Investing on a low income.

Stepping away from Dividend Growth Investing

The blog has been quiet and for that I apologise.But, I have finally finished my PGCE course after the most challenging year of my life.I really should write a blog…

The blog has been quiet and for that I apologise.

But, I have finally finished my PGCE course after the most challenging year of my life.

I really should write a blog about the PGCE course sometime - what an experience. It's crazy how some institutions operate.

Anyhow, the GREAT NEWS is that I’m back, and I’m more motivated than ever!

In September I officially start my journey to becoming an investing professional as I study an Msc in Finance and Business Analytics at the lovely Swansea University.

Now, let's get to the meat of the matter and the point of this post.

Some of you may be concerned at the heading of this post ‘A step away from Dividend Growth Investing’. 

After all, I have stuck patiently by Dividend Investing for 4 years now. Noting it as a low-risk, steady investment strategy – but I’ve been convinced to branch out into some higher growth shares.

Here’s why I've branched out.

Over the weeks following the end of my PGCE course I took myself to reading as much as I could about investing.

I went back over the investors bible, The Intelligent Investor, delved deeply into the methods of the godfather of investing, Warren Buffett, by re-reading Warren Buffett and the Interpretation of Financial Statements and taking a close eye to the outstanding archive that CNBC has created covering Buffett in his own words.

Lastly, I challenged myself to read these two classics; Common Stocks and Uncommon Profits by Phillip.A.Fisher and One up on Wall Street by Peter Lynch. Books I had (stupidly) never read before. It was upon reading Common Stocks and Uncommon profits that I began on my journey of change.

                   This book changed my life.

Am I too young to focus solely on Dividend Investing?

It dawned upon me - as a 24 year old student I was investing into companies that have very high capex and operate in industries that were highly saturated, with little room for growth. It's important to note here that I'm not talking about capex used for investing, but capex that's required just for these companies to stand still.

I was putting money into National Grid a company that had absolutely no prospect of compounding my money at anything more than their admittedly generous annual dividend and snail-like 2% earnings growth - see my earlier post on National Grid shares for my previous rationale. National Grid spends millions on maintaining infrastructure but is regulated as to how much it can charge and thus how much profit it can make. 

I also went head first into AT&T, a company that has leveraged itself massively and has decided to compete with other media giants head first through its acquisitions of Time Warner and Direct-TV. I see very little prospect of above-market returns here, even with a hefty 6% dividend. Again, the capex requirements here are huge and the market already saturated.

Now, there's nothing wrong with T and NG - these are solid picks for older investor approaching retirement. The dividends both look safe and will pay handsomely dividends to those who are willing to forgo share price growth.

Let me emphasise, I am not discouraging investments in such companies, I remain absolutely convinced of reliable dividend payouts from the majority of such low-growth companies, even where high levels of capital expenditures are needed.

But, it’s time to admit that I have been blinded by my obsession of ‘value’ in an investment. For so long I held off buying outstanding, high growth companies, such as Visa, Mastercard, Facebook and Nvidia simply because of their high p/e ratios.

In turn, I missed out on the glaring competitive advantages and ability to make above average returns these companies have.

Maybe it was my fault? Maybe I wasn’t valuing these companies appropriately? But, all looked expensive in relation to their 10 year p/e ratios and the market and all went on to raise emphatically in value, bar Facebook as a consequence of its recent, overdone in my opinion, 20% drop.

Here’s a hard learned lesson – an important one to any investor.

Looking at a company’s 10 year p/e ratio to try and determine value can hoodwink you into missing out on outstanding investments.

Surely I can't be alone in having dismissed outstanding companies with outstanding economic moats simply because they looked expensive relative to their 10 year p/e or because they had ratios upwards of 30 even 40.

Sure, it may assist you in painting a background of the company but it has absolutely no bearing on its current value.

It is very possible that a company’s future prospects have transformed dramatically and as a result the company deserves its high valuation.

WHAT?

Yep, this is in complete contrast to my previous approach to investing where I emphasised that one should only value a company on its current fundamentals, exclaiming that these along with the company’s history are the only facts that one can obtain about a company.

The now glaring problem with this stance is that companies change.

A company with an outstanding economic moat and enviable history of earnings growth may be about to face very predictable headwinds. For example, a pharmaceutical company that has just had a patent expire on its star product.

On the other hand, a company with a dreadful or subdued history may have just launched a star new product that will catapult it to a much higher valuation. Just look at Apple pre and post iPhone.

True. It is incredibly risky to try and predict a company’s future. After all, the future is always uncertain. But, one must remember that one can only ever lose 100% of one’s initial investment and that an investment’s upside is theoretically without limit.

So what’s changed?

I’m still a Dividend Growth Investor.

Dividend growth stocks offer enviable protection in economic downturns and instant returns via dividend for investors.

