Portfolio review

It's been a while since I took a look at my portfolio. The market has done well, and I'm in substantial overall profit. I'm not sure the market as a whole is tremendously cheap, but nor does it seem obviously overvalued.

In general I am happy to hold onto a fairly-valued share in a great company. But once a share in an average or mediocre company reaches fair-value, that should be the time to sell. So when looking at my portfolio I need to look at the quality of the company as well as the value of the share.

BRK-B: 9.6%

I am convinced by the intelligence, honesty and talent of Buffett and Munger, and would put Berkshire in the top rank of quality.

I recently assessed Berkshire's B-share value as being around $4000. Currently at $3270; I am up 40% in $ and 20% in £, but I will hold to $4000 and beyond.

IEEM.L: 8.8%
IAPD.L: 8.8%
IDVY.L: 8.0%

Relatively low-cost trackers, in markets that I think should do reasonably well in the long run.

I anticipate a yield of around 1.8% on IEEM and 3.6% on IAPD and IDVY. Considering I'm paying 1.24% on my mortgage, I'm satisfied that the value here is OK.

LLPF.L: 7.0%

A preference share, so the calculation here is different. I think Lloyds has made a huge mistake in acquiring Halifax, but with the help of the UK government it has built a large buffer of common equity and is in the process of reducing exposure to its most risky assets. From a capital safety point of view therefore, I'm satisfied that these are safe.

Looking at security of dividends, I think the key uncertainty lies around possible interference from the EU. Lloyds are unlikely to want to rock the boat, and given the UK government's enormous shareholding they are in that same boat.

On the other hand there is the potential upside of (a) Lloyds tendering for the preference shares eary, at, say, 75% of face value (currently trading at 53%), or (b) Lloyds calling the shares in 2015 at face value, giving a running yield of 25%.

If there is a tender offer at about 75% I am minded to accept, but for now I am happy to hold.

NXT.L: 6.6%

Next have a powerful brand and a UK-wide presence. They have an excellent RoCE and RoE, wide margins, moderate debt (approximately 2 years' post-tax profit).

Current yield is 3%. P/E ratio is around 12. Not as good value as when I bought it (at a P/E ratio of around 7) but certainly not excessive.

DGE.L: 6.1%

They have an excellent collection of brand names, which allows them excellent RoCE, RoE and margins.

Currently on a P/E ratio of almost 15, and a yield of 3.75%. Not cheap, but perfectly adequate.

SLXX.L: 5.9%

Most of the holdings in this ETF look pretty secure. It's heavily weighted towards the financial sector, but given the amount of government support in this area I don't expect any defaults.

On a running yield of about 6%, compared with the base rate of 0.5%, I'm happy to hold.

BATS.L: 5.3%

Excellent brands, good RoCE, RoE and margins.

On a P/E ratio of 16 and a yield of 4.27% it's not cheap, but not bad.

NG.L: 5.2%

I don't think I really have a good grasp of how safe National Grid's operations are. I'm hoping that they have extremely predictable revenues, and therefore their high leverage is sustainable. But there could be risks here that I'm failing to appreciate.

On a yield of 6% they are reasonably cheap, even if it does come off a P/E ratio of 16.

GNK.L: 5.1%

A decent company, with a mountain of debt. However, the debt is structured very favourably to Greene King - the have a secure source of funding for decades, provided they continue to meet the covenants on the debt.

Price/free-cash-flow of about 9. Reasonably cheap, if you ignore the debt. Expected yield of about 3.5%, covered about 2.5 times by free cash.

Market cap £950m, debt £1.6bn, so EV = £2.55bn. Earnings before interest payments are about £230m, minus tax at 30% = £160m. So on a debt-free basis Greene King would be on a P/E ratio of about 15. Expensive, but in fact in the current climate the structure of their debt is an asset, and means they are benefiting from cheap leverage.

GSK.L: 4.9%

Decent big pharma company, moderate debt. Pharmaceuticals face some headwinds at the moment, but I can't see Obama's plan making a significant dent in US healthcare spending.

P/E ratio of 13.6, yield of 4.7%.

TSCO.L: 4.8%

Tesco is the dominant supermarket chain in the UK, and is growing rapidly abroad. They continue to leverage the Tesco brand in non-food and financial areas. An excellent record of growth, superb margins (for a supermarket) and a good RoE and RoCE.

