Hi Occasionally I'll write articles for other companies, and this week's effort was written exclusively for bullbearings.co.uk, so it won't be published on the main ukvalueinvestor.com web site. However, I can still send it out by email, so here it is. As usual it takes a consistent approach to identifying above average companies at below average prices:
Investment analysis: Greggs (the bakers)
Greggs is a popular company, and a successful one too, so does that mean it’s a wise investment as well as a good place to find a hot pasty?
The first thing to note is that investing works best when it’s done systematically, with a simple set of rules to guide you along the way. By having a plan, the art of investing doesn’t become a make-it-up-as-you-go-along affair, because investing by the seat of your pants is rarely a good idea.
So here’s my 12-step plan, applied to Greggs (or any other company for that matter) to see how it stacks up as an investment for both income and capital growth.
Understand the stock market
Returns to shareholders come from dividends, growth in the earnings of the underlying company, and changes to the PE ratio, so these are the things we should concentrate on first.
Focus on the long term
The PE ratio can change dramatically in the short-term. The problem is that it’s driven by supply, demand and investor sentiment, all of which are unpredictable at best. In the long-term it is earnings growth and dividends which dominate investor returns, and they are also far more predictable.
Aim to beat the market
Of course, no sane stock picker is going to aim to underperform the market, so having a strategy to beat the market is a good idea.
Given that returns come from dividends, earnings growth and changes to the PE ratio, it probably makes sense to try and beat the market in terms of dividend yield and earnings growth, and to buy these high yield, high growth businesses with a low PE, to maximise the odds that the PE of our investments (and hopefully the share price) will go up rather than down.
Be a business investor, not a stock market speculator
Because PE changes are unpredictable, while dividends and earnings growth are more predictable, it’s the latter we should focus on first. Dividends and earnings growth are features of the underlying company and have nothing to do with the stock market, so fortunately we can ignore the stock market for a while.
Look for growth
A growing company is better than a shrinking company, all else being equal, and because the short-term is dominated by random and unpredictable changes to the PE ratio, we’re better off looking at long-term growth rather than short-term growth. For example, Warren Buffett bought Coke in 1988 and today the dividend paid is around 50% of his purchase price… every year. So long-term growth is a key source of returns for top investors.
Here is what Greggs has achieved in the last decade:
That’s a pretty impressive chart if I do say so myself. It shows a company which is able to grow, steadily and consistently over many years. The growth rate is around 7% a year, while the FTSE 100 has managed closer to 3% in the last decade, so Greggs is definitely a company with above average long-term growth rates.
Look for consistency
There are two kinds of consistency, and they’re both valuable for the same reason.
The first kind of consistency is operational consistency, in other words, has the company been operating in more or less the same industry over at least the last decade? Companies that flit from one thing to another, buying into new industries and closing their old operations, make it much harder for investors to think about what that company will do in the future, and how it will prosper.
With Greggs, it is a baker, it is pretty much only a baker, and it has been a baker for around 70 years. That seems like a fairly consistent business operation to me.
The other sort of consistency is consistency of results, specifically, consistency of profits, dividends, and growth. In the case of Greggs, it has been profitable in every year of the last decade, paid a dividend in every year, grew sales in every year, grew the dividend in every year, and only failed to grow profits in three of those years.
With a consistency score of 93%, it’s a far more consistent performer than the FTSE 100, which only manages 82% consistency; good, but Greggs is better.
Look for a low price
As a company, Greggs is both faster growing and more consistent than average, but no company is worth an infinite price, and the lower the price paid, the better the long-term results will be.
Because short-term earnings and PE ratios are volatile and unpredictable, it’s probably better to look at the share price relative to the company’s ten year earnings record, rather than to compare it just to last year’s earnings.
Using this measure, called PE10, Greggs has a valuation ratio of 15.2, while the FTSE 100 at 5,700 is priced at 13.3 times its ten year average earnings. On this measure, Greggs is slightly more expensive than the market, but that’s to be expected with a higher growth company, and 15.2 is far from excessive.
Look for a high yield
In the long run, dividends are the dominant factor in stock market returns, so it’s important to make sure that any investment is pulling its weight. At 467p, Greggs has a historic yield of just over 4.1% which is better than the FTSE 100’s income yield which is nearer 3.6%. In fact, relative to the index’s yield, Greggs will pay out around 14% more in income from day one.
With Greggs’ history of consistent dividend growth and its defensive, food-based industry, it’s not too hard to imagine that market beating dividend growth may yet continue for some time. As with Coke, a growing dividend may ultimately drive the share price higher.
Avoid Debt
With too much debt, even the best company in the world can go bust very, very quickly. Greggs can scarcely do better in this regard, having zero debt at present and a healthy cash balance.
Another occasional problem is excessive pension obligations. With obligations of around £92 million, Greggs doesn’t really have a problem here either.
My simple measure is that if pension obligations are under 100% of the market cap, and assuming all the other features of a quality company are in place, then I don’t consider that excessive. With a market cap of around £470 million, the obligations of £92 million are well within that limit.
Avoid major problems
Unfortunately the best time to invest in shares is often when there are short-term but surmountable problems, as that’s usually the reason for a low and attractive share price. In the case of Greggs, apart from the Pasty Tax, there doesn’t seem to be any significant bad news, which makes a nice change and a pleasant environment to invest in to.
Think about the future
Investment returns are made in the long-term future, so it’s important that any investment can survive and thrive for many years to come.
When it comes to bakers, there will probably still be a strong demand for tasty hot products long after most of us and our investment time horizons are gone. So far Greggs has managed to do well even as smaller and local bakers have struggled, and I see no obvious reason why this can’t continue.
Don’t bet the farm
I like Greggs. It’s exactly the sort of company I like to invest in. It has an above average record of consistent growth, and an above average dividend yield. The price isn’t excessive and the industry is defensive and unlikely to change radically in the future.
However, even though I might consider buying Greggs at this level, I would only put around 3% of my funds into it, and I’d make sure that I didn’t already own lots of other food producers already.
You never know what’s around the corner, and too much exposure to one company or industry is usually a bad idea. And having investments in different industries means some stocks will go up while others go down, giving you the opportunity to sell some high and buy others low, over and over again.
