Shares for the future: why I’m losing sleep over these stocks

One share is sent to the naughty step, and two more may join it, warns our companies analyst. Find out who they are here and also what’s stopping him getting a good night’s sleep.

Next week I will conduct my annual appraisal of Churchill China (LSE:CHH). It is a somewhat daunting prospect: the first time since Covid-19 shut businesses down that I must evaluate a company that, I imagine, is barely trading and has only distant prospects of a return to normal. Churchill China makes tableware for the hospitality industry, the ‘eating out’ part of which has substantially shut down.

All but the most optimistic scenarios for Covid-19 require us, or at least anybody considered vulnerable, to keep a low profile indefinitely. If things go badly, restrictions will tighten again, if not nationally, then locally. And at some point, even companies with strong balance sheets who rely on people gathering will have to change radically to survive and ultimately prosper. 

I have not read Churchill China’s annual report yet, and the numbers (for the year to December 2019) are untainted by the virus, but it seems likely I will reduce the company’s score. Churchill China faces new risks, which may require it to change strategy, and that could impact profitability for some time. Profitability, risks, and strategy are three of the five criteria I use to score a share. 

This puts me in a pretty awkward situation. The fourth criteria is fairness. Most of the companies I score, Churchill China included, have the maximum score for fairness because they treat customers, staff, and shareholders well. If I had to choose shares using one criterion only, it would be fairness because these companies and their, relatively speaking, selfless managers and motivated workforces, have the greatest capability to adapt. 

Shares that keep me awake at night

Reconciling these countervailing forces, and the additional complication of the fifth criterion, the market value of the shares, does not keep me awake at night. I go to sleep really easily.

This morning though, I woke up early, and when I rolled over to snatch another hour of sleep before the long commute downstairs to the office, thoughts about Churchill China and some other shares stymied me. Much as I love the company, that is not the way I want to start the day. 

The discomfort of making decisions is one of the many reasons I only review companies once a year.

The most important reason is that I do not trust myself to make good decisions in the moment - as a pandemic is breaking for example. Limiting the amount of time I spend investigating each share also enables me to learn more about other companies and build more diverse portfolios. 

Generally, the companies I choose to score are relatively stable, after all I picked them because they were profitable, I was comfortable with the risks, and they treated people fairly.

Hitherto events that might herald a big strategic shift have been rare and gradual and I have made a mental note to consider them when I next review the share.

The pandemic has increased this cognitive load, though, and I have started to note things to follow up in my Decision Engine spreadsheet. The result is that I am less confident in some of my scores than others.

This is something I know that readers do not, so in pursuit of transparency I have decided to highlight the scores I feel most doubtful about in orange.

I must admit to feeling ambivalent about this innovation. Often the most profitable investments are the ones that conflict us. It is also confusing.

The scores I give companies are themselves confidence measures, and I am essentially overriding a score arrived at soberly during a systematic review, with half-formed thoughts of a feverish mind that has yet to fully come to terms with the new information it is trying to process!  

Nevertheless, these doubts have proved sufficient to stop me trading these shares, a strategy known among investors as “sitting on your hands”, and I am unlikely to be liberated until I have scored them properly.

Hollywood Bowl

In addition to Churchill China (LSE:CHH), I have awarded the orange mark of doubt to Hollywood Bowl, a bowling alley chain.

By the conservative standards of my selections, it was one of three financially stretched companies in the list going into the pandemic and it will probably come out considerably more stretched (the other two companies are Next (LSE:NXT) and RM (LSE:RM.), which may join Hollywood Bowl (LSE:BOWL) on the naughty step). Like the company’s directors, I thought Hollywood Bowl could afford its debts, principally lease obligations, because it is a highly profitable business when it is open. That profitability is founded on a convincing strategy focused on prime locations, family friendly entertainment, and being a good tenant.

Hollywood Bowl has kept shareholders informed about its efforts to conserve and raise cash. It has been industrious too, raising money from investors in a placing, extending its borrowing facility and negotiating a relaxation in the terms of its bank lending, and (reportedly) negotiating a deferral of rental payments with landlords. It seems the company has the confidence of all its backers, but the pandemic has reminded me of two things that I find unsettling.

Although tenpin bowling is a relatively cheap form of family entertainment, Hollywood Bowl’s short history as a listed business means we have not seen how it performs in a recession, even a normal one, let alone one in which gatherings are restricted. I wonder whether, like many of the businesses I favour, the company should have eschewed all bank debt bearing in mind its large lease obligations. The prospect of higher debt may reduce my risk score.

Secondly, Hollywood Bowl’s directors are very well paid and, amid all the cost-cutting measures the company says it has taken, I see no mention that they have sacrificed an element of their pay. If this is true, it may prompt me to reduce the fairness score even though they are clearly working very hard.

Castings

Castings (LSE:CGS), which makes parts for trucks, is in a much stronger financial position. Remarkably, it not only has no conventional borrowings, it has no operating lease obligations, and it is in the process of offloading its pension obligations to an insurance company. 

I have no doubt Castings is prudently managed, but I notched up a new doubt when I noticed that profit in 2019 was no higher than it was on the eve of the financial crisis in 2008.

Historical growth is not something I think much about, trusting that a company’s strategy will produce growth in future, but I already had doubts about Castings’ strategy when I reviewed the company last year, and its strategy score may be reduced again when I conduct this year’s review in the autumn.

Castings’ cash cushion makes it a more comfortable proposition if the effects of the pandemic are prolonged. So does the fact that it is still operating, but I need to consider whether it is worth holding for the next 10 years, given it has not grown for the last 10.

Here are links to the most recent profiles of all the companies in the Decision Engine:

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

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