My portfolio is treading water at the moment. I’m still optimistic about the remainder of the year, which tends to be the strongest season for the stock market. As I mentioned in my last post, I’m going to move to trading at most only once every two weeks so that I don’t end up relying on stop losses too much, or overtrade. I started with one trade this week under this new system. In addition to that, I have to update on a trade made last week.

Last week I sold out of Churchill China for a small profit and bought a new position in the London Stock Exchange. I bought Churchill China immediately after it issued an ahead of expectations trading update, also observing that it looked cheap. The share price didn’t have much momentum when I bought in and the recent trading updates don’t seem to have kindled much. This makes Churchill a natural candidate for removal given my current desire to follow momentum more systematically. In addition to that and perhaps more importantly, I’ve also decided that Churchill isn’t really obviously high quality enough to warrant a place on my watchlist. It has a good track record but I’m less sure about its long term prospects than some of the other candidates vying for a place.

This week I sold out of NMC Health, again for a small profit, and bought a new position in Judges Scientific. NMC Health was clearly the lowest momentum share in my portfolio and under my new system it was down to be sold. I don’t understand why there has been such relentless selling after an initially positive reaction to its recent results. It’s disappointing to make little profit on trading NMC again but I think my capital is better deployed to something with higher momentum.

London Stock Exchange

The LSE is a relatively addition to my watchlist. This is a little surprising given its prominence from an investing perspective and fairly obvious quality attributes – it feels like it has been hiding in plain sight.

The LSE provides much of the UK’s investing infrastructure. Its main businesses are:

• FTSE Russell, an information services business that sells access to data and investment indexes
• LCH, a clearing house that provides liquidity across a wide range of asset classes
• Capital markets, where it generates fees from allowing companies to list on its markets and raise capital at IPOs.

Quality

• Business economics: LSE is a profitable business with consistently high operating margins. The underlying business model of using fixed platform infrastructure to earn fees from transactions and subscriptions appears to have very attractive economics and benefits from substantial economies of scale. It is highly cash generative. Its returns on capital have not been so high in recent years and are currently at around 12%. I think this is because it has been deploying capital in acquiring other superficially expensive but high quality assets that should generate growth for some years to come. I would expect its ROCE to improve over time.
• Track record: LSE has a very good recent track record of increasing revenues and profits. The share price has steadily risen for the past few years. While it is had good organic growth, a lot of its growth in recent years has also come from well-executed acquisitions. It is likely that the opportunities for acquisitive growth will diminish over time.
• Competitive advantage: stock markets are still very geo-centric and only compete globally with each other to a limited extent. The LSE appears to have a pretty rock-solid competitive advantage, effectively having a local monopoly position over key infrastructure and information. There is some competition and pressure to innovate across its markets, but this is limited and LSE seems to be a global leader. I think you can be reasonably confident that LSE should be able to maintain its competitive advantage over the long term.
• Growth prospects: the LSE’s short term performance is subject to the valuations and fluctuations in volumes of trading on the stock market. Over the longer term, I think you can be more certain that growth should be strong, as the markets LSE is in should benefit substantially from secular long term growth. I would also expect the LSE to continue its geographic expansion through acquisitions and partnerships.

Price

Current momentum is excellent, with recent positive results and the share price breaking out to new highs not long ago. The valuation seems pretty reasonable to me given the long term growth prospects.

Judges Scientific

I first came across Judges quite some time ago and have successfully invested in it before. It has made it back on to my watchlist recently since performance has improved after a couple of bad years. It is a ‘buy and build’ company that buys very small owner-operated scientific instrument businesses, typically buying them from their founders when they retire. It focuses on trying to identify businesses that serve very small niches and are effectively global monopolies. It’s basically a bit like a private equity fund, but focusing on smaller businesses than private equity typically would.

Quality

• Business economics: the economics are good. Judges isn’t hugely profitable at the moment but it has the potential to be and manages to generate good returns over time. It has decent margins and returns on capital and is extremely cash generative. The businesses it owns appear fairly capital light in general.
• Track record: Judges has a very good track record over the longer term and has been successful at growing revenues and profits at a decent rate overall. However, there are some ups and downs. A lot of its growth is driven by making acquisitions at very decent valuations and the availability of suitable opportunities varies from year to year. It has had a couple of difficult years recently with some operational issues at one of its larger businesses, though these now seem to be sorted. Its various businesses experience peaks and troughs as demand for their niche products can be quite lumpy.
• Competitive advantage: properly understanding all of the markets Judges’ businesses are in would be a level of detail too far for this investor. According to Judges they are small global niches where there is little competition. I’m inclined to believe this.
• Growth prospects: the long term growth prospects look decent as Judges’ markets are likely to experience secular growth – demand from its main customers in the education sector is likely to grow significantly over the long term. Given Judges is still relatively small I think there is still plenty of scope for it to find decent investment opportunities at decent valuations.

Price

Momentum is great. I bought the shares pretty soon after an ‘ahead of expectations’ trading update, with the price breaking out to new highs. The valuation seems very reasonable.