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Analysing shares: How do I know which shares to buy?

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Learning how to value shares and deciding which shares to buy is the toughest part of investing.

Do I buy Tesco, BP, BT or Next? ... The list goes on. You may even be sitting there wondering where to even start!

Unfortunetly, there's no magic formula that will guarantee you pick winning stocks all the time.

But I am going to show you how to identify stocks worthy of investment.

Here is my OFFICAL 10 Point Stock Checklist and the list software which I use to shortlist stocks.

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Check out @LewysAron 's 10 Point Stock Checklist. Ten things to look at before deciding on whether to buy a stock. Easy and actionable.

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Binary trading scam: My epic takedown of binary trading

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I hate binary trading – I even go as far as to call binary trading a scam

Now you may be thinking ‘binary trading scam?’ isn’t that going a bit far?

Well the dictionary definition of scam is;

‘A dishonest scheme’

And, I certainly feel that Binary trading is presented in a very dishonest way.

Just look at these messages that  pop up in my Twitter and Facebook inbox

Dishonest!

In this article I’m going to explain to you what binary trading is, why it’s a fool’s game and how dividend investing (the investing I advocate) is different.

Continue Reading

What share to buy?

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The first question I always get asked by newbie investors is focused around what share to buy.

Through some seminars I’ve held at university recently I’ve had the opportunity to gain valuable insight into how fellow students invest and what makes a share a buy for them.

But one thing has become clear – the last question newbie investors should ask is ‘what share to buy’. Continue Reading

Christmas clean up – Sorting out my portfolio

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My portfolio was a mess! With many of my early investing mistakes still present in my portfolio I finally decided to bite the bullet.

I CLEANED UP!

All investors evolve over time. We learn from our mistakes and adapt our strategies accordingly. But, what should you do if past mistakes are still evident in your portfolio?

It can be a painful process, that costs money in the short term BUT if a stock’s fundamentals mean it no longer fits with your overall strategy, couldn’t the capital tied up in it be deployed somewhere else? Continue Reading

Take pleasure when others spend big – Debunking their spending

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Sometimes, frugal living is tough, and one of the hardest things about frugal living is watching others spending big.

It’s sometimes hard to watch as your friends go on expensive holidays, buy expensive cars (mostly on finance) and enjoy the finer things in life.

BUT, we should take pleasure when others spend big! Continue Reading

An in depth look at the UK mail sector and Royal Mail

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Royal Mail.

Since the government put Royal Mail shares on the market in 2013, investors can be quietly happy with their returns.

Investors who bought in at day one at a price of 330p a share would have seen a return of just over 35% to date, excluding dividends.

With good dividend stocks at decent prices hard to come by in the FTSE, I thought I’d take a closer look at Royal mail.

With an attractive growing dividend, this may be one for dividend growth investors to look out for.

Background

What makes Royal Mail so interesting is that it’s a former state-owned monopoly which is still in transition from public ownership to private ownership.

The company still holds an effective monopoly in the letters market but are battling heavy competition in the parcel market.

Royal mail operates under two main divisions;

UK Parcels, International & Letters (UKPIL)

UKPIL operates in the United Kingdom collecting and delivering parcels and letters through approximately two main networks, the Royal Mail Core Network and Parcelforce Worldwide

General Logistics Systems (GLS)  .

GLS operates in continental Europe and the Republic of Ireland and has a ground-based deferred parcel delivery network in Europe. GLS provides parcel and express services, as well as logistics solutions.

A brief history;

In 2006 Royal Mail lost its monopoly on the UK parcel market when it became open to competition from companies such as UKMail, DPD and Hermes.

Although Royal Mail also lost its monopoly on letters in 2005, competitors just don’t seem interested in this ever shrinking market. The withdrawal of Dutch competitor Whistl in 2015 left the company effectively unopposed.

In 2013 Royal Mail was offered to investors for 330p a share, thus privatising one of the last surviving state owned companies in the UK.

The overall postal market

Royal mail’s two markets can be defined by the following statements;

Declining letter volumes and increasing parcel volumes.

In 2013, Royal Mail commissioned a review into future volumes from Pwc. The results can be seen below;

Screen Shot 2016-08-25 at 15.10.20 Screen Shot 2016-08-25 at 15.10.15

As the graphs clearly indicate, the UK has an increased demand for parcel services but a decreasing demand for letter services.

These trends are also clear in other developed countries and there are no signs of a reversal.

With a decline in mail volume, Royal mail is rightly positioning itself for the growth in parcels and cutting costs.

