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“These moves in the market are like a tale told by an idiot: full of sound and fury, signalling nothing”

The quotation is attributed to Jack Bogle (paraphrasing Macbeth, although he never mentioned markets!) the octogenarian founder of Vanguard Group, the world’s second largest asset management group. Jack has a habit of bringing a good degree of common sense during times of stock market stress and in his 86 years has seen a great deal. Furthermore, with US$3 trillion of passive funds under management at Vanguard, he is well placed to assess markets more objectively than the active funds that are causing the current upheaval with their manic trading.

Jack urged investors thinking of selling amid the current market turmoil to sit tight commenting “This is speculation that we’re seeing out there, and you can’t respond to it.”

While the share prices of some stocks had clearly risen too high, corporate balance sheets are, for the most part, in excellent shape with plenty of cash. The exception is the beleaguered oil and gas sector which has been a primary beneficiary of cheap money over the past few years and is now paying the price. However, even in oil and gas world there are plenty of well capitalised businesses that will exit the current maelstrom in terrific shape.

The recent fall in stocks and commodities, particularly oil, has raised questions as to whether or not the economy is at risk of entering a recession. In the short term this market mayhem has been for the most part about the oil price which permeates all aspects of the global economy. Until the oil price displays a degree of stability we foresee the speculators will continue to run riot. Saudi Arabia is intent on breaking the back of US oil and gas production to secure its own market share and place at the head of the global oil and gas table. With the price now below US$30 per barrel, and no doubt set to fall further still, we sense that the time approaches when US production will fall materially as higher cost US producers throw in the towel. Up to now technological advances have helped the US producers drive down costs and improve production, but geography will ultimately win.

Returning to the 86 year old Bogle he concludes that:  “In the short run, listen to the economy; don’t listen to the stock market,” he said. “These moves in the market are like a tale told by an idiot: full of sound and fury, signalling nothing.”

On home soil, fund manager Gresham House Asset Management (‘GH’) recently published an excellent article on its Investing Strategy. The full article can be found here.

GH commented how value investing has been out of favour with investors for a number of years, effectively since the financial crisis, and that the material underperformance of “value” stocks versus “growth” companies is comparable to levels last seen at the peak of the TMT boom in 1999.

With investors focusing on growth and momentum companies over the past few years the recent market activity reflects a reality check for the momentum trade.

We are now hopefully returning to a time when the proper analysis of fundamentals will be rewarded and with this in mind it is worth casting a glance at US technology giant International Business Machines (IBM).  As was the case with Microsoft several years ago, many commentators appear to be doubting the long term prospects for this previous bellwether of the technology sector. Over the past few years shares in IBM have tumbled 43% on fears that the group has lost its way in the fast moving technology world, with momentum firmly to the downside. While earnings have indeed stumbled, as the giant group goes through one of its periodic transformations, ‘real’ cash returns to shareholders have actually been rather good, to say the least. Over the past 5 years IBM has generated average ‘annual’ free cash of an eye popping US$14bn. It has used this cash to pay substantial annual dividends (Dividend yield is just over 4%) and buy back a colossal US$65bn+ of shares over 6 years.  In its recently reported results ‘accounting’ earnings fell again but the total ‘real’ capital return to shareholders during the year was still US$9.5bn, consisting of dividends of US$4.9bn and gross share repurchases of US$4.6bn. Shares in this high quality business, which still generates operating margins of 20% and returns on equity of over 90%,  trade at modest 9x forecast earnings for 2016. Transforming a business of this size is bound to take time and in the interim patient shareholders are being rewarded. More positively for the technocrats out there, its expansion into cloud services looks quite encouraging

Investors have also questioned the business prospects of UK listed WH Smith with its dull portfolio of high street stores. WH Smith has also been going through a transformation with the high street operation essentially being run for cash which is subsequently being reinvested in a growing portfolio of ‘Travel’ venues. It’s hard to visit an airport or train station without coming into contact with WH Smith. Much like IBM, the UK group has been returning cash to shareholders through dividends and share buy backs. WH Smith is a much smaller business than IBM and its metamorphosis has taken less time with the share price reacting very positively over the past few years as the transformation starts to deliver.

We anticipate investors will need to pay greater interest to ‘value’ investments like IBM in the coming years and focus on real cash returns, high returns on equity and capital and sustainable dividends.

