Individuals living in the UK own just 12% of the UK stockmarket by value, according to the Office for National Statistics (ONS). Peaking at 54% in 1963, it has been in decline ever since. As an economics undergraduate, I’m told everyone should invest.
The decision is framed as a no brainer – if you invest you increase wealth; if you don’t you miss out. Whether it’s down to people not knowing how, or a general unwillingness, only 20% of UK households invest in shares.
I would certainly fall into the category of willing but not knowing how to get started.
The reason I want to start investing is because, in the not so distant future, I will have amassed around £45,000 in student loans. The pessimist in me says it seems unlikely, considering that interest is charged on top of the outstanding debt at RPI +3%, I will be able to pay it back before it is written off 30 years after I graduate.
I currently have money in a fund, which I have let accumulate since I turned 18 nearly three years ago, but if I were to make the most of my £9,250 a year economics course, perhaps I should diversify and use some of what I’ve learned to invest and hopefully pay back some of the loan.
My limited knowledge of investing comes through my dad (Interactive Investor companies analyst, Richard Beddard) who, at various points in my early life, attempted to get me interested in investing. At first, I was reluctant, vowing never to do a similar job to him. However, a few years and half a degree later, here I am.
In the end, it seems not only have I broken my vow, but his approach has rubbed off on me. As I begin my investing journey, like my father, my goals would be to achieve long-term returns, with an emphasis on stability. I don’t expect or want things to change overnight, but to see stable growth over many years – the Arsenal Football Club of investing, but perhaps winning more trophies.
The aim at the end of this article is to pick a stock which, based on my approach and criteria (which I’ll discuss below), I believe will provide long-term sustainable returns on investment.
Over time, and starting with the markets I know best, I’ll pick a stock from each sector, learning more and expanding horizons as I go, with the long-term goal of holding a well-diversified portfolio.
Long run sustainability is an important factor. This encompasses whether a company’s market is growing. It’s important that there is evidence of historical and future growth, calculated by looking at future projections as well as past returns on investment.
Also, the company itself must be growing. For example, in the airline industry, growth would include, but not be limited to, a year-on-year increase in passenger numbers, increase in destinations flown or investment in aircraft which, importantly, is in line with increases in demand.
I’ll use standard measures, such as the price/earnings (PE) ratio, return on invested capital (ROIC) and return on equity (ROE). Measures will be compared to other firms in the sector to gain an understanding of market share and the relative sizes of their ‘moats’.
Warren Buffett coined the term ‘Economic moat’ to describe how a company can maintain a competitive advantage over rival companies to protect profits and market share – the larger the moat, the more they’re protected.
I believe ROIC to be particularly important, as it directly measures profitability and is, therefore, a good way of measuring the size of the moat. I will use 10% – mainly because the cost of capital tends not to be greater than 10%. This is not to say 10% is a cut-off point, but a figure which is consistently about 10% or above implies the company is good at turning capital into profits – the key being consistently – which suggests sustainability in the long run.
I also want ROE of about 10%. However, this won’t carry the same weighting due to potential skewness arising from debt. This means a small amount of net income could lead to a high ROE off a small equity base. If that happens, it would be omitted from any decision.
It’s also important to take a step back from financial data and ask what the person in the street thinks of the company.
Obviously, you can’t expect the average Joe to have an opinion on every company, but positive brand reinforcement cannot be ignored as it’s the consumer who determines a firm’s success. In a sector like food retailers, brands are especially important, and determining why people prefer Morrisons over Tesco, for example, could be very important in determining the overall success of an investment.
Ethical issues also play a significant part in my investment checklist. This is not limited to sectors such as tobacco, where companies such as British American Tobacco (BATS) or Imperial Brands (IMB) produce a product known to impact health.
Companies like Sports Direct (SPD) or Trinity Mirror (TNI), who have engaged in internal unethical practices, would also be excluded, perhaps more so than the tobacco companies. There is no hiding what a tobacco company does, and at least a potential investor has all the information.
However, a sports retailer should only sell sportswear, right? A publisher should only be known for publishing. An investor should be able to invest based on these assumptions, not that Mike Ashley’s Sports Direct was more like a “Victorian workhouse”, or Mirror journalists took part in phone hacking.
