Nick Train the King of Buy and Hold

NICK TRAIN, Joint Founder and Fund Manager, Lindsel Train

uying below book or buyinga low P/E stock or going contrarian, you have much to learn fromNick in. Nick doesn't look for any of the these when hunting forstocks. He doesn't even try to spot the n multi-bagger. And yet,

when he finds companies he likes, he keeps them for years. An

every value investor how to invest for value. Read on.

John Templeton once said, "Historyshows that time, not timing, is the keyto investment success. Therefore, thebest time to buy stocks is when youhave money" - a philosophy you share.Whatwould you do in a 1999 or2007-like scenario? Continue to invest? Yet

another view says, "Wait till there is'blood in the streets'." How do Vou

reconcile these two?I have never suffered from anydelusion that I am an unusuallysmart or far-sighted investor. A keensense of my many investingIimitations means I have had tokeep my approach simple. I ammostly concerned with avoidingobviously bad or'losing' investmentbehaviour such as over-trading orbacking low-quality companies andI'm willing to stick with basicinvestment principles that seem tome likely to work over time, evenaccepting there will be periodswhen they don't.

Your first question is a goodexample. For a while, as aninexperienced investment

40 | Wealth Insight February 2016

professional, I tried to judgewhether equity markets were cheapor expensive. I even allowed myseJfto express pessimistic views aboutmarket prospects in public and,worse, to act on them. Now lookingback over the thirty or more yearsof my career, it seems to me everyone of those negative calls I madeon markets was just plain wrong.They've gone up a lot over time andin hindsight there was alwayssomething to be enthused about.And iikely there always will be.

Eventually I acknowledged, forme, the futility of such guessworkabout market levels and concludedthat it makes good commercial,investment and - perhaps mostimportantly - emotionaL sense to bepermanently bullish. This, I believe,is good, 'winning' investmentbehaviour. Being bullish brings acompetitive advantage over themany market participants who areeither negative because that is theirhabitual outlook on life (an outlookthat tends to overstate temporaryproblems and to underestimatehuman problem-solving ingenuity)or who back themselves to trade in

February 2016 Wealth Insight 41

and out of equity markets on the basis Nick Train's human needs and wants. Investorsof their hunches about market levels; Career fret about the cyclical wobbles of

economies and periodic spikes and

Itl,- dips in equity prices but these arerr

' I qrr I

irrelevant to this central function of000 stock markets and to their long-termtrajectory For instance, people

opposite - I'm an optimistic buy-and- Equities, worry today about a turn in globalholder. In this way I put history on my M&c interest rates. I understand this is anside, given the long-term propensity of lnvestment issue if you invest in governmentstock markets to go up over time, Management bonds. But what equity investorsAnglo-Saxon ones at least. In addition, about isI feel a lot better about myself - being holdsoptimistic keeps you young! will

Admittedly this determined Europe continue to double every two years,bullishness means that periodically I (latest as it has for the past fifty). This is faram 'long and wrong' about stock position held)' more relevant to the outlook formarkets, including 1999 and 2007. Iotal stocks than the vacillations ofThis is no fun at the time, but holding interest rates.cash when markets are recovering is term chart of lIeven less so. market vou se

accumulation of long-term value isWhat amtrding to you, indicates that the associated with the emergence ofmarket is expensive or cheap? Arc dividend yields a new industries, new companies or thegood indicatoP productivity gains brought by newIn my opinion, nothing reliably indicates technology The ups and downs of interestmarkets as cheap or expensive. For this reason, rates? Not so much.as outlined above, I believe it is a better bet to I'm su.re that if you're optimistic aboutassume that equity markets are always cheap. technology and innovation, then you should beThe long-term returns from stocks suggest that optimistic about equity markets. In that sense,

this is not as deluded a proposition as it might markets are always cheap.appear to be.

Of all the losing investmentapproaches out there, that of being

a pessimistic trader must be the mostcertain to lead to disappointing returns

The fact is stock markets are driven bytechnology innovation and the associated riseand fall of industries brought about by thatinnovation. As a result, the constituents andindustry weights of markets are alwayschanging, so trying to judge the value theyoffer in relationship to a different historicalperiod is pointless.