So what does it mean for our client portfolios?

Small caps
Many of the small caps we follow have benefited from the momentum trade with valuations becoming more stretched; although quite a few are also substantially less expensive following the falls of the past few days! However, unlike their blue chip peers, these businesses are also demonstrating real growth, generating plenty of cash and possessing the desired balance sheet strength. While large well established businesses have been the major beneficiaries of quantitative easing and low cost debt, UK small caps have, for the most part had to tread more carefully with debt less freely available. Don’t be put off by the violent share price swings of small caps during heightened periods of market volatility such as the one we are currently experiencing; that’s the nature of small cap investing and its important not be sucked in Mr Market’s dark mood!.

Blended portfolios
We have maintained a generally defensive stance over the past year or so with a strong weighting in Pharma, Tobacco and Telcos and higher yielding equities with limited exposure to financials.  We remain on the look-out for real value and businesses that are able to demonstrate an ability to generate meaningful free cash and a willingness to return this to shareholders in some form.

AIM News
Real news from AIM quoted companies since the start of 2016 (it’s a busy period for AIM results) has been overwhelmingly positive. News from AIM can also be a good gauge of the state of the UK economy with the majority of AIM companies more reliant on the UK economy than blue chips. We summarise below recent news from some of the companies we follow, across a vast array of sectors and industries:

Majestic Wine (wine retailer)
Encouraging Christmas Trading Statement
Majestic Retail like for like sales grew 7.3% in the Period (versus decline of 1.7% in comparator period)

Breedon Aggregates (Quarrying of aggregates and the production of added value products)
Largest ever contract award

KBC Advanced Technology (Software technology and consultancy for hydrocarbon industry)
Takeover at a 50% premium, look out for more like this in the oil and gas sector

Shoe Zone (Low cost footwear)
Results in line with an additional proposed Special dividend bringing yield to 6.8% at current share price

Quartix Holdings (Subscription-based vehicle tracking systems)
Trading statement confirms revenue and profits are anticipated to be ahead of market expectations.

Smart Metering Systems (Integrated metering services company)
New domestic smart meter contract wins as part of the UK Government programme, requiring domestic energy supply companies to provide all of their customers with a smart meter in homes and small businesses across the UK by 2020.

XLMedia (Provider of digital performance marketing services)
Trading update confirms that the Company expects to exceed current market expectations with the dividend materially increased

Plexus Holdings (Oil and gas equipment provider)
New customer contract and region win worth approximately USD$0.6m.

Quixant (Specialised computing platforms for gaming and slot machines)
Trading update confirms profitability over the 12 months ended 31 December 2015 was comfortably in line with market expectations. The Company has started 2016 well, with a healthy order book which underpins their confidence in achieving market expectations for 2016.

We would urge investors to focus on real news and the real economy and ignore the market noise and actions of speculators. Long term investors (and real investment is all about the long term!) should view the current sell-off as a potential buying opportunity to acquire interests in good businesses at much fairer prices.


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Blue chips start the year in bearish mood but AIM continues to deliver

It has proved to be a torrid start to 2016 for equity investors with the Bears out in force and some commentators concluding that now is not a time to be exposed to equities, in any form. While some of these so-called experts are questioning the growth prospects of global equities and, more significantly, the affordability of dividends, several AIM stocks we follow have started the year in strong form, delivering positive trading updates. Many of these companies may also come with compelling inheritance tax reliefs offering another excuse to buy shares in good quality businesses which now trade at more modest valuations. We offer our thoughts below on 10 of the best to kick off 2016.

Majestic Wine (AIM:MJW), one of AIM’s old guard and a business that has seen its share price decline substantially from previous highs, issued its usual Christmas period trading update with like for like sales up an impressive 12.2%. Evidently the efforts of the team from Naked Wines are starting to bear fruit with the core Majestic Retail business delivering like for like sales of 7.3% in the period versus a decline of 1.7% in the prior period.

Global people management business Penna Consulting (AIM:PNA) has attracted a growing following over the past 12 months with its shares rising over 100%. A trading update early in 2016 confirmed that profits for the 9 months to end December 2015 were up 51% and management’s expectations for the full year to 31st March 2016 materially increased. While the shares have had a great run, the forward earnings multiple remains relatively modest and, with cash generative attractions, the shares still look interesting, especially if more indiscriminate selling takes hold.

