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.
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.