Share Sleuth: why I’ve halved my largest position

Having emptied Share Sleuth’s coffers last month by increasing the portfolio’s holdings in Churchill China (LSE:CHH) and Dewhurst Group (LSE:DWHT), this month I have finally started to confront the large number of shares the Decision Engine would have me sell.

As always, the Decision Engine’s recommendations are based on the scores I give each of the 40 businesses I follow closely, and their ever-fluctuating share prices.

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When it comes to portfolio building and rebalancing, the idea is to own more of the highest-ranked shares and less, or none, of the lowest ranked (see the link to the guide at the end of this article for more detail).

A sea of sells

Even after dividends from Anpario (LSE:ANP), Bunzl (LSE:BNZL), and RWS Holdings (LSE:RWS), the portfolio’s cash balance stood at just £669 on Thursday 1 August, when I sat down to consider which shares, if any, to trade.

The portfolio’s minimum trade size, 2.5% of its total value, was much higher. It was £5,388, so there could be no new additions.

To fund future additions I would have to liquidate some of the eight Share Sleuth shares languishing near the bottom of the Decision Engine table, or wait a long time for dividends to build the cash balance back up to the minimum trade size.

The candidates range from Jet2 Ordinary Shares (LSE:JET2), ranked 29 on the day, to Celebrus Technologies (LSE:CLBS) ranked 38:

Source: Richard Beddard. “ihs” is the ideal holding size based on the company’s score, “Value” is the value of the portfolio’s holding, and “%” is the value of the portfolio’s holding as a proportion of its total value.

All eight shares have an ideal holding size (ihs) of zero. This means their scores are so low that the Decision Engine recommends a holding size smaller than the minimum holding size, which, like the minimum trade size, is 2.5% of the portfolio.

I use a simple formula to derive how much of a share to own as a percentage of the portfolio’s total value. The Decision Engine spreadsheet takes each share’s score, deducts it from 10 and then deducts that result from the score (ihs = score - (10 - score):

For example the highest scoring share of the octet was Jet2, the leisure airline and package holiday company. It scored 6.2, so:

10 - 6.2 = 3.8

6.2 - 3.8 = 2.4

The formula recommends holding 2.4% of the portfolio in Jet2, just under the minimum holding size.

It is so close to 2.5%, I could turn a blind eye. There are more compelling reasons to reduce or liquidate other holdings, and I have another reason to go easy on Jet2. It publishes its annual report later this month.

The annual report will trigger me to re-score the business, so I do not want to pre-empt that. The same is true for Cohort (LSE:CHRT), a gaggle of defence technology companies. Celebrus, a marketing and fraud prevention software as a service business, has already published its annual report. It is on my to-do list.

Technically, engineer Goodwin (LSE:GDWN) is in the same boat. Its results are due on 8 August, around the time this article will be published.

The results may well make me look like a chump, because I have decided to halve the portfolio’s holding in Goodwin.

Reducing Goodwin

In doing so, I chose not to reduce or liquidate the portfolio’s smaller holdings in hospital disinfectant maker Tristel (LSE:TSTL), consumer and academic publisher Bloomsbury Publishing (LSE:BMY), vehicle tracking service Quartix Technologies (LSE:QTX), or sports watch and instrument manufacturer Garmin Ltd (NYSE:GRMN).

Goodwin was in the firing line because of the holding’s size. At a value of £22,610 (10.5% of the portfolio’s total value), it was Share Sleuth’s biggest holding, but it was ranked 36 by the Decision Engine.

Even if I give Goodwin top marks when I re-evaluate the business when it publishes its annual report, a small upgrade, a maximum score of 9 out of 9 would not be sufficient to justify holding as many shares as the portfolio does.

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That is because of the share price. The shares cost 31 times normalised profit, which translates into a price score of -2. At today’s price, the maximum total score Goodwin could achieve is 7 (9 - 2), once we deduct the price score.

That translates into an ideal holding size of about £8,500, way below £22,610.

However compelling Goodwin’s results are, the holding is too big.

Happily, the rising share price is also the reason the holding has grown. SharePad, the software I use to track the portfolio, tells me Share Sleuth has made a 253% return from its three investments in Goodwin so far, which is 14% annualised.

Past performance is not a guide to future performance.

My first trade in 2014 was exquisitely badly timed. Then, Goodwin’s biggest earner was check valves for oil pipelines but a crash in the oil price stymied investment in new infrastructure and consequently Goodwin’s revenue and profit contracted.

Growth in another division, refractory engineering, kept the group afloat as it enlarged its steel foundry so it could make even bigger components, and win new business from the nuclear and defence industries. That business is now building.

It did not always feel like it, but Goodwin was quite an easy turnaround to back. Although the foundry lost money, the group as a whole remained reasonably profitable and its debt never troubled me. It continued to be relatively prosperous through thick and thin.

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My cautious nature and my affection for Goodwin have stopped me liquidating the holding. Instead I decided to halve it.

I slept on the decision. Then, on Friday 2 August, I removed 133 Goodwin shares from the portfolio.

The actual price, quoted by a broker, was £81.09, which raised £10,775 after deducting £10.00 in lieu of broker fees.

The remaining 133 shares were also worth £10,755, which is about 5.2% of the total value of the portfolio.

Share Sleuth performance

The market is selling off as I type, but at the close on 2 August, Share Sleuth was worth £207,585, 592% more than the £30,000 of pretend money we started with in September 2009.

The same amount invested in accumulation units of a FTSE All-Share index tracking fund would be worth £86,662, an increase of 189%.

Past performance is not a guide to future performance.

After the reduction in the portfolio’s Goodwin holding and dividends paid during the month from Anpario, Bunzl, and RWS , Share Sleuth’s cash pile is £11,444.

The minimum trade size, 2.5% of the portfolio’s value, is £5,190.

Notes
2 Aug: Reduced Goodwin
Costs include £10 broker fee, and 0.5% stamp duty where appropriate
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance
£30,000 invested on 9 September 2009 would be worth £207,585 today
£30,000 invested in FTSE All-Share index tracker accumulation units would be worth £86,662 today
Objective: To beat the index tracker handsomely over five-year periods
Source: SharePad, close on Friday 2 August.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.  

Richard owns shares in Goodwin.

See our guide to the Decision Engine and the Share Sleuth Portfolio for more information.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard