Bitcoin has had a stellar year rising from a low of under $1000 a coin at the start of the year to an unprecedented high of almost $20,000 just last week. The general consensus is that Bitcoin is in a dangerous bubble that will pop very soon akin to the Dutch Tulip and South Sea bubbles of many moons ago. Yet the price keeps on rising. Analysts have been pronouncing the death of Bitcoin ever since the price was just a mere $0.23 a coin back in 2010. You can visit the website 99 Bitcoins to view the countless botched BTC obituaries. No matter whether you believe Bitcoin will continue on its dizzy heights or crash and burn, there’s no denying that the underlying blockchain technology will play a paramount role in the transition towards a cashless society.
A look at UK Fund manager Neil Woodford
With every person and their Jack Russell engulfed in the current crypto-mania epidemic, it is easy to overlook other potential red alerts on the financial landscape. Earlier this month, top fund manager Neil Woodford went on record stating that financial markets are entering a bubble phase yet elaborated on this by saying that while many stocks are overvalued there are also many companies, which are undervalued. Woodford has come under a lot of heat these last few months after a number of stocks in his CF Woodford Equity Income Fund portfolio have fallen substantially in value. Yet the stock selection of his portfolio is interesting. While the portfolios of other fund managers are weighted more towards large multinational and defensive companies such as consumer brands company Unilever or alcohol goliath Diageo, and are minimising exposure to the UK in the wake of all the uncertainty created by the 2016 Referendum result (as well as the possibility of an anti-business Jeremy Corbyn led Labour government abruptly coming to power), Woodford’s portfolio is heavily exposed to the UK. Woodford thinks that there is too much negative sentiment towards the U.K. economy and as a result many domestic U.K. companies are very attractively priced (due to panicky investors reducing their exposure to UK stocks) with potentially minimal downside and plenty of upside should sentiment towards the U.K. economy improve.
Warren Buffett, NASDEQ all time highs, and the 2000 dot-com crash
Any good student of the world’s most famous living value investor Warren Buffett would spot these opportunities and at the same time be very cautious of stocks with high valuations trading at close to all time highs. In the USA, the FANG (Facebook, Amazon, Netflix and Google) stocks fit the bill as well as several other stocks trading on the NASDEQ index which has been on an off the charts bull run. The incredibly high valuation of the NASDEQ Index combined with the mesmerising new highs breached by Bitcoin and other cryptocurrencies like Ethereum and Litecoin create the perfect storm for a repeat of the spectacular Dot.com crash of the early 2000s. At the height of the dot.com bubble, the NASDEQ composite shot up to a high of 5000 points around the turn of the new millennium before crashing to almost a 1000 points in 2002. Since the beginning of 2009, after the 2008 Financial Crash, the NASDEQ has been on an incredible run motoring from 1200-300 points to almost 7000 points reaching an all time high of 6,914 points this year. It is today trading very close to that high in the range of 6,840-80 points. Whether history has a habit of repeating itself or not it sure has a habit of rhyming, to quote Mark Twain.
Market sentiment and looking beyond it
One of Buffett’s most famous and often quoted mantras is; ‘be fearful when others are greedy and greedy when others are fearful’. Yet the Buffett pearl of wisdom I’ve always taken to my bosom is; ‘the market can remain irrational longer than you can stay solvent’. One would like to think that stocks are priced according to their fundamentals but it is always sentiment that is the winner. The current Bitcoin craze is the perfect example. Sentiment is incredibly positive and gung-ho towards this creation that is seen as revolutionary and a disruptive game changer in the world of money, and consequently many want in whatever the price. The FOMO (fear of missing out) bug is very strong. But sentiment can always change at the flick of a switch and when that happens it will be the fickle inexperienced investors with weak hands who bail out the first even if that means incurring staggering losses.
