A start from scratch portfolio: Each month Anthony Bolton takes a piece of paper and writes five columns across the top: ‘strong buy’, ‘buy’, ‘hold’, ‘reduce’, and ‘?’. Then he lists every company in the fund under one of the headings.
This technique is a way of getting to ‘a start from scratch’ portfolio – if you were starting with cash now, how would you allocate it to shares?
It helps him question his conviction levels.
In some cases it will highlight the need to do some more investigation to make sure he really understands the positives and negatives, and where more information must be sought (from analysts or from the company’s management).
Mistakes are inevitable
In running a portfolio Bolton says you need to be aware that a substantial proportion of your investment decisions will turn out to be bad however skilled you are – you must not expect to be right every time.
To be involved in managing a portfolio is to make mistakes regularly. If you can keep the mistakes down to only 40 – 45% of your investment decisions, then you will have a good hit rate; one that is superior to most investors.
You only need a few winners to outperform – try to win by not losing too often.
Even with all his experience Bolton reckoned that at least two out of five of his investment decisions are wrong.
Bolton keeps a watch list of companies that he thinks migh
Anthony Bolton is an investor who looks at individual stocks and invests where he sees unrecognised value (a bottom-up investor), rather than first allocating funds to sectors or countries before selecting stocks for the portfolio.
He certainly does not agree with the logic of allocating money to a sector simply because other investors are enthusiastic about it and have bid up the prices, resulting in it becoming a high proportion of the overall market.
For example, he refused to allocate much money to the dot.com, telecom and media sectors in 1999 when other fund managers felt obliged to take part.
But keep a balance
Despite this he acknowledges the need to keep an overall balance within the portfolio so that it does not become too heavily weighted on a theme, sector or a market.
His rules for this are that,
(a) an individual holding should not exceed 4 per cent of the total fund, except in very rare circumstances;
(b) he should not be more than 30 per cent overweight in any one sector, and
(c) he should not hold more than 15 per cent of a company’s equity.
Within these rules the size of his bet on an individual share depends on his ‘conviction level’ for the stock, how risky it is and how marketable it is.
For his Special Situat
There are a number of different types of value shares. I've discussed many times the approaches of Benjamin Graham and Warren Buffett, and, of course, my own as applied to contemporary UK shares. Today we look at the five categories Anthony Bolton concentrated on.
These are businesses that have been performing poorly for quite some time, but there is good reason to believe that matters are about to improve.
Investors, generally, like to be associated with companies that are doing well, which can lead to those in trouble receiving little attention. When a change for the better occurs, most investors miss their chance to invest at a low valuation.
Change can come about because of new management, restructuring or a refinancing.
One area where Bolton has done well is in purchasing shares coming out of bankruptcy, because these companies tend to be completely ignored by most equity institutional investors.
Recovery shares must be split into two groups: those that have a strong economic franchise and those that do not. Only go for the good ones – poor franchise businesses will never recover.
With recovery shares Bolton usually takes a small stake to start with – it is easy to be too early – then as his conviction grows that the worst is over, he adds to the holding.
This could be in areas unfamiliar to most investors, such as an obscure industry.
Another possibility is the firm has a terrific division hidden within the company by the less attractive divisions (e.g., Nokia).
For example, a share is the cheapest in its sector when it does not deserve to be.
Another possibility is that those shares with few trades become underpriced because the market tends to over-price the highly liquid shares and underprice illiquidity.
Bolton agrees with Peter Lynch that firms that sound dull, ridiculous, depressing or doing something disagreeable are disregarded and not owned by institutions.
‘I have always started my search amongst the stocks that
Anthony Bolton, the great UK investor, believes that every share you own should have an investment thesis. That is, you should be able to summarise why you own, or want to own, a share in a few sentences that your teenage son or daughter could understand.
The investment thesis should be retested at regular intervals. When testing it you should think about what might lead to the share becoming ‘bad’; what might the ‘bear’ in the market place latch onto?
Can you provide convincing counter arguments to those who are much more negative about the share?