P/E ratio of 14, yield of 3%. Pretty cheap as far as I'm concerned. Definitely happy to hold.

BDI.L: 3.2%

Operate in a crowded marketplace of recruitment software. Seem to be decently run, but their accounting methods mean that profit is significantly higher than free cash flow.

They trade at a P/E ratio of about 10, but Price/Free-cash-flow of about 14. Not disastrous by any means.

BARC.L: 2.8%

Barclays have weathered the storm better than RBS and Lloyds. I have my doubts about the integrity of upper management, so I'm not sure this is a place I want to be in long-term.

Barclays now trade at about 1.1x book value. Reasonably close to fair value I reckon.

MXM.L: 2.4%

Maxima is the opposite of Bond. Their high amortization charge hides a stonking free cash flow performance.

Currently on a Price/Free-cash-flow of about 5-6. They look very cheap.

CPT.L: 2.4%

Carpathian seem to be a perfectly adequate, highly-leveraged property company. I'm not looking to hold them for the long term - this is a short-term play on them realising the value of their assets.

I reckoned Carpathian was worth about 40p per share a while back, after taking into account a fairly dismal performance from their property portfolio, but the strength of the euro probably means that that is now an underestimate. Let's say 50 euro cents, compared with their current price of 27 cents.

And while I'm waiting for value to out, they should generate cash.

QDG.L: 2.0%

Quadnetics doesn't seem the best-run company in the world. I think I'm looking for a way out.

On a dividend yield of 4.7%, a P/E ratio of 7-8, they do look pretty cheap. But if the price moved up to ~200p I think I'd be looking to sell.

ZRX.L: 1.2%

Zirax seem to be very poorly run. Letting a couple of Russian banks abscond with all your spare cash is not the smartest move.

They do look quite cheap in terms of assets and potential earnings, but I'm giving up hope of the value ever being realised. At about 6p per share I'm probably out.

Conclusion

I don't think anything in my portfolio is screaming to be sold on value grounds. There are some elements of the portfolio I'm not entirely happy with, but I don't see a pressing need to act.

Total systems

I've been having a look at a tiny company listed on the main exchange: Total Systems. Its profit record is patchy, but its share price is underpinned by a fantastic balance sheet.

Current assets
Trade and other receivables £1.45m
Cash at bank and in hand £3,35m

Non-current assets
Property, plant and equipment £0.9m (but see below)

Current liabilities
Trade and other payables £0.99m
Current tax liabilities £0.18m

So according to the balance sheet this company is worth £4.5m. However, they own outright a 6600 sq ft office in Central London, EC1. This is listed on the balance sheet at cost of £742,000. It was bought in 1987, and property prices have increased somewhat since then! I found a property nearby, 50% larger, on the market for £4m. That would suggest a value for Total Systems' office of around £2.7m.

Property in this area can be rented for around £27.50 per square foot. A 6600 sq ft property would therefore cost £180,000 per year. The long-term average commercial property yield is 6.4%, which would translate to £2.8m.

Let's have a stab at their being around another £2m of hidden value on their balance sheet. Not to mention their intangible assets - none of their R&D appears on the balance sheet, and they are carrying no good will.

So it looks like Total Systems have around £6.5m of tangible assets, no debt, and presumably some intangible assets to boot. The market capitalisation is £2.5m at Friday's close of 23.5p.

US shares

In January I am able to cash in my dollars. This means two things:

• I am no longer heavily exposed to the US dollar.
• I have a lot of cash available to invest (enough to increase my share portfolio by around 50%).

So the US stock market becomes a viable place to invest. Previously I've limited myself to buying Berkshire Hathaway at the irresistable price of $2380. At $3540 I'm up 50% in $ terms, but in £ I'm only up 25%.

At the moment I'm agnostic as to whether the US market is good enough value to be worth investing in. But rather than decide in January, I think it's worthwhile starting to investigate the possibilities now, and keeping an eye on how things move over the next 6 months.

Dividend tax

I'll be taxed 15% on any dividends paid by US companies. While I live in the UK (and have a wife paying basic rate tax) that's a significant disadvantage over buying UK shares. But once I move to Norway I'll be lumbered with some dividend tax no matter whose name the shares are held in - and the US witholding tax will be offset against the Norwegian liability.

There seems little point targeting high-yielding shares (although I don't rule them out).

