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Time for Caution and How to Cope with Mistakes

THE WEEK: Rodney Hobson explains why he feels down about being up, and explains his rationale when dealing with a 'wrong'un' stock pick

Rodney Hobson 25 January, 2013 | 1:00PM

Why I Feel Down About Being Up

Shares have hit a five year high but that is a cause for regret rather than celebration for those who invest for the long term. It means that finding undervalued shares has become increasingly difficult.

I don’t deny that I feel elated when I check my portfolio and find it is up on average 12%, plus another 6% from dividends, from holdings that I have had on average for only a couple of years. It is a good deal more reassuring than nursing a loss.

However, I don’t intend to sell any of the solid yielders—which means about 95% of the portfolio—and I have decided to stick with a couple of gambles that didn’t pay off but might do in the future. Hence the capital gains are purely notional. I can’t even say they are gains on paper as they are held electronically.

My big concern is that the FTSE 100 index is back to where it was as the credit crunch and global economic crisis were unfolding and in the five intervening years the UK has been through one long recession that we still show no real sign of pulling out of.

The economy virtually stagnated in 2012, despite the boosts from the Royal Jubilee and the Olympic/Paralympic Games, and growth forecasts for this year and next are being gradually scaled back.

Chancellor of the Exchequer George Osborne has no idea how to get the economy moving and the Bank of England remains heavily against further quantitative easing, which in any case went into gilts to hold down government borrowing costs and did nothing for the real economy.

Our main trading partner, the European Union, is sliding back into recession and the United States is held back by the political standoff between the House of Representatives and the Senate/President. Caution is called for, to say the least.

Caution, but not pessimism and certainly not blind panic. I believe that somewhere around 5,400 points, which used to be the ceiling during 2009 when the market moved sideways between 4,800 and 5,400 points, is now very well established as a floor.

Indeed, we have had the index move sideways between 5,400 and 6,000 since the last upward breakout and we may now be seeing a further upward break, establishing 6,000 as the new floor.

Severfield Wrong’Un

It goes from bad to worse at specialist steel group Severfield-Rowen (SFR), which this week proved the old stock market adage that profit warnings come in threes. Chief executive Tom Haughey has departed after a third warning was followed by another collapse in the share price.

I originally took a small stake in Severfield in April 2010 because I wanted to diversify away from housebuilders but into another construction-related stock. The housebuilders, Barratt Developments (BDEV) and Taylor Woodrow (now Taylor Wimpey, TW.), had lost more than a quarter of their value and offered little prospect of an early dividend at the time. Since then, Barratt’s share price has doubled and Taylor is up 80% while Severfield last lost about two thirds of its value.

I took another look at Severfield only a week ago after the shares had made a modest recovery from the lows that followed the last profit warning. I just could not see any compelling reason to risk more money but I decided to stay in for the ride with my modest existing investment, which within the context of my wider portfolio I could afford to see go down river if the worst came to the worst. Buying shares for a gamble is not like backing a horse where you lose your entire stake in one go. You can choose to keep gambling with a reduced stake.

Cost overruns at a development in Leadenhall Street in the City of London are to blame. They will cause the group to report a loss for 2012. Severfield is looking at other contracts to see if they, too, are profitable. The fear now in that Severfield has made the mistake of putting turnover before profits.

Worse still, the company is going cap in hand to its lenders, always a bad position to be in. Borrowings are higher than expected and you can bet your life that Severfield will soon be paying a one-off fee to roll the debt over into a new agreement plus higher annual interest charges.

If, as is possible, Severfield needs a rights issue I will take some persuading to throw good money after bad. Any such issue will have to be at a massive discount to the current share price of around 80p.

Any readers of this column with the instincts of a vulture have been warned: there’s not much apart from the bare bones to pick at.

Market Performance: January 11 - 25

FTSE 100 Index: +2.11%
FTSE 250 Index: 1.47%
FTSE All Share: +2.01%
FTSE Small Cap: 1.33%
FTSE AIM 100: +0.11%
FTSE Fledgling: +1.07%

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Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Barratt Developments PLC391.90 GBX3.05-
Severfield-Rowen PLC64.25 GBX0.39-
Taylor Wimpey PLC112.40 GBX2.00-
About Author Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, most recently The Dividend Investor.