The parcel market and Royal Mail’s positioning

As we can see from the chart below, Royal mail continues to enjoy the lion’s share of the UK parcel market

Screen Shot 2016-08-25 at 15.23.40
Source: Royal Mail PLC 2015-2016 results

But, this dominance is declining year on year as is evident above.

The overall parcel market grew 6% growth  in 2015 and Royal Mail estimates a further 4% volume growth moving forward. This growth has allowed Royal mail to grow parcel volumes despite its declining market share.

Whilst focus on the parcel market appears to be a winning strategy significant hurdles exist that I’ll outline below.

Problems

The problem with Royal Mail’s strategy is the intense competition they face in the industry.

This is evident from the meager 1% revenue growth achieved from a 3% increase in parcel volumes. This is a worrying sign of declining margins to come.

If this trend is to continue then clear challenges await for the company;

2016 results show that the 1% increase in parcel revenue was offset by a 2% decline in letters revenue.

With the majority of Royal Mail’s revenue coming from its letters division this continued decline will slowly erode the balance sheet unless growth in other areas (mainly parcels) pick up.

Screen Shot 2016-08-25 at 17.40.15

As we can see from the above table taken from the company’s 2014-15 trading results Total letters accounted for £4,567mn of revenue as opposed to £3,190 for parcels.

Screen Shot 2016-08-25 at 17.43.40

The continued decline in letters revenue (although less than expected) as evidenced in the company’s 2015-16 trading results above creates a pressure on the company to deliver on parcel growth.

Even as the parcel market grows and parcel revenue increases it seems tough for Royal Mail to make a net gain on their overall revenue due to declining letter revenue.

Another revenue worry I have moving forward is the Royal Mails obligation to offer a universal service which means delivering to some very rural areas without the ability to charge more.

This is in stark contrast to competitors who can simply cherry pick the most profitable urban regions and rely on Royal Mail for ‘the last mile’ delivery. Royal Mail has hit back by ramping up the charges for this service but competitors have complained to the regulator Ofcom. With such murky legal waters ahead this certainly casts a shadow over the business.

Profit on the other hand looks promising if we strip transformation costs with profit up 5% in 2015.

Postives

Royal mail has done an outstanding job of turning the company’s finances around.

Debt is down significantly since 2012 and the company continues to make significant efficiency savings;

Screen Shot 2016-08-25 at 15.51.56

(Source: Ft Markets, Royal Mail Plc)

The group has also managed to shed 3,500 jobs since 2015 whilst also increasing productivity by 2.4%. These are promising signs for a company that needs to shed costs fast in order to maintain margins (especially in parcels) in a competitive market.

The company’s cash flow looks worrying at first glance;

Screen Shot 2016-08-25 at 16.09.57

But when you consider the transformation costs the company has occurred the weak cash flow becomes understandable.
Transformation costs in 2015 were £191mn, and the company projects further costs of £160mn in 2016-2017.

Most impressively is the operating profit margin now being achieved by the company as a result of these transformation costs with the profit margin jumping from 4.7% in 2014 to 6.1% in 2015.

Dividend

Royal mail offers a tempting dividend yield of 4.2% and sits comfortably at a payout ratio of 54% from results filed in May.

With room for movement in the payout ratio the company could continue to increase its dividend payments even if earnings disappoint.

The company is also committed to a ‘progressive dividend policy’ meaning that dividend investors can be confident of continued dividend increases in the future.

Value

Due to the scale of transformation costs it’s difficult to efficiently value the shares based on EPS.  Transformation costs in 2016-2017 are expected to come in at around £160mn.

Instead, I decided to use a dividend discount model to value the company’s shares.

As revenue is going to be difficult to expand in such a competitive market (and relative to management’s past performance) I see cost cutting measures as the main source of EPS growth for the company moving forward.

After a big dividend jump from 2014-2015 I expect dividend growth to stabilize at around 5% due to the above mentioned factors.

I factored in a 10% discount rate to account for the risk of our capital

The dividend discount model gives me a fair value of 442p a share. Meaning that this stock appears 15% overvalued by this metric.

Summary

Royal mail management is doing all it can to streamline the business moving forward, yielding impressive results with productivity and margins on the up due to a successful transformation strategy. But, there is only so far that transformation can go before the company is unable to continue to make large savings through efficiency.

The worry from then on would be the poor increase in parcel revenue relative to parcel volume achieved as this metric tends to point towards narrowing margins.

There’s too much uncertainty for me to buy the stock at this price but if the company goes on to continue to dominate the parcel shipping sector, investors should be handsomely rewarded with dividend growth and capital gains.

 

One stock I’d love to own – Just not at this price!