BUT

I am now tilting my portfolio more towards companies with higher growth prospects than my usual ultra conservative investments whilst also retaining many of my previous conservative investments for protection in a downturn.

I have updated my portfolio page to reflect my current portfolio holdings.

Remember to comment below and that I’m always available to answer any questions via lewys@frugalstudent.co.uk.

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Why calculating Dividend Cover is flawed…. What I use instead

Some of my worst investments were made back in 2014/15. That’s the year I really got stuck into investing. I blindly piled into stocks I would never buy at such…

Some of my worst investments were made back in 2014/15.

That’s the year I really got stuck into investing.

I blindly piled into stocks I would never buy at such valuations today.

I look at them in my portfolio today and cringe.

Glaxo Smith Kline, Whitbread… It just hurts.

Now, while Whitbread may be a decent buy at these prices, I’m down 15% and to be completely honest, I wouldn’t be buying at these prices regardless.

Luckily, one core calculation and one change to my investment style has stopped me from getting stung further.

In this weeks article, I’m going to share that calculation with you and that change with you.

Earnings Per Share

Now, many of you would have already heard about EPS (Earnings Per Share). That’s simply a company’s net profit divided by the number of shares outstanding.

This is a key measure often touted by company management, brokers, and analysts.

Naturally, when I first got into investing this was also the key metric I focused in on – after all, that’s what the pros and other dividend bloggers were doing.

Little did I know at this point that this focus would lead disastrous investments.

Now, there’s nothing wrong with focusing in on a company’s earnings per share but it’s the use of EPS in order to determine a dividend’s safety that gets me.

Ever heard of dividend cover?

My focus on dividend cover actually lead to me investing into companies with pressed dividends! 

Dividend Cover

Dividend Cover = Dividend Per Share/Earnings Per Share

For example, Company X has earnings of £1.00 per share and pays a £0.50p dividend then the above calculation results in a dividend cover of two.

1/0.5 = 2

Now, on the face of it, this makes the dividend look well covered.

After all, earnings per share could theoretically half and the dividend could still be paid.

One would assume that the dividend safe right?

Wrong, and I’m going to tell you why.

The calculation for Earnings Per Share is: Total earnings/Outstanding Shares.

So far so good.

Let’s assume Company X has earnings of £100 and 100 shares outstanding (let’s keep things simple).

100/100 = £1 Earnings Per Share.

But, what earnings per share doesn’t take into account is Capital Expenditure – the money a business spends in order to maintain, upgrade and purchase new physical assets.

If Company X spends £40 on maintenance and a further £30 on purchasing a new asset the dividend is suddenly left uncovered by cash generated through by the company’s operation.

We said above that the company paid a 50p dividend per share.

0.50 x 100 (the number of shares) = £50 total dividend paid.

Add on the £70 spend in Capital Expenditure and we can see that the company actually forked out £120 while it only generated £100 in earnings.

Where did that extra £20 come from I hear you ask?

Debt, new share issues or asset sales, all of which are reflected in a company’s cash flow statement and can be damaging over the long term.

Debt and share issues are reflected under the financing tab of a company’s cashflow statement with asset sales  under other investing and cashflow items.

So should you worry if a company has to rely on asset sales, debt or share issues to pay a dividend?

Not necessarily but it means you need to dig deeper into a company’s annual report in order to find out exactly what’s going on in order to determine if adding more debt is sustainable and whether asset sales damage the overall business.

As for share issues – this is almost always bad news for investors!

 

Let’s take a real-world example to see how this all works out

Here’s Whitbread’s Cashflow statement.

We’ll start in 2013.

I always begin by working out a company’s Free cash flow excluding other investing and cashflow items.

This is because I want to see whether a company generates enough cash from its core operations to fund growth and pay the dividend, without the need for any cash generation from Property Plant and Equipment activity such as asset sales.

That’s Total Cash From Operations – Capital Expenditures (Capex).

2013 = £63m

Great, that’s £63m worth of SURPLUS cash that Whitbread has after all costs including Capex.

BUT, we can see that they paid out a £78m dividend meaning that they had to generate £15m.

As it happens, in 2013 WTB gained £50m from an asset sale meaning the dividend is covered (reflected in 2013’s cashflow statement)

Using this formula, we can truly work out whether a dividend is covered.

Do the maths for 2015 and you’ll see that the dividend is grossly un-covered thanks to huge Capex.

Jumping forward to 2017 we can see that the dividend has become even more pressured.

Free cash flow = 626 – 610 = £16m

WOW! The dividend paid in 2017 was a whopping £167m.

Where did the additional £151m come from!?!

Well, if we consider the other investing activities you’ll notice that Whitbread made £200m.

Fair enough right? That covers the dividend.

Well, if we dig into the annual report, we can see that much of this money (186.2m) came from the sale and leaseback of hotels & restaurants.

