Interviews

Interview with Tim du Toit of EuroshareLab

How did you get started in investing?

From a young age I had an interest in business, I was always trading and selling stocks during my school years. In high school I took accounting and that really fascinated me. In 1986, shortly after finishing school, I enrolled in a stock market correspondent course that really got me started thinking about investing from mainly business previously. A year or so later I pooled my limited funds with an investment from my father and started to apply my investment knowledge in the real world.

Can you talk about your investment approach and how it has developed over time?

I made all the classical mistakes a beginning investor could make. I lost a substantial part of the money my dad invested with me using technical analysis to purchase gold shares. This taught me two important lessons. One, be very careful of companies that have no control over the price their products and secondly, technical analysis was not the Holy Grail I though it was.

I then lost even more money investing in ideas from ”helpful” brokers who of course wanted me to trade as much as possible. With none of my ideas working I continued to read as much about investing as possible. I somehow stumbled onto a book called “ Winning on the JSE” by Karl Posel, an engineer and former Professor of Applied Mathematics.

This book was my introduction to value investing. It broke investing down into a logical process with the following steps:

  • If an investor does not know what he is doing then the stock exchange is no place to be doing it
  • Purchase only after the announcement of interim or final results
  • Buy only where interim or final results indicate an increase in earnings per share and/or dividend per share
  • Only purchase shares where the calculated value is more than the market price using sector price earnings ratios and earnings per share
  • Realize that the price of a share can behave illogically and have the courage of your convictions to realise that logic will once again return to the market.
  • Do not purchase a company’s shares if its long term loans are more than 20% of its share capital and reserves
  • Do not purchase shares of a company where its pre-tax return on capital employed is less than 15%
  • Do not purchase shares that have a weekly trading volume of less than 20,000
  • Have some knowledge of the company concerned. Satisfy yourself about its history, track record and modus operandi. Read Managing Director’s and Chairman’s reports
  • Sell when the price earnings ratio or net asset value exceeds the sector price earnings ratio or share price is higher than its net asset value

The book made immediate sense to me, giving me a framework that can be applied to investing.

For the next 20 plus years I studied the results of every possible book, research paper and investment study I could lay my hands on that showed superior long term performance – and I still do.

This of course led me to Benjamin Graham, Warren Buffett, David Dreman, James O’Shaughnessy, Joel Greenblatt, Joseph Piotroski etc.

All this research led me to develop my own unique investment approach that is completely value investing based.

How did you weather 2008 and the first part of 2009?

I did quite well.

I had a bad 2007 because my largest investment went bankrupt. I made the mistake of making an investment in a small UK company called Lambert Howarth too large of a holding in my portfolio. The company lost a customer that made up 50% of its sales and at the same time and soon thereafter announced it was entering administration.

It was a very painful lesson I learned. This loss made me very careful as 2008 came by. I was also not finding a lot of really attractively valued companies. This led to my portfolio being about 80% in cash when things started falling apart. It was still painful as I ended the year with a loss of 12.8%. This was not nearly as bad as the 33% loss the FTSE All Share had or the 46% loss of the Europe STOXX 600 index.

In 2009 I waited on the sidelines far too long. I thought there was going to be another leg down later in the year. This kept me out of the market to a large extent. I ended 2009 with a gain of 6.5% while being 70% in cash, substantially less than the 25% plus that most world indices returned.

So overall I did a lot better than the markets. Not losing nearly as much in 2008 but not gaining as much in 2009. More information on my track record can be found athttp://www.eurosharelab.com/track-record

How do you typically find ideas and what is your selection process before an idea gets added to your portfolio?

I use screeners a lot. Over time I have put together a lot of criteria I screen for. The screens come up with a list of companies that I analyse using . a 50 point check list. The check list is not rocket science but it forces me to think systematically and not to overlook anything.

Companies that make it through the checklist get analysed further. I read the annual reports, look at presentations and listen to conference calls when available.

Once I am comfortable that it’s a good business and there is a margin of safety I invest. I also read letters by investors I admire for investment ideas. But I always do my own research.

How many positions do you typically have in your portfolio and what are your ideas concerning portfolio composition?

As a general rule I try not to have more than 30 positions. This is the number of companies I have found I can easily keep track of. More investments ties up too much time and I then am not able to look at enough new ideas.

Within the 30 companies position sizes vary. I used to have all my positions more or less equally sized but that changed when I did a lot of research on the subject and saw a great presentation by Zeke Ashton on the subject.

I wrote about it in an article titled How concentrated should you be?

At the moment I have 29 positions in my portfolio with sizes ranging from 2% to 6.5%.

Describe some of your biggest investment mistakes and what did you learn from them?

This is an easy question to answer. Isn’t it funny how we remember losers but forget winners?

For the life of me cannot say what my best investment was. I can however easily say what my biggest mistakes were.

The largest one was Lambert Howarth, the huge loss I had in 2007 (mentioned above) when the company went into administration. I am still in the process of writing something about the whole process but the basic story is as follows:

In July 2006 I identified Lambert Howarth on one of my screens. It had no debt and cash equal to 7% of book value. It was trading at 0.44 times book value. Looking at the average of the last seven years the company was trading on a price to earnings ratio of 2.5 and 3.1 times free cash flow per share.

It had a market value of £15.2 million and in 2005 bought back shares with a value of £10.2 million. And based on the 2005 dividend it was trading on a 14.7% dividend yield.

The company looked very cheap.