Another AIM high flyer from 2015, Breedon Aggregates (AIM:BREE), announced that it has been jointly awarded a contract valued at up to £55m to supply and lay asphalt on the £745m Aberdeen Western Peripheral Route/Balmedie-Tipperty project, the longest roads construction project currently under construction in the UK. It’s also the Group’s largest-ever contract award and will provide the backbone of work for their contracting division over the next two years. While shares in Breedon seem richly valued, the nature of its activities and regional positioning means it has the much sought after protective moat to its business.

Hornby (AIM:HRN) is a relative newcomer to AIM, but a business that will have touched many of our lives through one or more its iconic brands, including Hornby model railways, Airfix and Corgi cars.  Having disappointed over the past few years the Group is going through somewhat of a transformation with the start of 2016 heralding the launch of a number of new products. With debt much reduced following a refinancing in 2015 and evident value in the Group’s brands it could be an interesting year.

Two of AIM’s leading suppliers of tabletop products, Churchill China and Portmeirion, both based in Stoke on Trent, delivered positive trading updates for the year to 31 December 2015.

Churchill China (AIM:CHH), which was established in 1795, is a leading supplier of tabletop products, primarily to the worldwide hospitality markets. The trading update confirmed that trading in the second half of 2015 was ahead of earlier expectations resulting in operating performance ahead of current market estimates and well ahead of 2014. The news saw the house broker lift 3 year pre-tax profit forecasts by 6%-11% with scope for further outperformance.

Portmeirion Group (AIM:PMP) focuses on higher quality homewares, with its Royal Worcester brand dating back to 1751. Its trading update for the year to 31 December 2015 confirmed that pre-tax profit would be slightly ahead of market expectations on record revenues, being the seventh consecutive year they have achieved record sales.

Both stocks have delivered consistent growth over the past few years and a growing dividend covered more than twice.

UK specialist value footwear retailer Shoe Zone (AIM:SHOE) saw its shares flounder in 2015, with warm weather being one of the causes. Thankfully 2016 started more positively with full year results in line with revised estimates, cash flow attractive and a special dividend of 6.0p per share particularly appealing. With the online offering starting to accelerate, a compelling yield and relatively modest valuation, the shares could attract renewed interest.

Quartix Holdings (AIM:QTX) has excelled since arriving on AIM in November and it’s recent trading update didn’t disappoint with revenue and profits both anticipated to be ahead of market expectations. The high performing Group, which is one of Europe’s leading suppliers of subscription-based vehicle tracking systems, finished the year with more than 73,000 fleet vehicles under subscription with notable increase in the USA and France. Trading at approximately 23x earnings estimates for the year ending December 2016, the shares look fully valued on this over-used measure but this business, with its proven model and efficient capital structure, has got off to a great start in the US and France, and both markets offer huge growth potential.

The announcement of new domestic smart meter contracts for Smart Metering Systems (AIM:SMS) could herald renewed interest in the shares of the highly regarded integrated metering services company.  SMS will provide domestic smart meters as part of the UK Government programme, requiring domestic energy supply companies to provide all of their customers with a smart meter in homes and small businesses across the UK by 2020. Energy suppliers will be required by regulation to appoint a MAM (Meter Asset Manager) in respect of these assets, and SMS is one of only four market participants currently performing that role. Delivering annuity like returns and with a huge market opening up in the form of domestic smart meters, this business would appear to have an exciting future.

Flowtech Fluidpower (AIM:FLO), the distributor of technical fluid power products is a another lowly rated AIM stock that found little support in 2015. However, its recent trading for the year ended 31 December 2015 will hopefully dispel the doubters, with trading confirmed to be in line with estimates and a commitment to a final dividend which implies a yield of just over 5% at the current share price, covered more than twice. Net debt is modest and the valuation at just over 7x 2016 earnings estimates looks very modest.

Fundamental Asset Management’s dedicated AIM Portfolios have been producing outstanding results for more than 10 years, significantly outperforming the FTSE100 and other major UK stock market indices – to find out more visit www.fundamentalasset.com/aim-shares-inheritance-tax-planning/