I’ve been away for a week and so haven’t yet had a chance to update on a number of trades I have made. I have taken profits on two large holdings, Burford Capital and On The Beach as they fell through stop losses. I have bought three new positions, buying back NMC Health, Burford and buying Microgen for the first time.

Burford Capital and On the Beach both fell by more than 10% causing me to sell last week. I decided only four days later to buy back Burford as it rebounded, for a somewhat higher price than I sold it. I also bought back NMC Health not very long after I sold it and for a higher price. I bought after it issued some very strong results. This is my third trade in NMC Health and as yet I have little to show for them, despite the price rising quite substantially over the period. I seem to be buying on the highs and selling on the lows with this one.

My experience with NMC Health and Burford has caused me a bit of frustration. Had I just held rather than buying or selling I would have made quite a bit more with both of these holdings. As I have said before, the risk of a momentum based strategy is that you buy on the highs and get thrown out on the lows in a choppy market. On the other hand, several other of the shares I have sold recently have gone on to do badly and have been replaced with others that have done better. I undoubtedly have to accept that my strategy will lead me to sell too early in some cases, but it has brought into focus an issue that I think I need to think about more carefully: at what level is it best to set a stop loss? I’ll be coming back to this at a later date…

Microgen

Yesterday I bought an initial position in Microgen (2.8% of the portfolio). Microgen is a recent addition to the watchlist and as yet I haven’t written anything about it. It is a software business providing financial management and fund management systems. It has a partly acquisitive strategy of consolidating the wealth and fund administration market.

Quality

I think Microgen is a high quality business:

• Business economics: in general I love the economics of software businesses as, once they have developed a product, the marginal costs of selling more of it are fairly low. Similarly, they often benefit from recurring license revenues from individual customers while the costs of maintaining the product for that customer tend to be very low. Consequently, software businesses can be very profitable indeed, provided of course that they can develop the software cost-effectively and are successful in selling it in the first place. Microgen looks to benefit from some of these features and has decent returns on capital (currently 18%) and margin (19%). It has recently developed new versions of its product and these appear to be being successful – correspondingly its returns on capital are improving. It has good cash generation and net cash on the balance sheet.
• Track record: Microgen appears to have a good track record. Profits and free cash flow has been growing for the last 3 years. Prior to that, the track record is obscured by the fact that Microgen interrupted its acquisitive strategy with a decision to return a lot of capital to shareholders following the financial crisis.
• Competitive advantage: Microgen appears to have a good competitive niche and appears to be a major player in this niche. However, I have not found it easy to identify who the other competitors it may face are. In Microgen’s news statements, it seems to refer to the main source of competition as coming from in-house provision but that it offers a higher quality alternative to this, particularly for medium to larger customers who need a more flexible system with greater functionality. As noted above I think it is likely to benefit from recurring revenues due to its customers’ ongoing need for its services and the costs involved in switching providers.
• Growth prospects: Again, it is somewhat difficult to determine what Microgen’s growth prospects are with much accuracy. Its recent news statements refer to new sales in new geographies and in the newly opened US healthcare market. Given its relatively small size, current rate of growth and apparent potential to grow relatively cheaply through acquisition, I think the growth prospects look very promising.

 Pricing

Price momentum is excellent with the price trending smoothly upwards and recently breaking out to new highs. It has recently issued very positive interim results with very strong revenue growth for its Aptitude financial management product in particular.

These factors are suggestive to me that undervaluation is likely. This seems to be confirmed by my simple Ben Graham rule of thumb valuation, which suggests it is likely to be fairly undervalued based on my best guess growth estimates for the next few years (based on a moderation of the current trajectory).