It is wrong to think that stock marketsexist in order to make investors wealthyThis is a possible but by no means certainoutcome. No, markets have evolved as themost efficient means so far to test andfinance new ideas about how to satisfv

When market yields are below gilt yields, do you

still buy equities or wait it out?Gilt yields and stock-market average dividendyields are irrelevant if you have identified agood equity idea. Good ideas are rare, in myexperience, so buy

Equities, you mentioned in one of your insights,perfom well in recession years. How do they dothat if eamings are down?The 'duration'of the stock market can bethought of as its dividend yield divided into100. So, a 3 per cent market yield gives aduration of 33 years. One or two years ofrecession-depressed earnings are of littleimportance when investors, whether theyknow it or not, are looking out over this sort oftime horizon.

You have quoted Deirdre Mc€loskey, "a morereasonable diagnosis... is that booms and busts


arise from unconectable optimism and pessimismabout novelties." Do you see any novelties that canbecome a boom-bust scenario ahead?I certainly hope so. Booms ald busts areintegral to markets and without them theycan't do their job, namely flnance new ideas.We pejoratively describe booms as manias,suggesting that individual investors havebecome irrational - carried away by greed.This may be so, but at the societal level thesemanias are, in fact, quite rational andbeneficial. We wouldn't have Facebook andGoogle without the mania of 1992-2000. Andmany treatments for previously intractablemedical conditions will emerge from thecurrent biotechnology boom.

You ascribe a lot of significance to dividend-payingcompanies. What of companies that skip dividendsto invest in groMh?Yes, dividends are interesting, particularlyIong-term dividend histories of industries andcompanies, but maybe not for the reasons youmight think. Here's why

Technology change is the big driver of bothwealth creation and destruction. How does anequity investor respond to its chalienge? SomeIook to participate in cutting-edge technologyitself and this is probably the most rewardingapproach, particularly if you have a superiorunderstanding of the technology and thecompetitive advantages of the companies youchoose. I do not have this expertise. InsteadI've chosen another response: that ofidentifying companies whose value-added isunaffected by technology change, oq evenbetteg companies whose value-added can beenhanced by applying technology to itsexisting franchise. For example, Burberry is acompany whose brand and heritage have madeits products desirable for well over 100 years.And Burberry is now demonstrating how thedeployment of digital marketing techniquescan make its brand and heritage even moreaspirational. Technology can'tdisintermediate Burberry's products as itmight, say a telephone company But thecompany czui use technology to reach morecustomers and understand them better.

This means that longevit5l tradition andpredictability are important investmentcriteria for me. If a business has not iust

Nothing reliably indicates marketsas cheap or expensive. I believe it is

a better bet to assume that equitymarkets ale always cheap.

survived but thrived over previous periods oftechnology change, then there is a possibilit5lnever a certainty that it will continue to doso. For this reason, I am interested in thelong-term dividend histories of companies. Ifa company has proven capable of payinggrowing real dividends over long periods, it isa signifier that here is a business model orset of assets that has retained relevance andoffered protection against past disruptivetechnology change and the effects ofmonetary inflation. Of course, the past is nocertain guide to the future. But I prefer tostart from identifying existing great, durablefranchises and asking what could hurt themrather than trying to predict the nextgeneration. If at all possible, I avoidcompanies that appear to be certainlyvulnerable to technology change, however'cheap'they may appear. That seems to me tobe the most difficult approach of all.

lnvestmentprinciplesfollowedInvestorsundervaluedurable, cashgenerativebusinessfranchises.

Goncentrationcan reoucerisk.

Transactloncosts are a'tax' onretu rns.

Dividendsmatter evenmore than youthink.

February 2016 Wealth Insight | 43

Longevity, tradition andpredictability are important

investment criteria for me


You hold companies for many years. When, in yourview, does a company start losing the plot and is onthe sure path of decline? Are there any indicators?I don't like it when a theoretically cash-generative business model stops generatingfree cash. AIso if debt builds up for no goodreason, alarm bells ring. A long time ago Imade a bad mistake investing in the musicindustry I failed to understand how technologywas unravelling the record iabels' superioreconomics based on copy'right. The problemssoon showed up in falling free cash flow andrising debt. I should've reacted quicker.