Thus we have uncovered a red flag!

By leasing back a hotel the company has added an overhead for a one-off payment.

This seems concerning as this sale was required due to the weight of the dividend and the huge levels of CapEx needed in the hotel and restaurant sector.

It’s also worth looking at the company’s liabilities in light of its capital-intensive nature.

                                                                                                          2017          2016         2015         2014         2013

As we can see, total liabilities have rocketed from £1,640m in 2013 to £2,161m in 2017 with total debt nearly doubling.

This isn’t actually that bad considering how cheap debt is at present and considering that the company has also grown its assets substantially.

                                                                                                          2017          2016         2015         2014         2013

We can see that the liability to asset ratio has remained broadly stable (Liabilities/assets)

2013 = 1640/3175 x 100 = 52%

2017 = 2161/4689 x 100 = 46%

But.

Here’s the piece of the balance sheet that makes me cry as an investor.

                                                                                                            2017          2016         2015         2014         2013

Whitbread has issued a further 4m shares since 2013, diluting shareholder equity.

Each time a company issues shares, your stake in the company is decreased.

Someone who owns 1/100 shares in a company owns 1%.

If the company issues another 10 shares, you now own just 0.9%

Whilst 4m shares over 5 years is far from terrible, just 2.2% of total shares outstanding, when we compare this to a company with low Capex and plenty of cash to spare the importance of free cash becomes pronounced.

Here are the number of Next Plc shares outstanding;

                                                                                                           2017          2016         2015         2014         2013

So, how do I REALLY know if a stock’s dividend is under pressure?

Simple.

These are the EXACT steps you need to do.

  • Get the company’s cash flow statement.
  • Do the following equation: Total cash from operations – Capital expenditure.
  • Minus the dividend from this figure.
  • If the remaining figure is larger than the dividend paid then you can consider the dividend safe.

    WORD OF WARNING:
    Sometimes, stocks pay special dividends if they have surplus cash and don’t want to buyback its own shares or invest it. Because these dividends aren’t regularly paid, it’s unwise to include them whilst considering the sustainability if a stock’s ordinary dividend. As such, remember to check if the stock paid a special dividend. If the stock paid a special dividend following the following steps apply.

 

  • Get the company’s cash flow statement.
  • Do the following equation: Total cash from operations – Capital expenditure.
  • Minus the dividend from this figure.
  • Plus the amount paid out as a special dividend.
  • If the remaining figure is larger than the dividend paid then you can consider the dividend safe.

 

Conversely, if there is a need for investing activities in order to cover the dividend payment, you should take a closer look at exactly what’s going on in the company’s Annual Results.

Thanks for reading and I really hope this article has been a help.

If only someone had written this and linked me to it 3-4years ago I’m sure my investments would be in a much better spot.

Once more – I do not make ANY income from this blog. No ads, No affiliate links just me and my laptop.

If you could support my platforms by subscribing to my YouTube channel and sharing this article I would be very grateful.

As always any questions, drop a comment below or E-mail: lewys@frugalstudent.co.uk

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Market Meltdown & A Close Look at BT.

Well well, looks like we’re finally getting a minor correction in the market. The FTSE’s down 1.5% and the S&P500 4.4% About time too! With prices continually creeping higher over…

Well well, looks like we’re finally getting a minor correction in the market.

The FTSE’s down 1.5% and the S&P500 4.4%

About time too!

With prices continually creeping higher over the previous two years with little sign of a correction, bargains are getting harder and harder to find.

Saying that, my recent buys have been in for a rough ride regardless, with;

IMB, CARD, and NG faring particularly badly. Between these, I’m down £300 on a £2500 investment, ouch!

I’m not that bothered though, after all, investing is for the long term and I’m confident these companies will bounce right back and are currently trading at cheap valuations, especially CARD.

My goal is always to increase my yearly income through dividend stocks and not to watch the price of my portfolio rise, although that is somewhat comforting too.

This now sits at over £350!

Regardless, one bit of news this week was the lackluster results announced by BT the previous week.

WOW, am I glad I got out when I did!

With BT now at a 52week low, many people have asked whether now is a good time to get into the stock.

If you’re thinking of taking a punt at BT then keep reading.

BT Overview

Over the past decade, BT has transformed more and more into a ‘media’ company as opposed to its traditional fixed-telecoms base.

This has seen the company step into TV, Sport, Mobile whilst investing heavily in a quad-core offering consisting of;

Landline
Mobile
TV
Broadband

To be fair, BT has been successful in this transformation as the company now looks completely different to how it did just a decade ago. But I remain unconvinced. Here’s why.

Narrow economic moat

Followers of Buffett will be familiar with ‘economic moats’, a term coined by the Oracle of Omaha to describe a company’s continuing and lasting economic advantage.

A wide economic moat denotes a large competitive advantage whilst a narrow economic moat denotes little or no competitive advantage.