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I absolutely love consumer goods stocks! Unilever (ULVR) is one of my core holdings and I just bought into flower foods (NYSE:LFO).

I love Consumer good stocks because they are generally very defensive and predictable investments. After all, even in recessions people still need to eat, drink and clean.

Stocks in this sector also boast superior margins, as the value of their brand mean that customers are willing to pay that much more.

What would you pay more for, Unilever’s Ben and Jerry’s or a Tesco copycat?

Consumer goods stocks in today’s market

With low interest rates people have been buying these defensive stocks for their dividends, which trump measly bank account rates.

High demand for these stocks have left them at high p/e ratios. For example;

Proctor and Gamble (PG) sports a p/e of 25

Unilever of 24.1

Colgate Palmolive (CL) of a whopping 48!

Even at these high valuations the stocks continue to climb and even Procter and Gamble whom are struggling with growth are up over 16% year to date.

With such high valuations I often sit back and watch momentum and demand drive these stocks higher, waiting patiently for an opportunity.

One stock that I have my eye on is Reckitt Benckiser (RB), a British consumer goods company that specialises in health and hygiene products.

Its rapid growth and impressive portfolio of products has caught my eye.

The company owns internationally recognisable brands such as Durex, Dettol, Clearasil, Veet, Strepsills and Scholl. With such a great portfolio of products I felt the need to take a closer look at the stock’s fundamentals;

Growth

Reckitt Benckiser’s sales growth has been impressive as of late with year end results for 2015 showing a further 6% growth in like for like sales at the company. What I love most about this company is it portfolio of Health products, which people will buy regardless of pressures on disposable income.

The growth in revenue from its Health division continues to be strong with a 14% like for like growth in2015.

Screen Shot 2016-08-19 at 09.31.26.png

But, as we can see from this tablefrom the company’s 2015 annual results this growth seems to be a tale of two halves.

The company’s Health segment continues to perform strongly but there are certainly signs of weakness in their home division and portfolio brands – investors should be aware of this.

Whilst Home and Portfolio brands make up a minority % of sales, further weakness in these divisions could neutralize (or certainly damage) the impressive growth in the health division.

We can somewhat see this concern play out in the EPS figures – EPS growth has not been strong with an average growth rate of only approx 1.6% since 2012. The company’s turnover has actually declined over the past few years from £9.485m in 2011 to £8,875m in 2015.

Dividend

The company has paid a dividend since 2008 and has managed to increase its payments by 84% since then. The company’s payout ratio for 2015 was also a comfortable 54% meaning that there is room for dividend growth if EPS stay flat. Dividend yield based on 2015 year earnings is an anemic 1.9%

Value

With no major red flags concerning the company thus far, it’s time for me to burst your bubble.

RB is not a buy!

I feel that this company is grossly overvalued, especially compared to its peers such as ULVR.

Looking over the past five years, we can see that the stock has an average 5-year p/e ratio of 20.2. But today we can see that the stock is trading hands for 30.8x earnings.

Even if we take the highest estimate for 2016 earnings of 301p per share the stock is still trading hands for 24.7 times earnings.

The 30.8 p/e ratio means the market is pricing this stock for some serious growth, something it has failed to deliver over the past five years. Yes, the growth in certain divisions is impressive but we must look at the company as a whole.

I was really interested to see what a dividend growth model valuation would give as a fair price for Reckitt Benckiser and I decided to be generous with my estimations too.

I factored in a 8% discount for the risk of our capital (As it’s a pretty steady earning stock in a great sector), and assumed that the company would grow its dividend by 6% annually (above its average 5 year growth rate of 3.85%).

Even with my very generous and optimistic figures the stock came in at a fair value of – 6,950p a share. Meaning that by my estimations the stock is at least 15.3% over-valued at present.

Summary

Reckitt Benckiser is a brilliant company that is powering ahead with the growth of its Health division. In an uncertain world it makes sense to invest in companies that have a great portfolio of essential health products that people will always need to buy. I’m confident that management can continue to deliver growth in this segment but the decline in their portfolio brands puts a question mark on the degree of overall EPS growth moving forward.

At a lower valuation I’d certainly roll the dice a bit and feel confidence that the intrinsic value I’d be getting would make any disappointment acceptable (relative to the price I paid). But, this company is priced for significant growth and that is far from certain.

If the company does indeed grow as projected then I expect the price to continue to climb higher, sustaining its current momentum which makes the stock unappealing in terms of valuation and yield. But, one slip will certainly lead to troubling times for the share price and ,hopefully, a buying opportunity for me!

Advice: Avoid at these prices, but keep an eye out.

Disclosure: I am/we are long ULVR, FLO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.