Generally though I agree with Buffett thatinvestors are too ready to sell out ofinvestments, that they are too confident thatdoing something, as opposed to nothing, willmake a positive difference. It seems to methat it is more likely that experienced, smartmanagers of a company with temporaryproblems will find a solution to thoseproblems than that I will successfully switchout of said challenged company into a betterone. That might sound defeatist, but in acompetitive capital market, with otherinvestors highly alert to risks andopportunities everywhere, it is hard,particularly after costs, to demonstrate thatregularly trading in and out of companiesadds value.

Why is mismanagement of retained earningssignificant? Are there any indicators that signalsuch mismanagement?Sadly not until it's too iate.

What is a baggefi What are the qualities you lookfor in a bagger (or in a prospective investmentstock) and what not?A bagger is a stock that goes up multipietimes on its purchase price. So far as I knowthe first investor to use the term and to buildan investment approach around looking tocapture as many baggers as possible wasFidelity great Peter Lynch. But credit too toBill MiIIer, whose dictum "He who has theIowest book cost wins" expresses a similaridea. It seems almost a poiniless truism thatthe best investment you can make is onewhich rises many times over and that younever have to sell. But my observation is thatfew people invest in such a way as to give

themselves the best chance of multiplyingtheir capital because they're always, as thecliche runs, pulling up the plant to look atthe roots.

In the end, I think there is a psychologicalfactor here. There are those who love to trade

- to take cutely timed profrts and move on tothe next idea. Variety keeps them engaged.Then there are the hoarders. People whopainstakingly accumulate holdings in valuablecompanies over the years, harbouring themduring periods of underperformance, buyingmore on the dips - monitoring the gradualbuild-up of book value and dividends overtime. It takes patience. Both are equally valid.Perhaps the most important learning for everyinvestor is to figure out what psychological

, type they are.An old friend of mine - an investment

banker actually - Iikes to point out that thedividend per share he receives today from hislongest-standing personal equity holding ishigher than the price per share that he paidfor the stock - although, admittedly it waspurchased 25 years ago. Isn't that amazing?Only equity can do that for you. But you haveto own the right company and you have to bepatient. I always teII our clients that weexpect to be invested in the companies wecommit their capital to for a long time. We'relooking to stay invested over the course ofseveral business and stock-market cycles -way way longer than many professionalinvegtors. Of course, this sort of strategicapproach is not perfect. We're not nimble -not because we couldn't be, but because wedon't choose to be. We'll holdunderperforming businesses and sharesmaybe for too long. But there is a big benefittoo in what we do. We're giving ourselves andour clients the best-possible chance to benefitfrom compounding, which takes time.

Never invest in anycompany that makes

GF Lindsell Train UK Equity FundPerformance is for the CF Lindsell Train UK Equity Fund Acc Shares. This fund is a UK-domi-

ciled retail scheme, with an inception date of July 10, 2006. Perfomance is provided net offees in GBP (management fee 0.65% p.a. and TER 0.77% p.a.l. The fund's benchmark,

FTSE All-Share, has been provided for companson purposes.

OFund net returns (GBP%) € Index returns (GBP%)

t4

July 2006

Both, in your UK Equity Fund and the GlobalEqui$ Fund, you have no investments incommodities, industrials, mines, cement, steeland real estate. Why?

Investing is challenging - both intellectuallyand emotionally I prefer to avoid investing inindustries which I know for sure have grosscyclicality of earnings and./or which rely onborrowings to make their returns. I'm notsaying there aren't great opportunities to makemoney in these sectors. It's just that youalways have to remember to sell and I, being ahoarde4 prefer to own stuff I hope I never tohave to sell.

My two favourite pieces of investmentadvice help explain these preferences. 'Neverinvest in any company that makes anythingout of metal'. And'If you find a companywhose products taste good, buy the shares'. Byand large those two rules have helped me avoidthe worst investment errors and pointed me tosome of my best ideas.

In some stocks, with high dividend yields, is thercnot a dsk of getting into a value trap, wherc thestock behaves like an annuig but does not offermuch long-term stock pdce appreciation? How doyou identiff and do you in in such stocks?Just never buy anything for dividend yieldalone.

FavouritebooksWanenBuffet WayHagstrom

One Up onWalI SteetLynch

Stocks forthe Long RunSiegel

Big ShortLewis

WhatTechnologyWantsKelly.


anything out of metal. And ifyou find a company whoseproducts taste good, buy theshares.

LeisureactivitiesSpend timewith familyReadingYoga

In a recent interview, you said you have not boughtanything new for the last four years. What did you

mean, and what did you do during that period? Doyou wait for a fat pitch, as Buffett says? How long?Yes, I've just been through a four-year droughtwhen no new idea seemed sullicientlycompelling to supersede existing holdings. I'vebeen lucky enough over that period to enjoystrong flows into my fund and had no probleminvesting that cash into the currentconstituents. Doesn't Buffett say somewhere,"Often the best idea for new money is to buymore of what you already own?" I think it'sinteresting that this four-year period hascoincided with a streak of competitiveabsolute and relative performance from thestrategSz Activity is overrated!

Exceptional oompanies with durable competitiveadvantages arc often not cheap. Would you buy a

Diageo at 40 or 50 times eamings? What is themaximum you would pay for such companies in

terms of eamings multiples?Actually I'd argue the opposite. To me itappears tJrat'exceptional companies withdurable competitive advantages' are in factcheap almost all the time.

The point is such companies are rare. It isplain wrong to expect them to be valuedsimilarly to what is the vast majority ofephemeral, Iow value-added businesses. I liketo think about the conundrum of 20. Manyinvestors presented with a stOck on 20 timesearnings - Diageo for instance - will say that'sexpensive, relative to, for example, the long-mn average P/E multiple for Anglo-Saxonmarkets of 15. Howeven if I offered thosesame sceptical investors the opportunity toinvest in an asset with a guaranteed 5 per centyield, with likely protection against inllationover the next 25 years, with some real, above-inflation growth thrown in too, they'd fall overthemselves to buy Diageo seems to me to offersuch potential, by the way Yet, of course, the'high'P/E of 20 and the attractive real yield of5 per cent are one and the same.

So. a rule of thumb for me is that anexceptional business cal easily justify avaluation up to 30 times earnings or a realearnings yield of over 3 per cent. After all,idlation-protected government bonds arekeenly bought by investing institutions todaywith starting yields of lower than 1 per cent.

How can investors use the gilt rate to come up witha discounting rate to anive at the intdnsic value?Can you explain with examples?I do use the long gilt yield as a discountingrate, but it is important to understand that anyresulting measure of value is very imprecise.

To my mind, the real benefit of the exerciseis the questions it forces you to answer aboutthe company you are proposing to value. TheIongest dated government bonds have lives of30 up to 50 years. If you're going to use theseinstruments to value an equrty then first youmust have a reasonable expectation that thecompany will have a similarly long life.Otherwise, you are not comparing like withlike. Of course, most companies will notsurvive for 30 years or more. Most companiesfail. So just applying this filter -'will such andsuch a company likely be around in 30 years?'

- savagely reduces the universe of potentialinvestments for me. But every so often youcome across a business with a brand or afranchise that has survived and thrived overmany decades and where it doesn't seemtotally absurd to expect it to continue to do so.

Then you can start thinking about its valuecompared to a long bond. The next question is

-'how likely is it that this durable corporateasset will be able to grow its cash earningsover the next 30 or more years ahead of therate of fullation, whatever that turns out tobe?'Again, this is another unanswerablequestioq but again history suggests fewcompanies are able to maintain the real valueof their products or services over time.

But say you decide that Diageo's brands,Johnnie Walkeq Guinness, Captain Morganetc., are likely to at least maintain their realpricing power over the next three decades andmight even offer some inllation-beatingvolume growth too, as the world's spiritdrinking population grows. If you have madethat decision, then you're immediately facedwith the critical question at the heart of ourinvestment approach. Why should Diageo, or

Exceptional companies with durablecompetitive advantages are cheap

almost all the time

46 lWealth lnsight February 2016

any other of these rare wonderfulcorporations, be valued at less than agovernment bond? We know for sure that thebond wiII pay its fixed coupon for the next30-50 years. That's something. But we alsoknow for sure that the government bond willbe unable to protect investors against theeffects of unanticipated monetary inllationover time because the coupon is fixed.--'-.--'-Meanwhile,

we've already agreed thatrJrageo wiII not only have survived over theIife of the long bond, it will likely inaddition, have grown its earnings ahead ofinflation. This means Diageo ought to beworth very much more than a governmentbond to a long-term investor. But when youlook at current valuations, you find thatthis is not the case. The longest UK gilt has

' a redemption yield of 2.4per cent, or a P,/Eof 47.7 (L00/2.4).In contrast Diageo trades ata prospective P/E of 20 (according toBloomberg) or a yield of 5 per cent (100/20).If Diageo were to be valued just in line withthe UK long gilt, it should today be tradingat 840, rather than its market price of f,18.And there is a clear case to argue thatDiageo ought to be worth more than a giltbecause of the likely real growth it offers.

The above is in no sense a formal targetprice for Diageo. I don't know any certainway of arriving at the 'correct' value of anyasset. What I do know though is that I'vebeen asking the right questions about theattraction of any equity asset. And thething is history supports the propositionthat those companies that do succeed ingrowing real value over long periods oftime are not only rare, they are alsoextraordinarily valuable.

India's bank deposit rate is about 8.5 per cent.Should this be the minimum yield rate to demandfrom quality stocks? What if the yield rate offeredby high-quality stocks is lower than 8.5 per cent?

Companies that glow* real value over longperiods of time are not onlyrale but also extraordinarily

Lindsell Train Global Equity FundPerformance is for the Lindsell Train Global Equity Fund B-Class shares. This fund is Dublin-domiciled, with an inception date of March 16,2011. Performance is shown net of fees (man-agement fee 0.65% p.a. and TER 0.79% p.a.). The fund's benchmark is the MSCIDeveloped World and this is shown for comparitive purposes.

OFund net returns (cBP%) I Index returns (GBP%)

9

6

0

-5

-6

-9

March 2011 December 2015Source: l\4orningstar Direct

Should one wait for markets to cool down or yieldrates to go up?No. Short-term interest rates have nobearing on the long-term value of a realasset like a quality stock. Given longenough, its share price wiII correlateperfectly with its growth in free cash flow.

How do you value whether a company isundervalued or overvalued: DCF, free cashflows or private market value, or a combinationof all?On my time horizon, the calibre of a companyis much more important than its value. Youcan be wrong about value in the short term,but still have a great investment over time. Myworst errors have come from overestimating acompany's business model, not overestimatingthe worth of a fine companlz

That said, I pay a lot of attention to M&Aactivity in the sectors that I invest in. Oneactual transaction - when serious businesspeople, staking long-term corporate capital,are prepared to buy or sell 100 per cent ofthe equity of a business - is worth dozens ofinvestment-bank research notes.

FavouritesectorsConsumetbrandedgoo0s

Media(including,computersoftware)

Pharma(includinghealthcare)

' Retailfinancialservtces


When should a person sell a long-terminvestment and when not?Best to never sell.valuable

Dxcerpts from Nick TFain's'Investment Insights'

Lynch LawAugust 2OI5

I'Iamously Lynch built his

l{ investment performance aroundI "baggers" - shares that doubled.trebled, sextupled or better over time.Magellan benefited from over a hundred"l0-baggers" during his stewardship.Think about that. Few of us are luckyenough to identify and, crucially, havethe fortitude to hang onto, 10, Iet alone100, stocks that go up 1000%. It mightsound obvious, but you don't get toenjoy those sorts of gains if you sellout early. Yet all the psychologicalpressure is to take profits on winners


NickTrain authors'lnvestment Insi hts', which can be

followin excerpts are just a sample of the wisdom that

and to go fishing where stocks aredown and "cheap".

Another investor we admire,Richard Oldfield, wrote a stimulatingbook with a brilliant title. "Simple butnot Easy" And it is true, because Lynchdemonstrated it in his own career, thatinvestment can be simple. It can be sim-ple in that the ideas that make the bestreturns over time do not have to be

intellectually abstruse. For instance,one of Lynch's key ruleswas to watch out forwhere your householdshops and what for.It's important whenyour wife tells you

that M&S has lost the plot in kids' wear. It'simportant that you respond to the realisationthat you buy a Cadbury Crunchie every timeyou fill the car. These are not complex ideas."Know what you own." But the practice ofinvestment is not eas5r What makes it hard arenoise and distraction. Lynch wanted the pri-vate investor to understand that his or herideas can be just as valid as those of the profes-sionals and that for some professionals sittingall day in front of scrolling news and pricefeeds can distract and detract from the delivervof investment returns.

Common Sense never goes out of fashion.

Men more frequentlyrequire to be remindedthan taughtJanuary 2OI4

( (T ynch ran his winners, arguing thatI _if a share has done well - at least

I-/for reasons that are explicable andnot wholly speculative - then there is everyreason to expect it to continue to do well(although always remembering that nothinggoes up in a straight line). He (and we) disputethe conventional wisdom that says: "It's neverwrong to take a profit". It can be very wrong. Ifby doing so you permanently red.uce yourinterest in a great long-term investment. Shareprices of the best companies double, thendouble again and again over time. Locking intothat observed propensity for wonderfulbusinesses to compound wealth for theirowners is at the heart of our approach."

"l forgot more thanyou'll ever kno (about

Jan 2OO8

ir John Templeton's "InvestmentMaxims" and other words of wisdom arealways worthy of consideration. Truly

Sir John "forgot more than we'll ever knowabout" equity markets. Today we recommendinvestors dwell on the following:

"To buy when others aredespondently selling and LynCh

:T:ll,Ti}others are

wanted the privaterequires the great- investor to understand that

;:rf,T'j}ff"t$ his or her ideas can be just as

ieward.'," valid as those of the professionals"rhe time to and that fOr some professionals

buv stocks is*ii"",n",n*, sitting all day in front of scrollingterm owners have neWS and priCe feedS can dis-finished their sell-ing, and the time to tract and detract from thesell a stock is when delivefy Ofthe short-term owners fetgfnshave finished their buying."

"Too many investors focus on"outlook" and "trends". Therefore,more profit is made by focusingon value."

'An investor who has all theanswers doesn't even understand thequestions."

And my favourite - "History shows thattime, not timing, is the key to investment suc-cess. Therefore, the best time to buy stocks iswhen you have moneSr"

Size doesn't matter(very much)July 2OI4( 6T" our UK Equitv Fund rrye orvn:

TJ.World's #l Emerging Market FMCG

Company (Unilever)World's #1 Spirits and Dark Beer Company

(Diageo)

World's #1 International Beer Brand(Heineken)

World's #1 Educational Publisher (pearson)World's #2 Index Service Provider (LSE, post

Russell)World's #1 Scientific Publisher

(Reed Elsevier)


World's #1 Online Newspaper (MailOnline)World's #1 Trading and Investment

Infrastructure Software Provider (Fidessa)

World's #5 Most Valuable Luxury FashionBrand (Burberry, according to Interbrandsurvey)

World's #1 Chocolate Company (Mondelez)

World's #1 Business Information Provider(Thomson Reuters)

What we're conveying here can be sum-

marised as "size doesn't matter" - that much.In our opinion our portfolio comprises a collec-

tion of exceptional brands and franchises,many so at global level, or if not, strong region-al or national champions. What is attractive

about them has nothing to do with

Pearson ""11#::ffffX1T11'";iS nOt aS bi$ aS couldbsdescribedas

Apple, in fact it is only ' ur

1,/36 th of the size. Yet,

arguably, Apple needs Pearson thatdoesnot

more than vice versa in order #:illi:'JHI",to achieve their separate

ambitions in bi trEdTech. is on

size. Yet, arguablY, APPIeneeds Pearson more than vice versa inorder to achieve their separate ambi-tions in EdTech...Biggest is not neces-

sarily best."

o Identify your great investment idea.o Buy as much of the idea as you feel comfort-able with.o Buy the same amount again, so you can no

Ionger sleep at night, because of the size ofyour holding. Finallyo TELL EVERYONE ELSE ABOUT IT!

This advice can be summarised, in contem-porary parlance, as to build "high conviction,highly concentrated" investment portfolios."

An old-timer looks backNovember 2006

(6 ne of GT Management's founders,Richard Thornton, taught hisyoung fund managers an

important lesson. "Great money-making ideas

are rare" he'd say, "make sure that when you

find one, you make it count". Indeed, here isRichard's 4-point action plan for investmentSUCCESS:

Our portfolio comprises a collection of exceptional brands. What is

attractive about them has nothing to do with their market caps'

ardines and soapMay 2006

he story goes that sometime in the earlyyears of the Twentieth Century therewas a lull on the trading floor of the

New York Stock Exchange, a IuIl that extended

from hours into days - and the boys weregetting bored and restless. Come an afternoon,for want of any better entertainment, one ofthe traders pulled out an elderly sardine tinand announced his willingness to seII thisunique item for no more than a nickel. In amoment two jobbers from the Railroads pitchhad bid and counter-bid for the tin, pushing theprice up to a dime. Not to be outdone, theswells who trade Texas oil stocks jump in,doubling the price of the sardines, thendoubling it again. The tin passes fromprofessional hand to professional hand, withthe ticket sometimes a cent or two higher,sometimes up a quarter. At last the hubbubattracts the attention of the baby of the floor, awet behind the ears college kid. He spots theunusual label and can't miss the excitement inthe open outcry yelling of the traders. The kid,determined to show he can play with the bigboys and genuinely intrigued by the apparentrarity of the item, firmly calls out "Ten bucks"and is delighted when the bidding comes to an

abrupt end. Hefting out his pocket-knife, hepunctures the tin, only to be met with theunmistakeable stink of rotting fish.Bewildered and heavily out of pocket, the newboy turns to one of his elders and betters, who


It is not dangerous for defensive stocks to be apparently highly valued,compared to the average, mediocre company. They deserve to be.

had taken a half Dollar turn out of the tin anhour previously "I don't get it" says the kid,"these sardines are long gone." "Son", says theold jobbef "those weren't eating sardines,thems were trading sardines."

We're fond of this apocryphal story whichillustrates one aspect of the workings of capi-tal markets. We aII know about the ramped"concept" stock, the speculative issue thatalmost unaccountably captures the attention oftraders and the investing public. This is thekind of stock whose appeal begins and endswith the prospect that it might go up a lot in ashort period of time. Sometimes an entire sub-sector of the market is implicated, or even cre-ated, in the excitement. If you play the gameand, we must admit, we tend not to play thistype of game, then one important thing is tonot be the patsy who pays top Dollar. The otherconsideration is knowing, if and when themusic stops, whether you hold trading or eat-ing sardines. There were many months afterMarch 2000 and many rallies, when it was pos-sible to sell out of various Internet "trading"sardines, not at the top, assuredly but beforethe things reverted to penny stock status.

A new Nifty Fifty? Bringit on!December 2072

rent, we

l'l i'sJ- NiftyFifty episode in his invaluable book - "Stocksfor the Long Run" (2nd Edition, 1998) and I cribwhat follows from him.

The share prices of the Nifty Fifty - that col-lection of "one decision" stocks (the recom-mended decision being "buy and hold forever")and identified by Morgan Guaranty Trust -peaked in December 7972.It was a disparategroup, comprising some consumer staples, butalso technology companies, retail and industri-als. And at the peak the shares commandedexpensive valuations, by traditional measures.

The average P/E ratio for the group was 42x,with a dividend yield of 1.1%, respectively dou-ble and half that of the S&P500 inL972.

But what really is dynamite (and, reader for-give me, here I arrive at last at the real point ofthis lengthy piece) is that it is by no meansobvious that the Nifty Fifty was materiallyovervalued, even at its peak. With the benefit of25 years hindsight, Siegel worked out thereturn on the Fifty from its peak, compared tothe benchmark.

Notwithstanding a nastySometimes

an entire subsector ofthe market is implicated, or

who pays top

Iurch down inl974/5thegroup returnedl2.To/opa to December1997, compared to

payer, the NiftyFifty would have actu-

iX1lti"j,T#91 , even created, in the excitement.

wash. what,s ,f you play the game and, we mustmore, for a typi- admit, We tend ngt tO play this typecal real worldinvestor, that is "

0f game, then one importanthigher rate us tax- thing iS tO nOt be the patsy

ally outperformed theS&P because of the lowerdividend yield on the Fifty (capital

Dollar.

gains being taxed more lightly than dividend income).

Let's be clear what Siegel is saying. Acollection, however arbitrarily selected, of"great" companies outperformed the broadermarket over 25 years (for the likely averageinvestor), even from the point of its highest rel-ative valuation and despite the list containingmore than several that turned out to be realclunkers. In short, 42x earnings turned out notto be expensive.