Whilst some pundits have argued that BT boasts a medium economic moat with an unrivaled quad-play offering, I think this is unwise.

If we take a look into each of these segments we can see that all are intensely competitive.

Landline

Probably the only area where BT continues to enjoy a competitive advantage. BT owns, operates and maintains the telephone lines under its Openreach division and as such BT can continue to enjoy moderate profits in return for its expertise in the area and continued investment through high levels of Capital Expenditure.

But, with the government seems determined to force a spin-off between BT and Openreach buying the stock purely for this competitive advantage would be unwise.

Mobile

Well, it’s safe to say that EE has no unique offering compared to Three, O2 and Vodafone. Just like airlines, you can offer the best service or best signal in the world but consumers are increasingly focused on price and price alone making charging a premium to increase margins virtually impossible.

TV

Let’s face it. Even traditional TV companies are taking a pounding in the face fierce competition from Netflix and Amazon.

I really think BT made a mistake stepping into this insanely competitive field where they must pay BILLIONS to secure football rights against companies with much deeper pockets (and much smaller pension deficits). Is it really wise to have to add TV rights to a Capex list already containing broadband lines and a black-hole of a pension deficit?

Quick answer: No.

Broadband

Again, fiercely competitive where BT is straddled with the need for huge Capex to upgrade and maintain the lines but are then expected to compete for customers against the likes of Talk Talk, Origin and more.

Another race to the bottom on price!

Capex, Capex, Debt

Whilst BT rightly boasts it £68m increase in capital expenditure in their Q3 results reflecting their ‘ongoing investment in fiber broadband speed and coverage’ the sad fact of the matter is that BT can’t leverage this large investment in infrastructure to any meaningful competitive advantage due to government regulation.

Most worryingly is that BT is loaded with debt.

£21bn to be exact with we include the dizzying black hole of a pension deficit which stands at £14bn.

Taking a look at BT’s Free Cash Flow forecasts we can see that pressure isn’t going to ease up anytime soon.

(1st grid = Q3 17/18 – 2nd grid = FY 17/18 Estimate)

A full year FCF estimate of £863m leaves BT’s £1.4bn+ dividend payments uncovered.

VALUE

Many pundits note that BT is looking undervalued at this point with Morningstar releasing this summary of analyst expectations: http://www.morningstar.co.uk/uk/news/164881/bt-still-undervalued-say-analysts.aspx.

But, with no economic moat, it really isn’t a company that I’d be comfortable having in my portfolio having made the mistake of buying it in my newbie investing days.

FrugalStudent Opinion: Hold with the view to sell at a more reasonable p/e.

 

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OUCH – I caught a falling knife. The dangers of stock market investing.

The stock market. What a crazy place! Anyone who read last Monday’s article would have seen that I recently purchased £222 worth of Dignity Plc shares. Well, these went on…

The stock market.

What a crazy place!

Anyone who read last Monday’s article would have seen that I recently purchased £222 worth of Dignity Plc shares.

Well, these went on to crash and burn 50%.

I must be a genius, right? It takes something special to turn £222 to £111 in just a few days.

Luckily, my portfolio is HEAVILY diversified and the £111 loss I suffered is barely a scratch in my portfolio that’s now approaching £17,000.

Anyone wanting to know exactly what happened to Dignity shares should click here for my live reaction of the 50% drop!

Having just experienced the pain – this seems like the perfect time to talk about falling knives.

The term “catching a falling knife” is when an investor reacts to a declining share price by mistakenly thinking that all the bad news of a stock/sector has been priced in and buying a stock they deemed undervalued expecting a recovery over the longer term.

Last week, I caught a falling knife.

Here’s how I messed up.

Whenever I investigate a company there are two things I generally look at immediately – The market cap and the price to earnings ratio.

These two measurements are related and both hold a clue to how I got burned last week.

Let me show you how.

To illustrate this, let us take a look at two retail competitors, Next Plc and ASOS Plc.

Next currently has a market cap of £7.13B

ASOS, on the other hand, has a market ap of £5.6B

To the newbie investor, it may seem that Next and Asos are of similar scale.

But, if we look at the revenues of both companies we can see that Next is substantially larger.

Next’s 2017 Total Revenue came in at £4,097m with ASOS way behind with Total Revenue of £1,924m.

Here we begin to see how disjointed from reality and business fundementals the stock market can become.

This is why I like to think of the price to earnings ratio of a stock as a indicator of how jointed/disjointed a stock is from the underlying current fundementals of a stock.

Reasonable p/e ratios of 10-18 for the FTSE are my sweet spot. Anything lower may indicate serious underlying problems while anything over may be overvalued.

You see, the key difference between the valuation of Next and ASOS stock comes at their price to earnings ratio.

Next boasts a p/e ratio of a touch over 11 with ASOS trading at close to 89.