Neil Woodford is the quintessential student of Warren Buffett who is periodically on the look out for undervalued and unloved stocks whilst steering clear of expensive and hot overvalued stocks. If positive sentiment towards the U.K. economy returns at some point in the future and Sterling makes further gains against other major currencies, Woodford’s fund will end up not only beating the FTSE index but substantially outperforming the funds of other star fund managers. (Note from June 10th 2020 – I more than realise that I got my prediction on Neil Woodford horribly wrong. To be clear, I am referring here to his ‘value investing’ strategy of finding unloved, but robust dividend paying blue chip companies. A huge part of his downfall was due to him straying away from his investment strategy that for so many years had worked very well for him. Instead, he decided to allocate a substantial percentage of the portfolios of his new funds towards highly speculative start-up growth companies mostly in the biotech field.)
Why has the FTSE been reaching all time high levels?
The root of the FTSE trading at a very high level is because of the high valuations of big multi national companies such as Unilever, Diageo and British American Tobacco trading at (or at least close to) all time high levels and their current combined market caps representing a humongous slice of the total FTSE 100 pie. At around the beginning of 2000, shares in Diageo were trading below £5 a share. They recently reached a high of almost £27 with a total market cap in excess of £65 billion. Shares in British American Tobacco were also trading at below £5 a share around that same time period and over the years have performed very well reaching an all time high of £56.43 earlier this year with a market cap in excess of a whopping £120 billion. Unilever shares less than ten years ago in 2009 after the 2008 Financial Crisis could be snapped up for under £15. Earlier this year they reached a record high of £45.57 a share with a market cap almost nudging £60 billion.
One of the principle reasons why many FTSE companies have been reaching all time high levels in the last 12 months is because, since they are global companies, their earnings are received in many different currencies. When the Referendum result was announced in the U.K. last year Sterling dropped to a 30 year low of 1.34 against the dollar. Since this time, the value of Sterling continued to decline bottoming around the 1.20 mark against the dollar before returning to that initial 1.34 level against the dollar that it was just after the Referendum result. During the last 18 months, these multi national companies have benefited enormously from a weak Sterling valuation and yet in spite of this some are still trading on PE (A company’s share price against it’s earnings per share) ratios of 20 or more. Now what would happen if sentiment towards the U.K. economy were to improve and consequently Sterling were to climb to pre Referendum valuations of 1.40 to the dollar or higher? This would affect the foreign earnings of these multi national companies when converted back into stronger Sterling. And by extension lower their earnings per share. Their share prices would likely cool down quite significantly
Out of the Sinking: Recent performance of recovering blue chip miners
The Holy Trinity of Unilever, Diageo and BAT are all solid bullet proof defence companies but cheap they are not. At the height of the commodities slump less than two years ago around the start of 2016 all of the blue chip mining companies were trading at unimaginably low levels. Today with sentiment towards these mining companies vastly improved, they are trading at much higher levels and, consequently, are not the bargains they once were not so long ago. During that time one could have hovered up shares in Australian mining titans BHP Billiton and Rio Tinto at just over £5 and £19 a share respectively. Earlier this year BHP shares were trading at over £15 each (with an LSE market cap on the LSE in excess of £30bn) whilst Rio shares went over £38 (with an LSE market cap at one point breaching £50bn). Even more impressive is Anglo-Swiss multinational commodity trading and mining juggernaut Glencore. Today the shares are trading at over £3.50 (LSE market cap over £50bn). At the height of the slump Glencore shares could have been snapped up at less than 70p. Many junior mining companies with higher production costs didn’t survive the slump in iron ore prices but the blue chip mining companies with lower production costs got through this difficult period. Sentiment towards all miners at the time was very bearish and that was reflected in the share prices. But those investors brave enough to take the plunge are now, providing they are still holding their shares, sitting on enormous paper profits.
Hunting for bargains
Although some companies are trading at, or close to, historic highs and thus pushing the FTSE index close to record high levels and fuelling fears of a stock market bubble, a large number of companies are trading at heavy discounts. Interestingly the vast majority of these companies are UK domestic companies where sentiment towards the U.K. economy is poor. For example, many of the UK house-building companies, while not trading at the very low levels they once were after the Referendum result was announced, are trading on low PE ratios in the region of 10-11, which is less than the accepted fair value PE of 15. These include FTSE 100 companies Barratt Developments and Taylor Wimpey (both firmly in Neil Woodford’s fund) trading today at £6.28 and £2.03 respectively and both with similar market caps around the £6.5bn mark. If there is any future further weakness in the share prices that would obviously make them even more attractive as investment opportunities.