Bolton is one of those rare individuals who goes in search of disconfirming evidence – people are naturally inclined to search for evidence that confirms their currently held views, so it takes a lot of self-discipline to hunt out disconfirming facts and opposite views.
For example, he lik.......
Anthony Bolton, the great British investor, does not have a favourite valuation measure because he likes to look at a range, believing it dangerous to focus on only one. Note that for all the measures listed below he looks at them both on an absolute basis and on a relative basis.
Absolute values are particularly useful at market extremes to avoid being sucked into a share at times of great exuberance.
He normally looks at the ratio of price to predicted earnings for the current year, and for the next two years. He is particularly looking for companies that are priced at less than 10 times the earnings in two years from now.
Cash flow yield well above prevailing interest rates.
Free cash flow as a percentage of market capitalization. Looking for a high cash flow calculated after paying for changes in working capital and capex as a percentage of the amount investors are paying for the shares. This is both a useful input to valuation estimations and for financial solvency consideration.
Enterprise value (EV) to gross cash flow
EV is the market value of the company’s shares plus its net debt
Gross cash flow is before deduction of interest
EBITDA – Earnings before deduction of Interest, Tax, Depreciation and Amortisation
EV is adjusted down to the extent that there are minority interests and pension fund deficits.
This is a measure examined by companies when valuing a prospective acquisition, it is therefore useful if you are interested in anticipating potential take-over bids.
Prospective free cash flow per share. Next year’s estimated FCF.
Price of shares relative to sales per share, and EV to sales
Particularly useful for loss-ma
The first is excessive debt. Ignoring risk in the balance sheet risk can lead to some bad investments. The companies within your portfolio with weak balance sheets - high borrowings - are the ones that will depress portfolio returns when the economy or an industry goes through a rough patch.
Even if they do not go bust, they may find that their bankers force them to make disposals of divisions to bring down their debt levels. Unfortunately, prospective buyers will often spot they are a forced seller and the price received is reduced to levels below what the company and investor thought they were worth.
Given that an investor has to pay as much attention to avoiding disasters as to picking winners then sidestepping highly geared firms is one way to hold fewer losers.
As well as straight-forward debt you should take into account pension fund deficits and the value of redeemable convertible preference shares where the likelihood of conversion is slim.
Also consider the debt maturity profile: what has to be repaid this year, next year, and so on.
Debt covenants may be onerous for shareholders so check them out.
Some companies select year-end dates when their seasonal cash flows are at a high point. In these cases, the analyst should look beyond the absolute debt levels at the year-end and consider the debt through the year.
The amount paid in interest for the year may be of some help here – if it seems high relative to the year-end debt and prevailing interest rates then, perhaps the debt levels for much of the year were much higher than those reported at the year-end.
Half-year balance sheets often have raised debt levels so it is worth looking at a few years-worth of those.
As regular readers know I regard Piotroski type analysis of financial distress risk, which focuses particularly on the trend in key accounting variables, as useful for getting a handle on the likelihood of the company struggling.
I’m not saying that I will never own a company with a weakened balance sheet – look at Smiths News - but that I will do so with his eyes open and then pay special attention to its progress (I’m expecting Smiths News to reduce its debt dramatically over the next 12 months given its great cash flow).
Will the business genera
Investors need to prepare for meetings with those managers charged with the stewardship of shareholder money. Having good prior knowledge of the publicly available information allows intelligent probing of company performance, business conditions and divisional ups and downs at the meeting.
For AGMs I usually prepare 5-6 key questions to ask in the formal meeting. These are about the issues facing different parts of the business.
In framing the questions I try to be sympathetic to the difficulties and dilemmas facing managers on the front line. I try never to be condemnatory or confrontational - after all they have tough decisions to make.
Furthermore, a demonstration that I don't understand those complexities by crudely complaining about outcomes will not lead to the informal and open discussion I need after the formal meeting.
Review your written justification for the investment you made all those months/years ago and subsequent updates in that narrative.
This should have information on earnings going back a decade, strength of the balance sheet and cash flow generation data. It should also contain a discussion on strategic position and quality of managers (competence and integrity) as well as a consideration of operational risk and financial risk at times of stress. It is for these factors that you are seeking more insight at any meeting with directors.
