In 2008 I had cause to fly with them for pleasure and business about a dozen times. I had only used them a few times before so my regular use in this year was sheer chance. Although not every aspect of the service was a joy (Speedy Boarders!), overall it was a very positive experience and attractively priced. I noticed that the flights had very few empty seats, in-flight food was purchased at every row and staff on board seemed to appreciate that customers have a choice (not always the case!) This made me think it was a business in which I would be happy to be a co-owner.
I bought shares in December 2008 at £2.52 and took profits from half of the holding just one year later at £4.60. Although the share price has been a little erratic since (due to ash clouds, snowed-in airports etc.), it still stands a fair way above my purchase price.
3. Straight [STT]
The final example focuses on wheelie bins!
I noticed that the number of different bins we had at home had increased from one to three. I then stayed with a friend in Motherwell and noticed they had four, all in different colours! I travel a lot for business and driving around, keeping my eyes open, it appeared that wheelie bins seemed to be growing on every street corner faster than a triffid in a compost heap! It wasn’t just the bins, but the whole concept of recycling that caught my imagination. I made some enquiries and discovered that Straight was a company with a significant stake in the wheelie bin market and was growing both by acquisition and organically.
I bought shares in the company at 67p in June 2009 and today they are priced at 115p (hopefully with more growth to come as I still own them).
The lessons
All three of the above examples are investments I originally discovered when I was just living my normal daily life. Obviously, I researched them properly after they had come to my attention, but the fact is they only came to my notice originally when I was chatting to my daughters, flying about or just driving around my local neighbourhood. It pays to keep your investment brain switched on even when you are away from your laptop!
Keeping it simple
Another point I want to make, which in a way is closely connected in conceptual terms to Buffett’s “circle of confidence” and Lynch’s “investing in what you know”, is the idea of focusing on simplicity when you select the companies you invest in.
The point I want to make here is that some businesses are a lot easier to understand than others. I suggest you make things easier for yourself by vetting out the difficult investment opportunities early in the selection process. The more straightforward the business of a company, the better.
Look again at the three example investments I gave above; they were involved in selling clothes, transport, and making wheelie bins. None of that is very sexy or complicated – just simple, solid businesses.
The greater the clarity in a company’s operations and how and where it makes money, the more attractive as an investment proposition it becomes. I find that opaque is not a good style for a company to adopt for its business plan if it wants me as a co-owner. Nor for the great Warren Buffett, who famously said:
“never invest in a business you cannot understand.”
Nevertheless, some companies seem to go out of their way to muddy the waters. Very often this happens when a company grows by means of multiple acquisitions over a short period. I think you need to be very careful when this happens, as it becomes almost impossible to make comparisons or judgements on a like-for-like basis. They seem to never stand still long enough to do so.
Let me give you an example of a company that I believe achieves the clarity that I seek.
Medusa Mining [MML] is a high-grade, low-cost gold producer based in the Philippines. It is actually one of the world’s cheapest gold producers as it currently produces it at a cost of less than US$190 per ounce. It sells it for more than US$1300. How is that for a simple business case?
Why would you not want to be the co-owner of a business that digs something out of the ground and sells it on for 650% more than it costs to dig it up?
I believe companies with business cases as straightforward as this are ones to put on your investment shortlist. Make life easier for yourself by taking the complicated ones off!
Chapter 3: The PE Ratio
Over the next couple of chapters I will look at what I regard as the two most important methods of evaluating a share: the PE and the PEG ratios. I will start with the Price Earnings ratio (PE), one of the oldest and most widely used measurements.
What is it used for?
The PE measures the value placed on a share by the market–this value is sometimes referred to as a share’s rating.
It has two main applications as a measure of relative value to see whether a share is cheap or expensive:
1 For individual stocks. It can be used to compare the relative value of the current price of one share against another share, or against an index or sector.
2 For overall market levels. It can be used as a means to evaluate how cheap or expensive a whole market, or a sector, is compared to their long-term average or to other markets or sectors.
Why is it important?
The relationship between the value of a company and its level of profits is obviously a very important one. The correlation between share price growth and earnings per share growth is positive and in the long-term very close. Clearly, as the profits of a company rise the price of its shares will ultimately follow – the problem for investors is the exact timing of the share price response to rising profits.
If we can forecast the profits of a company (and this is often possible) and we understand the relationship between a company’s profit growth and share price growth then this provides a possible solution to forecasting future share prices.
Calculating the PE
The PE ratio basically compares the market value of a company with its profits.
To calculate the PE we use the share price to represent the market capitalisation and earnings per share (EPS) to represent profits. The formula for the PE ratio is:
PE ratio = share price/earnings per share
For example, if a company’s share price is 36p and its earnings per share are 4p, its PE ratio is nine (sometimes expressed as “9x” – meaning “nine times”).
If a company does not have earnings (i.e. they are making a loss) then a PE can not be calculated.
One way of looking at the PE ratio is as representing the number of years required for the earnings per share to cover the share price.
Let’s look at two companies:
| Company A | Company B | |
| Share price(p) | 100 | 100 |
| Earnings per share(p) | 20 | 50 |
| PE | 5 | 2 |
Company A has a share price of 100p and EPS of 20p; it therefore has a PE of 5 (100/20); it would take 5 years for the earnings to cover the price paid for the share.
Company