Two other UK companies in Neil Woodford’s portfolio which are currently very depressed are the FTSE 100 company Capita and the FTSE 250 company Provident Financial. The share price of the latter company collapsed spectacularly back in August this year from a high of close to £35 a share to at one very brief interval sinking to below a fiver. Since then they have currently been trading in the £7-£9 range and can currently be bought for around £8. The crash was rooted in the problems encountered in the business’s Home Credit division. It is a risky share and more downside cannot be ruled out but the potential upside if the business were to recover is huge. Woodford has taken a lot of criticism for the performance of this share yet he remains unfazed and in fact has been accumulating more shares at these new depressed levels. The business support services company Capita has also experienced a huge share price decline tanking from a high two years ago of over £12 a share to its current price of £4.74 a share. The decline in the share prices of both companies means that they now pay very generous dividends. Whether they will be maintained is anyone’s guess but in the case of Provident the current yield is too good to be true at over 15% and for Capita it’s just under 7%.
Two enormous British multi billion pound companies trading at depressed levels are BT Group and energy giant Centrica. BT shares have almost halved in value from a high of around £5 back in 2015 to a low of £2.42. The shares are currently trading at £2.70 with a current market cap of close to £27bn (with nearly that same amount wiped off its from its all time high – quite a dent to the overall FTSE index) and paying a generous dividend yield of over 5%. Centrica has been experiencing an even rougher ride falling from a high of over £4 in 2013 to a low of just £1.33 this year. The last time the share price was below £1.50 was over ten years ago in 2003. Currently the shares are trading at £1.45 and at this level paying a dividend of more than 8%. And at this price the market cap of the company is over £8bn (with around £14bn wiped off the company’s value from its high in 2013). The root of BT’s fall from grace is an accounting scandal at the Italian division of the company. Centrica is struggling with the prospect of political intervention via price caps for its customers and increasing competition. Both companies display certain levels of risk and sentiment is poor for those reasons. One could also come to the conclusion that much of these risks are priced in to the depressed share prices. There is also the risk that those companies now experiencing huge dividend yields because of their low share prices risk having their dividends cut. That cannot be ruled out.
Not all big multinational companies are trading at close to all time highs. The pharmaceutical giant GlaxoSmithKline has a huge global presence and is currently trading at above £13.14 after having fell to £12.70 from a high of over £17 all within the space of this year. At its current level it still has a collosel market cap at around £64.5bn and is now paying a dividend yield in excess of 6%. The company does come with quite a lot of risk despite its size. It has very high levels of debts and the pharmaceutical industry is very competitive. In spite of this GSK is a diversified pharmaceutical business and a huge money spinner. However I think it can still fall further especially if the dividend is cut (which may be a sensible idea to reduce the company’s debt pile) which I see as very likely. This would probably create further weakness in the share price and would be an absolute steal if £10 or less were breached (being a huge company further deterioration in the share price would dent the FTSE 100 composite substantially – every time the share price loses a pound in value, GSK – and by extension the FTSE 100 – becomes £4.9bn poorer).
One more solid British company, which I like that is trading at a low valuation is the defence and engineering service company Babcock. In 2008 after the Financial Crash, the shares were trading under £4 before going on an upward trend reaching an all time high above £14 in 2014. Since that high was reached the shares have been on a downward trend and are now priced at £6.76. This is a substantial discount to it’s all time high. As well as the attractive price its trading on a forward PE of less than 10 and currently offers a not to be sniffed at 3.89% yield. Babcock is also featured in Neil Woodford’s portfolio. What’s more, I see plenty of potential upside to the current price and even the possibility of the dividend being increased.
Disclaimer: For the record I am not a qualified financial adviser. I am not Nostradamus. I have no crystal ball. As always it is very important that you do your own research before making any investments. Never ever make investment decisions based solely on what someone says.
By Nicholas Peart
Written: 11th – 12th December 2017
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