online
business in both the UK and the USA. This is partly in response to the
growth of eBay, which enables collectors to buy and sell stamps and
coins easily and at a low cost.
At the top end of the
market, vendors choose large auctioneers. Sotheby's
are auctioning the only example of an 1856 British Guiana 1 cent magenta
(pictured above) in June, which is expected to sell for $20 to $30 million. This
would be the highest price ever paid for a single stamp.
SGI shares trade on
AIM and are eligible for 100% relief from
inheritance tax. The company has a market capitalisation of 157 million pounds
and nearly 100% of the shares are free float. Institutions own 40% of the
company led by BlackRock with 9.2%.
Financial results for
SGI from 2003 to 2012 were strong:
Ø
Earnings
per share grew at a compound 16% p.a. and the dividend
increased in proportion.
Ø Equity per share
grew at a compound 15% p.a. over the same period.
Ø The historical return on equity is a
healthy 17%. However, the return on retained earnings since 2003 has declined
to 13%. In 2013 ROE fell to 4%.
Ø Net margins were
15%.
Ø Cash flow has
been consistently positive with net operating cash flow of 16 million pounds
covering the dividend more than twice these last five years.
Ø
At
December 2013, SGI had no debt and net cash of
17million pounds, nearly 10% of its market value.
The company is riding
a wave of interest in 'alternative' assets, driven
in part by the very low cost of money. The price of gold, for instance, has
increased by 360% since 2003. And rare British stamp prices have moved ahead of
gold:
Graph
courtesy Stanley Gibbons, click to enlarge
SGI's share price (in blue) easily
outperformed the FTSE All Share (in red) since 2009:
SGI
in blue, FTSE All Share in red, courtesy Google, click to enlarge
The quite sudden fall
in SGI's share price since March might seem like a
buying opportunity, and a buy tip from the Investors Chronicle (published
yesterday) has caused the shares to rebound by 10% in just one day.
SGI's business is
changing:
1. Noble Investments:
In November 2013 SGI
acquired Noble Investments for 45.3 million pounds.
Noble specialises in rare coins and owns two small auctioneers
specialising in rare books and manuscripts and jewellery, watches and fine
wines. SGI's purchase valued Noble at an historical PE ratio of
15. The company placed shares to the value of 39.8 million pounds to cover the
31.8 million pounds that was the cash consideration for Noble, leaving
8 million pounds for use elsewhere in the business. As a result, SGI
shareholders saw their holdings diluted by 37%.
In its 2013 Annual
Report, the company explains the rationale behind
the Noble acquisition:
"The acquisition
of Noble
in November last
year immediately transforms
The Stanley Gibbons
Group from being
the predominant name in the
stamp market to
being a major
force in both
dealing and auctions
in the wider
collectibles market. The
strategic importance of this acquisition is most relevant in respect of
our online strategy to create a global online marketplace for collectibles as
a result
of the wider
range of collectibles
in which we
now have authority
and expertise. The
primary objectives of
our online marketplace will
be to make
selling online faster
and easier through
our bespoke collectibles
sellers’ tools at
the same time
as providing buyers better protection against authenticity risks and
from miss-selling practices."
In the last month of
2013, Noble's rare coin business helped to
triple SGI's coin sales to increase trading profit by 0.7 million
pounds. This was the result of cross selling its coins to SGI's customer
base. The company also anticipates cost savings of close to 1 million pounds
this year.
2. The internet
SGI has been straining to develop an online market, both in the UK and
the USA, to compete with eBay. This has proved to be difficult and
costly. In 2013 the company reported a pre-tax loss of 1.4 million pounds on
internet sales, which is large when compared to SGI's total pre-tax
profit of 3.5 million pounds in that year.
Internet sales are a mere 8% of the total, and once SGI sorts out its technical
problems this should be a source of new business.
However, the costs
associated with the acquisition of Noble and developing the internet market are the main reasons why SGI's 2013 earnings per share
declined by a third on 2012. Traditional trading in philately and other
collectibles improved in 2013, with the Singapore and Jersey offices showing
strong growth. 65% of SGI's customers are located in the UK, including
the Channel Islands.
At today's share
price of 342p, SGI is on an historical PE ratio of
21 (adjusted for exceptional expenses) and a prospective PE ratio of 16. At the
present price, the shares yield 2.2%.
My valuation model
values SGI at around 300p. This assumes that SGI
meets its forecast for next year's earnings and continues to trade at an
average PE of 17. Earnings growth after 2014 is assumed to be 5% p.a. through
to 2018. This has been discounted at 10.8% (Bond rate - SLXX 3.8%, 2% operating
risk, 5% margin of safety).
The cautious investor
will note:
·
An
eventual return to dear money might prick the
bubble in the price of collectibles.
·
Management
do not own a significant part of the company. The
large share placing in 2013 followed a smaller placing in 2012. The company
also buys new businesses with shares, the latest in January 2014, further
diluting existing shareholders. While the acquisitions might make commercial
sense, the exclusive use of SGI shares as a means of payment dilutes SGI's
traditional earnings and existing shareholders. For a cash generating company,
with 17 million pounds net cash at year-end, the reliance on equity issues is
odd.
·
Return
on equity has fallen from an average of 17% between
2003 and 2012 to 4% in 2013. This reflects the large increase in capital in
recent years and a decline in earnings.
·
Three
directors sold shares worth 1 million pounds at
365p in January 2014. There were no director buys since the placing at 295p in
November 2013.
·
SGI is spending large sums to get its online platform up and running.
There is no guarantee that SGI will compete successfully in this market
with established companies such as eBay.
·
The
deficit on the defined benefit pension scheme climbed to 3.3 million pounds. Although the scheme was closed to new entrants in 2002, it is
likely to require further financial support.