If the City gets a whiff of scandal, confidence in the company is lost and share prices are often impacted. Sports Direct’s share price fell around 300p in just over a month and has never recovered. Only four months before the scandal broke, Sports shares peaked at 805p. Total returns for both Sports Direct and Trinity Mirror are far below that of the FTSE All Share (ASX).
Obviously, you can’t attribute all changes in the share price to these ethical issues. There is no doubt the movement away from print journalism to digital and a reduction in readership has led to a falling and non-recovering share price for Trinity Mirror. Historical legal issues cannot be excluded as a reason for investors losing faith in the company – as the graph shows.
When considering a recipe for investing, I wanted to include some traditional criteria, such as ROIC, as well as more contemporary or not thought of figures like ethical issues. I think it’s important investment isn’t just seen from the quantitative, results driven side, as often behavioural factors, like company ethics, can play a large factor in investment success.
Dart Group (DTG) is an aviation and distribution company, originating from Carpenter’s Air Services which flew flowers from Guernsey to the UK mainland. Now, the business makes most of its money from Jet2.com and Jet2holidays (who provide seat-only flights and package holidays respectively), but also owns distribution and logistics operation Fowler Welch.
Long term sustainability is not often a term associated with the airline industry, however Dart Group is not one which fits the regular mould.
Unlike most carriers, Dart operates an older and smaller fleet than rivals, having made their first purchase of new aircraft in 2015 (Boeing 737-800 Next Gen) – at a “significant discount” to the $2.9 billion list price, as they were late production. The main ‘pro’ of newer planes is fuel efficiency, however, with the cost of fuel so low, an older fleet appears a big gamble which has paid off so far.
Many airlines are also guilty of ‘over purchasing’ aircraft. easyJet (EZJ) founder Stelios Haji-Ioannou berated the easyJet board for buying 135 new aircraft, arguing a larger fleet would make it impossible to set prices during a downturn.
Jet2’s purchase, it is anticipated, will satisfy an expected high demand from their new bases in Birmingham and London Stansted. As Jet2 CEO Stephen Heapy put it: “we don’t get greedy”.
Their expansion to Stansted took some by surprise. Stereotyped as the airline which fly’s northerners to Spain, the expansion ‘down south’ represents a new challenge for Dart. With Ryanair, one of their largest competitors, controlling over 80% of Stansted’s total seat capacity, they will be hoping Jet2Holidays takes off, where it is believed Stansted is underserved in terms of package holiday flights.
A move to Stansted also helps exposure abroad as 40% of Stansted’s terminal passengers are non-UK citizens – significantly higher than their other bases.
Dart is also no stranger to competition, having historically seen strong growth despite only 14% of total capacity being on routes where they are the sole operator.
The figures look good too. ROIC was 30.7% for 2016, representing a 12% increase on 2015. It has been consistently above the 10% ballpark figure I set since 2008. Future projections suggest it will be 22% in 2017, falling to 13% and 14% in 2018 and ’19 respectively. The estimated fall would be partly due to a rise in the cost of capital due to new aircraft – which is expected to be financed through debt. Initially, this investment may not lead to increased profit, but further down the line, figures should recover.
Projected PE ratios show an increasing trend from 10 times this year to 13.1 in 2019. However, this is lower than competitors, with both Ryanair and easyJet on around 15 times forward earnings. This suggests to me that Dart may be undervalued.
The consensus among travellers is that Dart’s service is family friendly, good value and has great customer service. It’s why a large proportion of the customer base are repeat customers. If paying customers enjoy the experience, it’s logical that people will come back.
Key risks associated with Dart are shared across the airline industry. Brexit, fuel costs and economic growth may all throw a spanner in the works.
They also need to see long-term growth at new bases in Stansted and Birmingham to fill the new planes they’ve ordered. I believe there is great potential at Stansted, by tapping into a customer base of over 15 million – within 60 minutes travel of Stansted – and introducing package holidays into an underserved area it is highly likely they’ll see passenger numbers soar.
As a frequent user of Stansted airport myself, it will be a welcome relief to have the option of using an airline other than Ryanair. I might even own shares in the company!
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.