Up 68% in one year: was I good or just lucky?

Disclosure: This page provides information about shares I own. However, it is not guaranteed to be a complete or current reflection of my own portfolio and does not constitute any kind of investment advice.

2016 was a good year for my value portfolio, which delivered an outstanding gain of 68.2% and soundly outperformed the FTSE All-Share Total Return Index, which rose by a more modest 16.2%.

It’s an investment performance I suspect I may never repeat, so I think it’s important to try and understand how much of my success was due to good method, and how much was down to dumb luck.

In this post, I’ll review the performance of each of my current holdings in 2016. I’ll also take a look at the stocks I sold last year.

What went so right?

I went into 2016 heavily overweight in mining and banking stocks. After experiencing painful levels of drawdown early in the year — during which time I either did nothing or averaged down — these stocks delivered most of the gains generated by my portfolio last year.

But there were also a number of other good performers, such as Morrison’s and BP. Indeed, pretty much every stock in the portfolio ended the year higher.

I’m obviously pleased with this outcome. But I’m conscious that a fair chunk of luck may have gone into this result. Indeed, one of my goals in writing this review — as its title suggests — is to try and decide whether I was good, or just lucky, in 2016.

A particular concern is my approach to averaging down. A recent post by the always-entertaining John Hempton of Bronte Capital has made me think again about this. Am I too ready to buy more when the price dips, or is my logic sound?

I’ve ordered this list in alphabetical order to make it easy to find specific companies, but have included the original purchase date of each holding to provide some context.

Anglo American (AAL.L)

Original purchase: 19 June 2015 (averaged down 7 Dec 2015)

I was too early when I bought my original Anglo American shares in June 2015. The lesson I learned about commodity downturns was to wait until valuations became distressed before buying. By the end of 2015 I thought we’d reached that stage, and added more shares to my holding.

The market came round to my view in 2016, helped by a surprise rebound in commodity prices. Although perhaps it shouldn’t have been such a surprise: the decline in coal and iron ore prices had been ongoing for about five years. At some point supply and prices would respond. The risk was that the recovery was always going to be dependent on the enigmatic Chinese authorities.

Anglo’s plan to flog its iron and coal assets was put on hold indefinitely to allow the firm to tap the flow of cash now gushing from these ‘non-core’ assets. Ironically, the firm’s supposedly core assets — diamonds, platinum and copper — had a more humdrum year, albeit with copper displaying signs of life during the final quarter.

The City is now firmly behind Anglo. Earnings forecasts have been upgraded in every month since February. This proves what short-sighted nonsense broker analysis can be, but it does also provide a useful gauge of expectations. As things stand at the start of January 2017, Anglo trades on a modest 2016 forecast P/E of 11, falling to a P/E of 7 for 2017.

I’m hoping for a solid set of results in February and will be looking closely at margins, free cash flow and debt — and dividend policy.

Barclays (BARC.L)

Original purchase: 3 March 2014 (averaged down 13 April 2016)

Barclays is currently the oldest holding in my portfolio. Last year saw concrete progress towards a turnaround, as part of the group’s Africa business was sold and profitability started to improve.

The non-core division remains a challenge, but based on his performance so far, I’m prepared to accept CEO Jes Staley’s assurances that progress will continue apace.

My initial target price remains somewhere in the region of 300p, in line with the bank’s tangible asset value of 287p.

BHP Billiton (BLT.L)

Original purchase: 10 Dec 2014

BHP benefited from a rapid improvement in coal, iron ore and oil prices last year — as well as a turnaround in market sentiment. But the big story — and the reason I’m still holding — is the expected free cash flow from the firm’s assets in 2017.

Capex and exploration expenditure fell by 42% to $6.4bn last year, and is expected to fall to $5bn during the current year. Production costs also fell — for example, the unit production cost of the firm’s conventional petroleum assets fell by 30%. Unit cash costs for iron ore fell by 19%.

Management guidance is for free cash flow of $7bn in 2016/17. This implies a price/free cash flow ratio of 12.3 and an enterprise value/free cash flow ratio of 17. Both figures are attractive, in my view, especially as recently revised broker forecasts now give BHP stock a forecast P/E of 14 and a prospective yield of 4%.

BP (BP.L)

Original purchase: 3 Feb 2016

One of my better-timed purchases. My BP shares have risen by 50% in less than a year, and no averaging down has been required!

The depreciation of the pound means that the dividend yield on my original purchase cost of 335p is currently a whopping 9%. Of course, this assumes that BP’s payout will remain unchanged at $0.40. I believe that’s likely, but with the firm now starting to increase capital expenditure and target growth once more, I’ll want some reassurance that cash flow is responding to the higher price of oil.

I don’t really want to see debt levels rise much further, relative to profits. However, with such a massive yield on tap, I’m not planning to sell unless I think management are taking too many risks.

Braemar Shipping Services (BMS.L)

Original purchase: 25 Oct 2016

I bought shares in this shipping and energy services group in the wake of Braemar’s most recent set of interim results. Both management commentary and the figures seemed to suggest that trading and cash flow could improve during the second half of the year.

As I explained in my original buy post, the shares also looked cheap to me on a host of traditional value measures.