Here's how Siegel summarised his findings:"Those stocks that sustain growth rates abovethe long term average are worth their weightin gold, but few live up to their loftyexpectations."

And, even more apposite to this discussion:"Stocks with steady growth records are worth30, 40 and more times earnings."

In other words and turning to today's debate,it is not so dangerous for defensive stocks to be


[Gadbury's] assets are of significantly better quality than those of the

average UK company and therefore deserve to be valued more highly

Hitting the twentY-Year

invented. in the 1930's and now account for50.0% of international cough drop sales' This

makes the Hall's brand not only the ieader of

the world medicated confectionary market,

with a share of 22.0%,but also the top global

sugar confectionary brand, with a 2.0% share -goodness knows how many packs of HaIIs nes-

tle in the bottom of grandmothers'handbags,alongside the Trebor Extra Strong Mints(established in 1935, owned by Cadbury and the

UK's number one sweet brand by size)' Back inthe 19?0's, Dominic Cadbury, then chairman of

the family business, made a proud boast -"schweppes will still be being mixed with gin

long after North Sea oil runs out". Of course'

here in 2005, those reserves are indeed deplet-

ing, encouraging investors to fund speculative

surveys for oil as far away as the Aegean Sea'

When, periodically, such appraisal wells prove

to be dry, those same investors will doubtless

console themselves with several stiffSchweppes and Gordons (Iet's include a Diageo

brand in this pantheon of "predictabies") -proving Dominic Cadbury's earlier prediction'

The longevity of Cadbury's brands and theirproven capacity to generate cash mean thatthese assets are of very significantly betterquality than those of the average UK company

and therefore deserve to be valued more highlythan the average. It is, in particular, franklyabsurd. for institutional investors to dismiss

Cadbury shares on the grounds they are over-

valued. comPared to the UK Food

Manufacturing sector. This is now a sorrygroup of companies, mainly comprising low

margin raw material processors and the manu-

facturers of "own-label" goods for the super-

markets, in whose pockets they firmly sit'

Northern Foods sells on a prospective P/E of

I2.0x, a discount to the market average'

Cadbury sells for a prospective 16'0x, a premi-

um to the All-Share and over 30.0% more

"expensive" than Northern Foods. But over the

last decade Cadbury's EBITDA per share is up

70.0o/o,while Northern's is down 17'0% - which

is going to be "cheap" or "expensive" over the

next ten years? We think anyone who answers

"Northern" - "knows the price of everything,but the value of nothing"' WI

sweetie spot

apparently highly valued, compared to the

average, mediocre company' They deserve to

be. What is dangerous, though, is to be compla-

cent about their perceived defensive qualities'

Oniy the most exceptional sustain very Iong

steady growth records'

June 2005/ /

^' ur starting Point is nt t I f tnat the best share

l -rt rrt".. irt"t you buvsome point in the distant future, Iet us say

twenty years, is worth man)1 many times whatyou Paid for it.

QVgf So, whataboutCadburY?

the last decade *"il ff"tilXr'l?:i: "Cadbury's EBITDA per share itable companv' with

is up 7}.6o/o,while Northern's is ?::1X':i:fAT*'down L7.OYo.We think anyone years averaging

who answers "Northern" [is over 15'0% and an

cheaperl knows the price of "ffi|?-t"fiftTffievefything, but the value period or over 24'0%'

of nothing". ."H""?|::ll,?Lll,Tt"tgenerate these attractive

returns. have exhibited extraordinarydurability Dr Pepper was first formulat-ed in 1885, before Coke and 120 Years

later, its volumes and cash flows are stillgrowing. The Dairy MiIk "megabrand"' as

Cadbury calls it, was introduced exactly 100

years ago and is today sold in 33 countriesworldwid.e, with annual retail value of $1'0 bil-

Iion. Bassett's Jelly Babies came to parturitionin 1918 and now over 1 billion are consumed

every year' Creme Eggs are of more recentprovenance, 1971, but over 300 million are laidevery year at Bournville (a dubious statistic -

our office secretary must eat over 100 million a

year on her own). Hall's cough drops were

52 | Wealth lnsight February 2016

Nick Train the King of Buy and Hold

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