This morning I sold Gattaca PLC (GATC) for a 53% loss, following a trading update suggesting profits will be 10-15% below expectation. This for me was a final straw in what has been a bit of a mess from start to finish. I am obviously disappointed, but I’m also taking the opportunity to both learn from my mistakes and look back at how my investing philosophy has changed since I began.
The name is ridiculous. There, I said it. Whilst I could just about understand the need for a change (so as to differentiate the parent company from their engineering subsidiary), the name they chose was bizarre. Anyone with a remote interest in science fiction will have instantly recalled the 1997 film by the same name. I was so incredulous I almost sold right there and then. In hindsight, I wish I had.
Gattaca (formerly Matchtech) appeared in 2015 to be a company worth investigating. They had a decent dividend yield of 3.5%, a reasonable P/E of 15 (slightly above their 3 year average) and they had little debt. Return on equity was decent, if not spectacular, and they had a price to free cash flow of 14. Having read 3 years’ worth of annual results and noticing nothing of immediate concern, I made the decision to invest. It was downhill ever since. Literally.
The red circle marks my entry point. The company had been stuck in a range for approximately 18 months before I made my purchase, which in and of itself isn’t a terrible thing. However looking at the ten year numbers on Morningstar paints a picture of a company growing healthy revenues but with tepid net income growth (click to enlarge):
In fact, net income has only grown an average of 4% a year for those ten years.
Today, Gattaca looks attractive from a quantitative perspective:
- P/E – 8.5
- P/B – 1
- P/S – 0.2
- P/CF – 6.6
- Yield – 8.5%
But for me, the growth isn’t there. The PEG (price/earnings to growth) ratio for the company is currently 2.46 (with anything less than 1 being considered undervalued), and Gattaca appear to be having trouble translating revenue growth into their bottom line figures.
Discount Cash Flow
What about a DCF calculation for Gattaca?
- Ten year free cash flow has been choppy, rising in recent years. I will use an average of £10m.
- As mentioned, net income growth has been a shade over 4%, which I’ll use.
- As this is low, it is fair to suggest this can be maintained for ten years. Being a low margin company I feel more secure suggesting this.
- As ever, I suggest this drops to 3% following these ten years to approximately match inflation.
Using these numbers suggests an intrinsic value of £5.00, against the current value of £2.67. An 87% discount to intrinsic value. This would suggest Gattaca is massively undervalued at present.
Would I buy today? No. I wouldn’t. Aside from the profit warning, momentum on the stock is clearly downward and may still have further to go. Net income growth is too low for me, margins are too low, and there is no consistency to return on equity to pass my screen.
Would I buy in future? Possibly. If this storm passes and things start to improve, momentum starts to pick up and there is operational improvement fed through to margins and net income, I may consider it.
A Changing Investment Philosophy
But this post is about how my philosophy has changed since I began investing seriously in August 2015. This change has come due to a multitude of factors. In that time I have read more, from different authors, who have had different investing strategies and philosophies. Names like Jim O’Shaughnessy and Peter Lynch. David Dreman and Meb Faber. I have discovered new tools to help me identify interesting opportunities. I’m a big fan of the screening metrics on Google Finance (or was before it seemingly broke), and the sheer amount of data available for free on Morningstar (I’ve said before, but use .com instead of .co.uk. More data).
Gattaca as a case in point, when I look at my portfolio I can see the companies that are doing well are those with positive momentum. I’m more inclined now to add to a watch list those companies who look appealing but have negative momentum, and wait patiently for an opportunity at a later date.
I still make use of valuation metrics (P/E, P/B, P/S etc) but have perhaps become more comfortable relaxing these when circumstances dictate. Morningstar usefully automatically calculate 5-year CAGR for a company. It seems fair to me to suggest that a P/E of 20 on a company growing at 25% compounded isn’t all that unreasonable. I think there’s a difference, however, between paying for a 20 P/E multiple and a 60 P/E, and I don’t see this changing. Refer back to the excerpt from my review of Simple But Not Easy regarding Coca Cola to illustrate my point.
There is no ‘one size fits all’ approach to screening, but I believe the more data you have available, the more you can start to refine which of it you pay attention to. I like companies with low-to-no debt (although I’m sure I’ve read at one point that statistically companies with some debt do better than those with none), with growing revenues and net income, and steady or improving margins. And above all, free cash flow either growing or at least steady.
If I had to put a name to my type of investing, it would be GARP (growth at a reasonable price). That being said, it has been suggested that all investing is value investing (after all, we are all looking to buy something cheaper than we believe it is worth). This is nothing new, and a lot of this post may seem common sense and obvious to you. But ultimately every investor is on their own journey. This is mine.
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