That means investors purchasing these stocks today would be paying £11 for every £1 of Next’s earnings and £89 for every £1 of ASOS’s earnings.

But here’s the mistake I made.

The p/e ratio of a stock is based on a stock’s current year’s earnings (ttm – trailing tweleve months).

When I bought Dignity at a 15 p/e I thought I had a bargain!

Here was a solid stock in a recession proff industry trading at historically low valuations.

Sure, competition was heating up but I felt the risk had been priced in to the stock and that it was “worth rolling the dice” regardless of the competition risk.

After all, I was reassured by the words management – they had a statement in November regarding competition and were confident that their pricing stratergy at the time was generally fit for purpose.

BUT – it seems that management really didn’t have a grasp on how much the competiton was heating up, and, in response to falling customer numbers decided to slash their funeral package prices for next year by 25% OUCH!

What? Seriously, in three months things got that much worse?

This folks, is what we call a falling knife.

Just when I thought the bad news was priced in, management dropped a bombshell!

Here, I’ll introduce you to another little phrase – “Value trap”

Let me explain;

Dignity’s 2017 earnings are on track for £1.19 per share and this was the figure used to caluclate the firms p/e raito when I purchased shares, but, next year, after the drastic cuts announced by management Dignity’s earnings per share are forecast to drop to just 88p for 2018/19.

Given these new estimates I purchased Dignity shares at a forward p/e ratio of 21.

21 P/E for a company in an increasingly competitive field?!?!?!

😭 

I got hoodwinked by managements smooth talk for sure and should have stayed well clear until the competition dust had settled.

I can’t say I wasn’t warned and will take everything a company’s management says with a massive grain of salt from now on. I should have stuck to the fundementals and sector trends.

DOH!

What lessons can we take from this investment?

In reality, Dignity’s decline has been a pretty cheap lesson in the grand scheme of things.

Here’s a 50% loser amongst triple digit winners that I invested a lot more money into.

MSFT is up 120% since I bought in, MCD 112%, Apple 91%.

These were all £500 buys.

Luckily, one of my investing rules saved my bacon when it comes to Dignity.

Let me explain – my average investment in a single stock is a strict £500.

If I feel really confident and the stock is meets all my ‘Safe buy’ criteria I’ll go in up to £1,000 as is the case with Unilever and Next. (£800 and £900 respectively)

As Dignity was a small cap stock that had significant risk due to debt and competition, a half position was more sensible.

This is exactly why I arrange my portfolio into a house.

Foundations, Walls, Auxillary.

As Dignity was in my Auxillary it was always going to be a riskier play.

As for Dignity’s future – I’m going to hold and see how things go.

In summary, here are the key lessons I learnt from this investment and my adjustments from here on.

  1. Take EVERYTHING management says with a HUGE grain of salt.
  2. Fundementals and industry trends don’t lie.
  3. I should continue to organise my stocks under the ‘dividend house’ model as this saved me from a material loss.
  4. I should look for companies with wider and more secure economic moats and be wary of a company that’s considering moderate price cuts – this may be a sign of harsher price cuts in the future (as was the case here).

Before going, I have a small favor to ask of you.

At Frugal Student, I hope that you enjoy tracking my portfolio and appreciate the fact that I don’t shy away from any investing mistakes or hide anything from you as a follower.

I’m a full-time student and running this blog isn’t easy.

I don’t earn a penny from this blog and will never run ads on this site – it’s lame and kills the browsing experience.

So, I ask you, if you enjoy my content if you could introduce just one friend to my blog it would mean a lot!

Happy investing.
Lewys

PS: Any questions just drop a comment or E-mail me at – Lewys@frugalstudent.co.uk

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Rolling the dice: Dignity PLC shares.

Hello, and welcome to week 2 of my new year’s resolution to bring consistency to this blog by posting every Monday. Just 50 weeks to go! I’ve been very active…

Hello, and welcome to week 2 of my new year’s resolution to bring consistency to this blog by posting every Monday.

Just 50 weeks to go!

I’ve been very active on the stock market as of late and as such I’m very pleased to present you with my latest buy.

I recently purchased a small position in UK Funeral and Crematoria operator Dignity PLC.

I bought 12 shares of Dignity Plc for a total of £222.00 – meaning one share cost me £18.50 or 1,850p including fees.

Dignity PLC slots nicely into the ‘auxillary’ or ‘roof’ of my dividend growth portfolio – This represents the relatively high risk of this addition.

Links;

1. Business Overview
2. Share History
3. Why I Invested
4. The Dividend
5. The Industry
6. The Risks
7. Valuation
8. Summary

Overview

Dignity PLC is a UK-based funeral operator that operates in three main segments;

1. Funeral Services

2. Crematoria

3. Pre-arranged funeral plans

Funeral services

Funeral services represent 63 percent of the Group’s revenues and relate to the provision of funerals and ancillary items such as memorials and floral tributes. Dignity operates a network of more than 792 funeral locations throughout the UK trading under established local trading names.

