JD sold; GAW bought

I’ve sold my holding in JD Sports at about the same price I bought it and invested the proceeds into Games Workshop, shortly  following a very positive trading update.

I picked JD Sports to sell solely because it’s the weakest holding of a currently very strong portfolio, to buy Games Workshop. I have started with a 2.7% holding.

Gwlogo

Games Workshop is a designer and manufacturer of fantasy figurines, principally for use in the tabletop role playing games it has created, including Warhammer among others. If like me you dabbled in it when you were younger, or indeed if you and/or your children are currently collectors then you should have a good understanding of the business model already. If not, the idea is to cultivate loyal customers who treat the games as a hobby, playing at home and at the companies stores with the encouragement of the store manager, and over time amassing an army of figurines, which are constantly refreshed with new additions and developments to the game.

Quality

Overall, I think Games Workshop is a good quality business with some very clear strengths, but also some weaknesses:

  • Business economics: Games Workshop is a very profitable business requiring little investment to generate a lot of cash. It has excellent returns on capital and margins. It returns a lot of the cash it generates to shareholders in the form of sizeable dividends.
  • Track record: the long term track record is quite patchy and this is a weakness. Games Workshop has made some mistakes over the past decade with overexpansion and changes to its products alienating some of its customer base. While it is consistently highly profitable, its growth and long term share price have been quite up and down over the last decade. This track record indicates that there are risks, particularly in the execution of new product development not to be taken lightly.
  • Competitive advantage: the competitive advantages Games Workshop has are quite clear. It has developed IP effectively giving it a monopoly over its customers and, while it faces some competition from similar types of games, this is quite limited. Customers also tend to be very loyal. Once they have invested in time, effort and figurines to start playing the games, it is hard for them to switch. Games Workshop also benefits from network effects, as the value of the game to its customers increases with the size of the network of other customers also playing. This can makes it hard for potential rivals to establish themselves.
  • Growth prospects: it is quite a mature business compared to some of the others I invest in but I believe Games Workshop does have good growth potential.  It seems to have good opportunities to continue its global expansion, to continue to introduce new products and potentially earn royalties from licensing its IP for computer games. I think the risks are mostly around its ability to continue to attract new players into the future by continuing to recruit good store managers and further developing its products. Its characteristics should make it a defensive business too (though short term ups and downs may come from its own product cycle).

Pricing

Momentum is really excellent and is the main driver for me wanting to buy the share now despite my somewhat ambivalent views of the quality of the business. The share price is breaking out to new highs and the company has today issued a really excellent trading update. The valuation also appears very reasonable, despite the rise in share price over the last year and taking account of the possibility of some uncertainty in growth in the future.

Overall, while I may have some qualms about the longer term risks it faces in continuing to grow, this seems like an excellent opportunity to buy into a highly profitable and reasonably valued business that is firing on all cylinders. I’m not minded to take a very big position in it for now but will see how it continues to trade.

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