It was a difficult week last week, with falls across a lot of the portfolio. The weekly performance at almost -5% was the worse for more than a year. I’m increasingly feeling that we are embarking on period of volatility where my momentum strategy is going to come a bit unstuck. Though it’s premature to say that of course. September is often not a great month for investing.

As a result of the volatility last week, I sold out of three holdings that appeared to have lost momentum: Keywords Studios (for a 50% profit), Fevertree (for a 46% profit) and Tristel (for a 17% profit). These were all on fairly high valuations and Keywords Studios also issued interim results that I thought were a little disappointing, given the high expectations I had previously.

I spent some of the proceeds buying five new holdings: Ted Baker, Micro Focus, Microgen, JD Sports and Cranswick. The new holdings are also in general valued more cheaply than the holdings I sold. But five new positions is a rather alarming number for one week! In hindsight, I think I was too quick in buying into all these positions and was probably influenced (subconsciously) by wanting to recoup my recent losses. Nevertheless, the positions I sold were quite a bit larger in size than the new holdings, so I have been left with quite a bit of cash in the portfolio.

I’ve held the new stocks previously and have written about all of them on the blog before: Ted Baker, Micro Focus, Microgen, JD Sports, Cranswick. I don’t have much to add to my previous posts on Microgen, JD Sports and Cranswick as these were fairly recent, but the other two could do with updating.

Ted Baker

Ted Baker is a fashion brand owner, operating globally in both retail and wholesale.

Quality

I think Ted Baker is a high quality business:

• Business economics: Ted Baker looks to have very good business economics with consistently high returns on capital and margins. Its free cash flow generation has deteriorated in recent years as it has been investing heavily in expanding its distribution network and portfolio of stores. Despite this it still doesn’t have too much debt. The capital investment currently appears to be paying off in terms of growth.
• Track record: Ted Baker has an excellent track record. It has been consistently growing revenues and profits for many years and correspondingly the share price has risen fairly steadily. The long term share price chart also suggests that it wasn’t overly negatively impacted in the last recession.
• Competitive advantage: Ted Baker’s competitive advantage is likely to come from its brand. It appears to be able to sell clothes at high prices and margin due to its brand. My impression of its brand is pretty positive. It is fairly high-end and high-quality but also appears to have a broad appeal.
• Growth prospects: The growth prospects look very good. Ted Baker appears to have plenty of scope for further geographic expansion and increased market share. It is still a relatively small sized business.

Pricing

Ted Baker’s last significant news update was back in June when it stated that all was going well. Before this analysts had been revising their expectations moderately downwards. Since the last update there has been little change to expectations. Its interim results are due on 8 October.

While Ted Baker’s performance has continued to be on track, share price momentum is not so great. Its share price has suffered a lot of volatility and is currently about the same level it was two years ago. It has done fairly badly for most of this year, following generally poor sentiment in retail, but in the last couple of weeks it has started to bounce. The valuation looks very reasonable indeed given the growth prospects – I’d say it was substantially undervalued provided nothing too serious happens. So this one is a little more on the ‘value’ and less on the ‘momentum’ end of the spectrum of shares on my watch list.

Micro Focus

Micro Focus provides legacy software services – helping customers get the most out of old IT investments. Micro Focus has a growing portfolio of mostly ex-growth products but also SUSE which is growing significantly. While I have a broad understanding, I have to admit that I find the overall business and products a bit complex to fully understand. To complicate things further Micro Focus has recently undertaken three very large transformative acquisitions, including lately a reverse takeover of HP software business, catapulting it into the FTSE100.

Quality

I think Micro Focus is a very high quality business:

• Business economics: Micro Focus business has great economics: it has huge margins, ROCE and FCF conversion. It is able to generate very high profitability from its customer base without much investment.
• Track record: Shareholder returns have been exceptionally and consistently high in recent years, particularly for a large company. Micro Focus is one of very few companies whose share price grew through the 2008 downturn.
• Competitive advantage: Micro Focus is largely almost totally insulated from competition for existing customers who are effectively locked in to using its products. Even more widely it faces little competition. It also benefits from scale and operational efficiency and appears to be well run.
• Growth prospects: this may be its relative weakness. The market it operates in is stable in the long term and its products are indispensable to its customers. It therefore makes stable profits and is very defensive. This allows it to generate decent growth throughout the cycle. However, it appears a fairly mature business. There are some areas of growth for its products, though Micro Focus recent strategy has been to grow by driving consolidation and greater efficiency across the sector. It appears to be executing this strategy very successfully so far, though it comes with some risk.

Pricing

Micro Focus has fairly recently updated with some better than expected results for the Hewlett Packard business it is acquiring. The share price momentum is fairly good, after a bounce back from some recent volatility. The valuation seem fairly cheap given its growth prospects.