I’m hoping that this position will prove a well-timed entry into a notoriously cyclical sector. Although the 8% forecast yield suggests a dividend cut is likely, the group has net cash and solid history of profitability. I think the downside risk ought to be relatively limited.

However, I’m live to the possibility that I’ve set sail too soon here… I await the next set of results with keen anticipation.

Hargreaves Services (HSP.L)

Original purchase: 29 May 2015 (averaged down 8 Dec 2015, 13 April 2016)

Hargreaves’ recent rebound has lifted my position to breakeven, but has also made it the largest position in my portfolio. I’m not sure whether I should be comfortable being so heavily exposed to this company. I may trim my holding soon.

For me, Hargreaves’ attraction is that it’s an asset play that’s run by an owner-manager with an excellent track record. CEO Gordon Banham owns a 7.1% stake in the firm, and in my opinion has delivered on all of his promises so far.

Hargreaves has emerged from a complex and wide-reaching restructuring with minimal debt and a profitable operating business. The group is now in a position to realise significant value from its property portfolio and legacy coal assets.

Concrete progress will be needed this year, but in the meantime I’m happy to continue holding. As a sidenote, this company’s RNS statements are always detailed, precise and transparent. I commend them to the house!

Indigovision (IND.L)

Original purchase: 30 June 2015 (averaged down 3 March 2016)

It’s been a tough eighteen months for shareholders in this small-cap video surveillance firm. I probably should have heeded Paul Scott’s regular warnings about the unpredictable nature of the group’s lumpy profits.

However, cash flow and the balance sheet remain sound, and operating performance is expected to improve significantly this year.

The shares are currently trading at a discount to tangible book value and Indigovision has net cash equivalent to 37% of its market cap. I’m happy to continue holding, and expect further improvement in 2017.

J Sainsbury (SBRY.L)

Original purchase: 19 Dec 2016

One of two purchases I made just before the end of last year. I believe the group is undervalued based on its assets and the synergy potential of the Home Retail Group acquisition.

For a more detailed look at why I bought, take a look at my original buy post.

Lamprell (LAM.L)

Original purchase: 24 March 2015 (averaged down 22 Sept 2016)

Last year’s interim results were a turning point for Lamprell. With the oil market starting to recover and cash due to start flowing in from completed projects, the group’s shares were trading significantly below net current asset value when I bought more at 59p.

I explained the numbers in detail here.

The shares have since rebounded strongly, but still look good value to me if the firm can continue winning new work for 2017-19. With the outlook improving in the oil market and Lamprell branching out into the renewable sector, I’m happy to continue holding.

Royal Bank of Scotland Group (RBS.L)

Original purchase: 19 Dec 2016

This was the second of my two pre-Christmas buys.

I explained why I’ve taken the plunge in this post. In brief, I think 2017 could be a turning point for several reasons. I believe the underlying value in the stock may soon start to be recognised by the market.

Standard Chartered (STAN.L)

Original purchase: 28 Jan 2015 (took part in rights issue 27 Nov 2015)

After a long time in the wilderness, things seem to be improving at Standard Chartered. I touched on some of the reasons for this in an article for the Motley Fool today. In short, bad debt levels appear to be moderating, and profitability is improving.

The added potential for higher interest rates could give profits a boost. I also believe that as with Barclays and RBS, StanChart’s newish chief executive Bill Winters is making good progress in dealing with legacy problems.

The shares remain at an attractive discount to book value, despite an improved balance sheet. I continue to hold.

Wm Morrison Supermarkets (MRW.L)

Original purchase: 18 August 2014

Last year was a good year for Morrison’s, as CEO David Potts delivered solid sales performance and very impressive free cash flow and debt reduction.

An improved deal with Ocado and a new deal to supply Amazon added icing to the cake, but the real eye-opener for me was the speed at which Mr Potts generated cash and reduced Morrison’s debt levels.

It seems that the balance sheet was quite inefficient under previous management, with working capital levels much higher than necessary. Optimising this has generated a lot of free cash flow.

Clearly this process can only go so far. The contrast between Morrison’s trailing P/E of 25 and its trailing P/FCF of about 8 is remarkable. I’ll be watching closely to see how this gap closes during 2017.

The ones I sold

I sold five stocks last year. I was going to cover these here, but time is short and this post is now far too long. Instead, here’s a list of the stocks I sold, along with a link to my original ‘sale’ article:

• Fenner (FENR.L): Sold 28 Nov 2016 — read why I sold.
• Home Retail Group (HOME.L): Sold 8 Jan 2016 — read why I sold.
• Laura Ashley Holdings (ALY.L): Sold 8 July 2016 — read why I sold.
• Lonmin (LMI.L): Sold 8 April 2016 and 2 August 2016 — read why I sold.
• South32 (S32.L): Sold 18 August 2016 — read why I sold.

Final thoughts…

That’s it for another year. For what it’s worth, my conclusion about my performance last year is that my averaging down was okay. It was the original purchases that were poorly judged! In a number of cases, I should have waited longer for signs of deep value and (sometimes) distress to emerge.

My goal for 2017 is to become a harsher critic of value: is a stock really cheap?

The game plan for my existing holdings is simply to keep a close eye on the fundamentals and valuations of each firm, and allow these to guide my trading decisions.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.