They feed into your estimates of future cash to be generated for shareholders and thus estimates of intrinsic value.
It always useful to see data for at least a complete business cycle. Often, less than 10 years of data as inadequate and misleading because this will not cover enough variety of business conditions.
Update the data you have on director dealings in the company’s shares - this is a possible lead indicator of an improving or deteriorating business. Trades by chief executives or finance directors are often more significant than those by divisional directors.
Also update the table on s
If you have any questions on trustworthiness or competence, then avoid the company. The people running the firm must have the highest integrity and openness. They must be candid and not prone to hyperbole. You must feel that managers are giving a truthful and balanced view of the business.
They must be willing to discuss the minuses as well as the pluses – because all businesses have both.
And they must be managers who under-promise and habitually deliver a bit more than they indicated. Be very wary of those who promise great advances because they are unlikely to deliver.
“You can’t make a good deal with a bad person” (Warren Buffett). The purchase of shares is a deal: you must be reassured that stewardship of the company is in good hands.
If there are blemishes on their character, then be wary because people rarely change. If managers are unethical and dishonest no amount of corporate governance checks (e.g., outside directors) or accounting probes will reveal the truth; there are simply too many ways for managers to pull the wool over the eyes of investors. They can get away with spin and falsehoods for many years.
Tip: unreliable types
Recovery shares and others that are currently out-of-favor will produce the best returns because buying them is the opposite of going along with the herd. The stock market takes things to extremes. Your job, as an investor, is to take advantage these excesses.
By spending time looking for recovery shares you are forced to go against the herd. This is an uncomfortable thing to do for most people who feel much more confident doing what the herd’s doing. If the press, brokers and everyone else is telling them that Tesla is a good company, then they want to believe that Tesla is a good company.
An indicator that the herd has gone in a particular direction is when many brokers or bulletin board writers are excitedly talking about and recommending buying a certain share.
It’s usually best to have a contrarian spirit.
Common sense says that joining with the excited ones would be a bad move because if the market in general is optimistic the share is probably already fairly or over-priced.
On the other hand, there are occasions when the market gets too pessimistic on things, focusing on the short term and missing the longer-term dynamics of a business.
Often an ideal situation is where things have
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Anthony Bolton is widely acknowledged to be the greatest British investor of his generation. Peter Lynch, the leading American investor, described him as one of the best investors on earth. He was a contrarian-value investor, who searched for out-of-favor, under-researched shares with potential that others have missed. He found most of these in the small and medium capitalisation company sectors.
These undervalued and unloved shares were often found where things had gone wrong (but where redemption is likely) or where the company was going through a period of change.
He looked for situations where he believes that investor sentiment about a company is likely to improve in the medium term.
Bolton managed his funds with an above average risk profile. His investors were asked to live with a greater degree of volatility than the average fund. The kind of medium-sized companies he invested in would often, in a recession, fall further than the large companies.
So, while his approach did very well in the medium and longer term a follower of his philosophy has to accept that there will be uncomfortable periods.
He has a remarkable record. The fund he ran at Fidelity, Special Situations, for 28 years between 1980 and 2007 produced a return that averaged 19.5%. This beat the benchmark FTSE All-Share Index by 6% pa. A £10,000 investment at launch was worth £1,480,200 by the end of 2007.
It is difficult, if not impossible, to find someone who has a bad word to say about Anthony Bolton as a person. Unfailingly courteous, he is described variously as modest, genial, collegial and a great listener.
He has an air of quiet efficiency, of deliberateness in his actions, a manifestation of a very orderly mind; he reminds many people of a quintessential professor with a deep intellectual well and agile mind.
Peter Lynch says that he is ‘cool’ in the very best, most British sense of the word – passionately unflappable, intensely calm. He accepts that he is a fairly unemotional sort of person but counts this as a virtue because emotional people generally make poor fund managers.
What you can learn from Bolton:
The making of a great British investor
Bolton ended up in investment by chance. He had a con
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I'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk
investing is about making the right decisions, not many decisions.