S&P fair value

Based on historical earnings and P/E ratios, fair value for the S&P 500 is about 900. It's current trading at about 1000, so is moderately overpriced at the moment. I'm not averse to investing at these sorts of levels, but I will be selective.

Possible candidates

A few different sorts of investment appeal:

• Good quality blue chips beaten down by the market. General Electric springs to mind here, but there are undoubtedly others.
• Large-cap growth shares that are reasonably valued. Buffet-type shares: Johnson & Johnson, Coca-Cola?
• Technology shares, if they are reasonable valued. Google, Microsoft, Amazon?
• Corporate bonds - a decent yield, US$ exposure, and adding some diversity to my portfolio.

One investment I'm definitely excluding: US treasury bonds. An uninspiring yield, and a vast programme of money-printing by the Fed: not a good combination in my view.

Google

Let's take a look at Google first:

Net tangible equity: $22bn

Revenue: ~$22bn

Post-tax earnings: ~$6bn

Dividends: No

Selecting info from their latest 10-Q:

"as of June 30, 2009, our two founders and our CEO, Larry, Sergey, and Eric, owned approximately 90% of our outstanding Class B common stock, representing approximately 68% of the voting power of our outstanding capital stock"

"We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future"

How enduring is Google? I'm sure it will be around in some form in 10 years time, but it relies largely on having a large share of the search market. I think it could be displaced by Microsoft - Microsoft can leverage their dominance of the OS and browser markets to drive search traffic through their own site.

What is a fair value for Google? They dominate a fast-growing highly profitable market, have an impeccable financial strength, a strong history of earnings and revenue growth, wide margins, and a powerful brand.

On the other hand, we should not get too carried away. Google will likely face increased competition in the future; their margins and growth will come under pressure. The future of the internet is inherently unpredictable. They are not run for the benefit of ordinary shareholders. Their earnings could very easily be frittered away on unprofitable acquisitions, or simple hoarded, benefiting shareholders very little.

I think a reasonable P/E ratio is around 20, which equates to a market cap of $120bn vs their current market cap of $144bn (at a shareprice of $457).

So Google is a little overpriced at the moment. I'd say $380 is a fair price.

Microsoft

Net tangible equity: $26bn

Revenue: ~$58bn

Post-tax earnings: ~$15bn

Dividends: 52c per share (yield: 2.2%)

I would say that Microsoft have a more secure revenue stream than Google, but without the same growth potential. They return a large part of their income to shareholders via share repurchases and dividends - in the last year about 1/3 to dividends and 2/3 to buybacks.

I would say a fair P/E ratio for Microsoft is a little lower than that of Google: 18. That is a market cap of $270bn, which is a share price of ~$30. That compares to their current share price of $23.50 - so I'd say MSFT is undervalued.

Amazon

Net tangible equity: $2.2bn

Revenue: ~$19bn

Post-tax earnings: ~$600m

Dividends: No.

So, what is a fair value for Amazon? They dominate a sector of online retail, they have a tremendous growth record and the prospect of continuing it into the near future. Their size gives them strong purchasing power and fantastic economies of scale when it comes to distribution. I'd say a P/E ratio of 20 is reasonable. That's a market cap of $12bn, or around $28 per share.

Their current share price is an astonishing $85. Assuming that eventually their growth rate will moderate to ~10% per year, and at that rate they justify a P/E ratio of 20, that means their current 30% growth rate must continue for another 4.5 years. I reckon I can get a 10% return on plenty of other shares, so applying a 10% discount stretches that required growth period out to about 7 years.

Amazon's net profit is around 3% of revenue. If that continues to hold true, then in year 7 their revenue will have to be $125bn. That compares with:

• Walmart $400bn
• Carrefour $140bn
• Tesco $80bn

So to justify their current share price, we are looking at Amazon leapfrogging Tesco to become the world's 3rd biggest retailer - without selling any consumer staples. Or, alternatively, they may start to achieve a better margin, improving profitability and boosting their share price. That seems more likely - but can they do that and continue to fight off competition?

There is way too much growth factored into Amazon's share price.

General Electric

Net tangible equity: $8bn

Revenue: $183bn

Post-tax earnings: $18bn (allegedly - but they somehow only paid $1bn in tax!)

Dividends: $1.24 (yield: 8.3%)

GE is a behemoth. Their growth in the recent past has been driven by GE Capital Services - the financial crisis has rather put the skids on that one.