Crematoria

Crematoria represent 30 percent of the Group’s revenues and arise from cremation services and the sale of memorials and burial plots at crematoria and cemeteries.

Funeral plans

Pre-arranged funeral plans represent 7 percent of the Group’s revenues. Income represents amounts to cover the costs of marketing and administering the sale of plans. Pre-arranged funeral plans allow people to plan and pay for their funeral in advance.

A brief history of Dignity shares & Why did Dignity shares drop so much?

Since Dignity debuted on the stock market in 2004 it has earned a reputation as a recession-proof cash machine.

The company has easily grown revenue through acquisitions and yearly price hikes of 6-8%.

But what was seen as a recession-proof machine is now somewhat out of favour.

Dignity’s success and high rate of return on capital has enticed competition and as a result, in November, Dignity slumped over 20% to a low of a touch under 1,600p a share after their Chief Executive warned of intense competition in the funeral sector due to an increase in local start-ups.

As most of Dignity’s profit and revenue growth has come from yearly 6-8% price hikes, the market is now spooked that intense competition will strangle margins and lead to slowing or, worse still, declining earnings momentum in the coming years.

There’s no doubt, any need to cut prices and aggressively compete for market share will put significant pressure on the stock.

Regardless of these fears, I swooped in at 1,850p a share.

Dignity’s fall from grace.

So, why did I invest?

Dignity has been on the periphery of my stock radar for a while now but has always been trading at a pretty rich valuation.

But the huge November drop presented me with the opportunity to buy this still growing stock at just 15 times earnings.

Although the funeral care industry is set to become very competitive I am confident Dignity can leverage its scale and its strong cash generation to come out on top when the dust settles and that the current collapse in share price is an over-reaction.

About that cash flow….

One of the main reasons I like Dignity is its ability to generate large amounts of cash.

£58m in 2016 and £73m in 2015.

Such strong cash generation has meant that Dignity has been able to continually expand its operations through purchasing of crematoria (June 2016: 39, June 2017: 45) and acquiring new locations for its Funeral services segment (June 2016: 777, June 2017: 811).

This strong cash flow will enable Dignity to continue acquiring new funeral locations and crematoria to grow its revenue in the short and medium term even if new-entrants succeed in eroding company margins in the short term.

Better than this, such strong cash flow has meant that shareholders have been rewarded handsomely via dividends.

The Dividend

As a dividend investor, a company’s dividend is of utmost importance. This is because a regular dividend helps reduce risk through instant returns and allows me to compound my wealth.

So, what does Dignity’s dividend look like, and is it safe?

Dignity has paid a dividend since 2006 and has increased the dividend by an impressive and inflation smashing 10% a year ever since.

Dignity’s dividend growth.

But is this kind of growth sustainable?

Taking a look at the company’s cash flow for 2016 we can see that the £58m generated in free cash easily covered the £11m paid out in dividends. This results in a FCF payout ratio of just 19%! (11/58 x 100).

As a result of this very low FCF payout ratio – I am very confident that Dignity can continue to grow its dividend at an above-inflation pace for the foreseeable future even if the company faces adversity as a result of competition.

But, a downside to this low payout ratio is that the stock is sitting at a dividend yield of just 1.36%, as a result, investors will need to rely on continued double-digit dividend growth in the far future.

The industry

Funeral services and crematoria are highly specialized industries and one would think that this would provide dignity with a medium, economic moat.

It has spooked investors, therefore, that management is becoming increasingly bearish given the emergence of competition.

I’d even go as far as to say that management took their eye off the ball and took eye-watering price hikes for granted.

But…

As Benjamin Franklin said – ‘In this world, nothing can be said to be certain, except death and taxes.”

thus, the inevitability of death provides Dignity with a somewhat steady flow of business and ensures that the company’s offering isn’t going out of fashion anytime soon!

Better still, the UK’s population is booming and the ONS doesn’t expect that to slow down, projecting continued growth.

It doesn’t look like the services that Dignity offer are going out of fashion anytime soon and such a predicatble and steady flow of business makes Dignity a solid recession-proof play.

The Risks

Having gone so heavily into Card Factory and Next after significant drops in their stock price, readers will be forgiven for wondering why I have invested a mere £222 into these shares.

Well, the answer is that I consider Dignity as a much riskier investment, mostly due to its high debt leverage and the tiny dividend yield.

Dignity’s debt is probably my largest worry.

Dignity is currently holding total debt of £590m with assets standing at just £715m.

This gives a debt to asset ratio of 83% meaning that Dignity is highly leveraged and may find it difficult to access cash if the debt to asset ratio continues to head northwards.

Dignity’s debt pile.