I invested in August 2006, and after I invested the share price kept on going down. I re-evaluated my analysis and decided to buy more. As the share price declined I kept on buying more until the company made up 15% of my portfolio.

Shortly after, the company announced that it had lost their largest customer, Marks & Spencer shoe account. Marks & Spencer accounted for 50% of their revenue. Not long after, the company announced it was going into administration.

Looking back at my notes and analysis my decision to invest was correct. What was wrong was me continuing to buy as the share price went down.

Since then I am a lot more conservative with positions in small companies. And I consider stop loss levels a lot more, especially if an investment continues to decline after I have decreased my average price by buying more as it drops.

My other large mistake was with the sofa retailer SCS Upholstery that also went into administration after credit insurers cancelled its cover.

You can read more about my experience with SCS in a comprehensive post mortem.

It’s never too late to sell http://www.eurosharelab.com/newsletter-archive/398-its-never-too-late-to-sell

Do you follow any key risk-management guidelines in managing your portfolio?

I do follow a relatively strict stop loss and trailing stop loss strategy. I decided on following a stop loss strategy because of my experience with Lambert Howarth but also due to the following reason:

My investment process is focused on buying undervalued good businesses that have a high probability of increasing in price. But investing is not an exact science I may also be wrong. I thus want the investments I have correctly identified to run but minimize losses from wrong decisions as quickly as possible.

I also follow a trailing stop loss strategy mainly on investments that have substantially increased in price. I started doing this after looking over the performance of investments after selling (I keep a separate portfolio) and realised that a lot of the investments went on to increase a lot further in price after selling at what I thought was fair value.

In order to participate in this momentum I follow a trailing stop loss strategy on companies I have classified as fairly valued. I also move these fairly companies to a separate part of my portfolio.

What is the current geographic mix of your portfolio?

I had to calculate it as it’s not something I purposefully look at. I have no limits on country concentration; I look for undervalued companies irrespective of where they may be. Germany, France and the UK make up 59.7% of my portfolio, with the USA only at 9.4%

How do you manage currency exposures?

I have done a lot of research on the subject but in the end it all pointed in the direction that it’s not worth it.

My own portfolio is not very large. You can only really hedge currencies economically once you have a portfolio of €5 million or more. Again I look for undervalued companies irrespective of where in the world they may be. That is what I do I am not looking to play around with currencies.

A good research paper on the topic can be found at the Brandes Institute (http://www.brandes.com/Institute) called “Currency Hedging Programs: A Long-Term Perspective (April 2007)”

How did you get involved in writing an investment blog and publish a newsletter?

I wanted to write something like a blog for the private bank I was worked at. They however declined the idea due to regulators concerns.

The idea did not want to go away and I asked management if I can do it in my private capacity. Because of my investment approach was so different than that of the bank they agreed. So in June 2009 Eurosharelab was born.

What has been your most notable success while blogging and why?

When I set up my website I also wanted to write something to educate investors. Especially someone that was new to investing. I started a free newsletter where I write about things I would have liked to know when I started investing. I try to only include the most valuable things I have learned over more than 20 years of experience. I am glad that visitors have found it helpful. At the end of February 2011 I had more than 1200 subscribers.

What has been your most read blog posts and why?

The most popular page on my site is a resource page I put together on James Montier .

It is basically a long list of all the articles I could find on him in the internet sorted by year.

I met James at a seminar in Italy and really liked the way he explains complex investing principles in an easy to understand way. Also he backs up everything he says with data or research.

I mainly write about things I have found helpful.

From the comments I have receive its unbelievable how we all struggle with the same problems and we think we are all alone.

What company do you find interesting at the moment and why?

I mainly look at small and mid-cap companies in Europe the UK and Scandinavia, because I have found them to be the most undervalued.

There are a lot of good value investors that only look at the US market, but there are much more bargains in Europe right now.

Here are a few examples:

Clinton Cards – Sells cards in gifts in the UK

Kappahl – Clothing retailer in Sweden and Poland

William Hill – Largest bookmaker in the UK

DS Norden – Danish shipping company

Disclosure (11.03.2011): I have a position in Kappahl and William Hill

What is your view on the sovereign debt problems in Europe?

I think a debt restructuring is inevitable, for all or the bulk of the countries currently experiencing debt problems. Politicians are treating this as a liquidity problem but it is not. It’s a solvency problem. These countries have all borrowed too much but do not want to admit the fact.

Investors are demanding a higher interest rate because of the increased risk. And the politicians are blaming speculators. As a lot of people have written, you cannot solve a problem of too much debt with more debt.

I have no idea if these countries will remain in the Euro zone when they restructure. Who ever said that a Eurozone country cannot default? Bankers taking their book have so far convinced the politicians that it cannot be allowed.

I think German Chancellor Merkel was correct when she said private investors must carry part of the cost of bailouts in the form of haircuts.

Any investor holding Greek, Irish or Portuguese bonds must seriously consider the probability of default by one or all of these countries. If they do not have enough capital to manage the losses they should get rid of the position. Buying or holding these bonds while lobbying and arguing for bailouts isn’t an investment strategy it’s gambling!

What I am relatively certain of is the weak Euro has been the biggest stimulus package the German economy could have hoped for. German exports are booming so they can afford to help the struggling Euro members up to a certain point.

Should the Deutschmark have been reintroduced at the beginning of the crisis, German exports would have been a lot lower as the Deutschmark would have been as strong as the Swiss Frank and the Norwegian Krone.

Tim, thanks for your time

Thank you Jacob.