Their earnings for the first half of 2009 are down on 2008. This year they might earn ~$12bn. On those reduced earnings I'd be prepared to put a P/E ratio of 15 on them. That's a market cap of $180bn, a share price of $18.

They current trade at $14.70 - they look reasonably cheap.

Johnson & Johnson

Net tangible equity: $15bn

Revenue: $64bn

Post-tax earnings: $13bn

Dividends: $1.795 (yield: 3%)

Johnson & Johnson don't have a great deal of debt: $12bn, easily covered by one year's earnings. About 17% of their earnings come from consumer healthcare; the remainder is split fairly evenly between pharmaceuticals and diagnostic devices.

JNJ's growth comes from (a) R&D, which counts as a cost and therefore reduces profits, and (b) acquisitions, which are paid for out of earnings. Their is a constant rate of attrition as their drugs lose their patent protection and suffer from generic competition.

JNJ increase dividends by around 13% per year. Their dividend cover has remained consistent at around 2.5 times.

Their gross margin is constant at around 70%, so their growth has not come from squeezing margins.

The split of sales between the US and international has remained roughly equal. So the growth is not wholly dependent on rampant US healthcare expenditure.

Long-term debt is constant at around 10% of assets, so growth has not come through leverage.

All of this is quite impressive. A consistent 13% growth rate is not to be sneezed at. It can't be maintained forever (because JNJ would take over the universe) but there seem few signs of it moderating yet.

I'm going to give JNJ a P/E ratio of 16. That puts fair value at $73, or a market cap of $210bn. They current trade at $60, so JNJ are somewhat undervalued, in my opinion.

Coca-Cola

Net tangible equity: $8bn

Revenue: $32bn

Post-tax earnings: $5.8bn ($6.4bn underlying)

Dividends: $1.52 (yield: 3.1%)

What is there to say? Coca-Cola dominates the non-alcoholic beverage market. Most of its revenue now comes from outside the US, primarily from emerging markets. Its tremedous return on equity means that it can grow successfully while distributing most of its earnings as dividends.

I would give Coca-Cola a reasonable P/E ratio of 16. Multiplying by the underlying earnings of $6.4bn that gives a market cap of $102bn. With 2.3bn shares outstanding, that gives a fair price of $44 per share. They currently trade at $49, and therefore I reckon they are slightly overvalued.

McDonalds

Net tangible equity: $12bn

Revenue: $23.5bn

Post-tax earnings: $4.3bn

Dividends: $1.625 (yield: 2.9%)

McDonalds have about $10bn in debt, or about 2.5 years worth of profits. Not too bad.

Like Coca Cola, McDonalds is a very powerful brand with global appeal. They have growth prospects in emerging markets. Like Coca Cola they have spectacular return on equity.

I would give McDonalds the same P/E ratio as Coca Cola: 16. That equates to a market cap of $70bn, or $62 per share. Currently the share price is $55, so McDonalds is slightly undervalued.

Portfolio status

I haven't made any changes to my portfolio recently. But my personal circumstances have changed significantly. I've gone from being one half of a two-income couple / no children to the sole earner supporting a wife and baby daughter. That means I'm no longer generating spare cash each month, and I need to be more careful with cash reserves.

In January my US dollars will become available. I plan to invest these in non-sterling assets, mostly denominated in US dollars. In the meantime, I can expect a few dribs and drabs here and there, but nothing dramatic.

My reserves of cash aren't huge right now. I can afford to increase my portfolio by perhaps 20% between now and January. That's a little more than half the rate I was investing over the first half of the year.

Recent market movements
The move in the wider market have been good for my portfolio. Particular highlights over the last 3 months:

• Bond doubled. Quadnetics were up 40%, Maxima 20%.
• LLPF are up over 50% since purchase.
• RBS and Barclays continued their strong runs to be up around 40% each.

Shame my US$ fell 10%, but overall I was well in profit.

Prospective trades
At the right price:

1. Offload my Lloyds shares to eliminate the concentration of risk I have (given my large holdings of LLPF). Invest the proceeds in GSK, bringing my holding up to ~5% of my portfolio.
2. Sell my last remaining RBS shares, add some cash to the proceeds, and then bring my holdings in BAT and NG up to around 5% of my portfolio each.
3. Sell my Zirax shares and use the capital loss to reduce my taxes this year.
4. Invest further in IAPD, IDVY, IEEM, bringing each of them up to ~10% of my portfolio.