With such strong cash generation, this isn’t a worry, that’s until one considers the direction that Dingity’s management is moving the company.

As competition in the high-margin funeral services sector heats up, Dignity’s management has indicated that it will increase its focus on the acquisition and ramping up of thinner-margin operations in order to fuel revenue growth in future. But – if margins in funeral services get cut significantly due to competition (as management is predicting), the company may become reliant on debt in order to fund these acquisitions.

In the worst case scenario Dignity may face a perfect storm of declining FCF due to tighter margins and the inability to raise revenue through acquisitions due to being highly leveraged although the sheer scale of current cash generation leads me to think that this would be unlikely.

More likely though is that this squeezing of FCF could cause a slowing in the company’s dividend growth leaving me with a low yielding dud!

Valuation

Over the past five years, Dignity has been able to achieve EPS growth (5years) of 9.29%.

BUT – the years of ‘lazy’ growth is over and it’s very unclear as to what EPS growth we could see in the future.

It is therefore VERY difficult to accurately analyze what shares in Dignity are worth today.

If things turn out as I think they will (remember – I have no crystal ball), Dignity will struggle to grow EPS in the short term as competition heats up but will succeed in overcoming the competition and return to higher growth in the medium term.

In order to reflect this scenario, I used the Discounted Cash Flow fair value calculation model to try to put a value on Dignity shares.

I factored in 8 years of EPS growth at 3% and 5% EPS growth thereafter.

This gave me a fair value of 2119p a share.

Summary

Dignity’s management has their work cut out. They can no longer sit back and raise prices by 6-8% a year to smoothly grow earnings.

Increased competition now means they’ll have to work for growth in the future.

The uncertainty in management’s ability to successfully compete and thrive has created a buying opportunity but significant risks remain.

I’m rolling the dice on this one.

Dignity PLC: Speculative auxiliary buy.

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National Grid Shares – My First Buy of 2018 (+ A blogging update)

Blogging Update To skip the blog/life update to go straight to the stock analysis click here. Having been pretty inactive on the stock market as of late, I finally picked…

Blogging Update

To skip the blog/life update to go straight to the stock analysis click here.

Having been pretty inactive on the stock market as of late, I finally picked up some shares in National Grid.

For followers of this blog, this article has been a long time coming as I haven’t posted in what feels like forever!

In September of this year I started a PGCE (teacher training) course with the hope of fulfilling my long term  aspiration of becoming a teacher, after all, this was the whole reason I started my university journey to begin with.

But – it’s been far tougher and time-constraining than I ever anticipated.

It’s safe to say that the hours are longer and the work a lot more demanding than my wildest imagination  – naivety perhaps.

The sheer demand on my time has meant that I have barely had time to meet and socialise with friends, let alone upkeep my beloved blog.

Despite this, I have managed to keep my portfolio in order and my dividend income for this tax year has just peaked above £300 for the first time (with 3 months of dividends to go!)

Not to bore you with negativity, I do have once piece of exciting news – Starting September 2018 I will be taking my first step in a new career direction.

When I started investing I was just frustrated with the terrible savings rates on offer and wanted to earn extra cash.

I wasn’t really that interested in business, enterprise or the stock market as such, this was simply my vehicle to achieving some decent return on my savings.

But, what started as a hobby and some painful investment losses has turned into my core passion.

I now spend hours upon hours (albeit much less since beginning my PGCE course) researching stocks and acquiring investment knowledge.

I now feel like it’s the time to take that leap into getting some accreditation for this acquired knowledge and to learn much more about stocks – more precisely the underlying businesses that these stocks represent.

I’m therefore HUGELY excited to have been accepted to study a MSc in Finance and Business Analytics starting in September 2018.

It’s safe to say that I have been routinely humbled by many of my peers who have completed such a qualification and it is through being humbled that I have aquired most of my stock market knowledge – turning from a sheep following the investment advice of other bloggers to taking independent stock purchasing decisions.

Here’s hoping to acquire some serious knowledge come September – knowledge that will no doubt improve my investment decisions and the value of this blog to readers.

In short – I look forward to being humbled further.

Some essential news to readers is that I will now be posting an article every Monday – a new year’s resolution I expect to stick to – This early article being the first in my string of 52 posts for the year. 

Anyhow – it’s time I stop rambling, let’s take a look at my most recent purchase – 59 shares in National Grid!

I purchased these shares of National Grid (NG.) for an average price of close to 880p a share with these shares adding £27 to my yearly dividend income.

National Grid is currently trading close to a 52-week low of around 850p and to me, this represents a ‘good’ price for a very predictable company that has a great track record of consistently raising its dividend.

National Grid plc is an electricity and gas utility company focused on transmission and distribution activities in electricity and gas in both the United Kingdom and the United States. The Company’s segments include UK Electricity Transmission, UK Gas Transmission, United Kingdom liquefied natural gas (LNG) storage activities;, and US Regulated activities.

In short – National Grid makes sure you can turn your lights on and fire up your gas stove!

At a 5.2% yield – I’m a buyer of this great utility company, but, I don’t expect much capital appreciation from here with shares only marginally undervalued at a 18.24 p/e or a more generous 15.11 p/e if we use the manipulated ‘adjusted EPS’ figure that management is touting – this is compared to an industry average p/e of a touch over 19.2 p/e.

So why are National Grid shares trading at a discount vs the industry?

Utility stocks have been HAMMERED as of late and I feel that there are two people driving this sentiment.

Mr Corbyn and Mrs May.

In Labour’s recent election manifesto Mr Corbyn promised to;

“Take energy back into public ownership to deliver renewable energy, affordability for consumers, and democratic control”.

If this were to happen – National Grid could likely be bought out by the government at it’s Net Asset Value of 497p a share thus meaning investors would lose close to 50% of their initial investment.

Yup – that’s spooky!.

This wasn’t really a possibility – I mean Corbyn was unelectable right?

That’s until May limped to victory and now has to rely on support from the Democratic Unionist Party to govern.

As we can clearly see from the below chart – the share price has declined steadily following the political earthquake following its prior large drop in May due to the stock going ex-dividend on its 87p special dividend.

Surprisingly May is seemingly keen to abandon the neo-liberalist principles of the modern Conservative party by introducing an energy price cap which I argue would have a knock-on effect on National Grid shares due to lower industry profits.

On top of this ‘market noise’ – there are also more concerning fundamental factors behind the current drop – 2017 was down 2.30 pence on the year prior (although adjusted EPS jumped 8.9 pence to  after weak results in 2016 – adjusted EPS now sits at levels similar to 2015).

The current half-year results are also slightly disappointing with operating profit and EPS taking continued significant hits when compared with 2016.

So why buy?

1. National Grid is currently in transition.

After selling two-thirds of its UK gas supply business National Grid is now looking towards the states.

I believe this transition has thrown of earnings in the last few years making National Grid shares appear weaker than reality.

2. National Grid has committed to buying back £835 MILLION pounds worth of its own stock with proceeds of the sale of most of its gas division which will boost EPS over the long term and provide a little more room to grow the dividend.

3. National Grid is that it’s a defensive dividend stock that operates in an industry where demand isn’t going to disappear overnight. We’re always going to want to turn the lights on! – Expect National Grid shares to hold generally firm during a recession.

4. Regulation, regulation, regulation! National Grid operates in a highly regulated industry which provides a high barrier to entry to competition.

The dividend

Any long-term reader of this blog will know by now that I love nothing more than a big fat juicy dividend and with a 5%+ yield I’m a happy investor.

But is this a growing dividend?

You betcha!

National Grid’s dividend policy is to growth the dividend by at least the rate of inflation. This has resulted in a very reliable yet very uninspiring 2% 5-year dividend growth rate and a recent 2.1% increase to the interim dividend.

The dividend is currently covered by earnings at a rate of 1.3 times which would be a close shave for most businesses but this is a highly predictable, wide-moat, recession-proof business with a long history of dividend raises bar a disappointing 3 pence cut in 2011.

But, by taking a close look at National Grid’s Free Cash Flow we can see that the company’s regulatory obligations to invest significantly in its infrastructure leaves it with little room for maneuver in 2016.

2017 FCF came in at 1725m with 1463m of this being paid as a dividend.

Conversely

2016 FCF came in at a healthier 2699m with 1337m of this being paid as a dividend.

Bearish points

This neatly brings me on to the bearish points;

  • National Grid is aggressively investing in North America and infrastructure is expensive and as such, I can’t see the squeezing of National Grid’s FCF going away anytime soon. As such, it is likely that National Grid will have to issue new debt in order to both maintain the dividend (of which I’m confident they will do) and to fund capital expenditure.
  • National Grid’s share price is sensitive to interest rates as it is most generally held for income –  any rise in UK interest rates will likely lead to a short-term decline.
  •  National Grid’s North American operations are thus far proving less profitable than its UK   operations which is worrying given management’s tilt to the States. (Return on invested capital in the states is 2-3% lower than in the UK currently).

Valuation

Morningstar currently has a 990p price target for National Grid shares.

Using the bottom end of management’s 5-7% long-term EPS growth target and a 10% discount rate – a dividend discount valuation models gives me a fair value estimate of 1092p.

Given the attractiveness of the current yield and the slight discount to fair value – I rate National Grid shares an INCOME BUY as a stock that fits nicely into the ‘core holdings’ of my portfolio.

But investors need be patient. Don’t expect much capital appreciation over the short to medium term, this is an income play.

6 Comments on National Grid Shares – My First Buy of 2018 (+ A blogging update)

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