That would account for 2-3 months worth of my investment budget.

Update 24/07/09

I've executed some of my plan:

1. I've got out of my Lloyds Ordinaries at 78.5p, and invested the proceeds in GSK at 1164p. GSK is now 5.2% of my portfolio.
2. I sold out of RBS at 42.4p and invested in BATS at 1796p and NG at 566p. They are now each 5.4% of my portfolio.
3. I've decided to leave my Zirax shares alone for now. I think they are undervalued, and I can sell them anytime before the end of March 2010 and still get the benefit of the capital loss.
4. I'll leave IEEM, IAPD and IDVY for now. Depending on whether I find other opportunities worth investing in, I may wait until January before investing further.

My portfolio breakdown is now as follows:

BRK-B: 9.6% of stock/bond portfolio (excluding currency)
IEEM.L: 8.8
IAPD.L: 8.4
IDVY.L: 7.3
NXT.L: 6.8
LLPF.L: 6.4
DGE.L: 6.3
SLXX.L: 6.2
GNK.L: 5.8
NG.L: 5.4
BATS.L: 5.4
GSK.L: 5.2
TSCO.L: 5.0
BDI.L: 3.6
BARC.L: 2.7
MXM.L: 2.2
QDG.L: 2.0
CPT.L: 1.7
ZRX.L: 1.3

Here's the breakdown by asset class (including currency):
USD: 31.9% of total portfolio (including currency)
Large UK Shares: 25.6
Small UK Shares: 8.7
UK Bonds: 8.5
Large USA Shares: 6.5
Large Emerging Shares: 6.0
Large Asia Shares: 5.7
Large Europe Shares: 4.9
Small Europe Shares: 1.2
Small Emerging Shares: 0.9

So my portfolio is 42.8% in UK assets, 38.4% in US assets, 18.9% in Europe/Asia/Emerging assets. But bear in mind that a lot of my UK assets are actually international companies, e.g. GSK, BATS, DGE.

Carpathian in, HSBC out

I decided that Carpathian was worth investing in, but didn't want to invest any new cash. I therefore sold my HSBC shares, since they seem to be close to fair value, and used that to fund the purchase.

Carpathian is now 2% of my portfolio.

Carpathian

I've been challenged to find a property company worth investing in, and on minimal research have plumped for Carpathian Plc. http://www.carpathianplc.com/news/2752987.go

Let's see if it's actually worthwhile.

Price

Share price is 15.75p, Market cap £38m.

Earnings

Underlying earnings of £12m for last year, on a net rental income of £34m.

Balance Sheet

£508m of investment property, £406m of debt. All debt is non-cross-collateralised, non-recourse.

Equity of £185m, minus £13m of goodwill leaves £172m of tangible assets. 72p NTAV per share.

£41m of uncommitted cash at holding company level = 17p per share. £20m earmarked for injecting into subsidiaries to satisfy banks.

Plans to return at least 8p per share to shareholders this year. That accounts for the rest of the cash.

Value

Taking a realistic view of Carpathian's situation, I think we can expect:

• Returning 8p per share to shareholders this year. They wouldn't put that in their results if they didn't think they could deliver. Not sure if they plan to do this via a dividend or buybacks.
• Investing of the rest of their cash into their properties to satisfy bank requirements.
• Abandoning perhaps 25% of their portfolio and letting the bankers take it. I would expect this to have little impact on their NAV, since their LTV ratio is so high, and presumably the properties they abandon would be likely to be those where there is little to no equity remaining.
• A further decline in property values. Currently the yield on their property is 6.7% - assuming that increases to 8% (which I would consider reasonable) that suggests a fall of £83m, or 35p per share.

That would leave a tNAV of 29p per share, even after a cash payout of 8p.

Conclusion

I think Carpathian is a wothwhile, if risky, purchase.

TW

Bye bye TW. My new shares were admitted to trading and sold at 33.538p. I didn't really cover myself with glory in that investment, and perhaps I've now sold out too cheaply, but I'm happy to see the back of it.

At least I can comfort myself that I held on in expectations of better times when they fell to 5p. I 10-bagged from that point, it's just a shame that I was 95% down to start with, for an overall loss of 50%.