2023-07-26 17:43:10 ET
Summary
- I decided to sell my shares in Games Workshop Group PLC, despite a 74% return on investment, due to concerns about the European economy and the company's over-optimistic share pricing.
- The company's financial results have been outstanding with revenue and net income growing by 15.15% and 4.9% respectively, and the dividend grew by 46% from last year.
- I believe "buy and forget" is a suboptimal strategy, and encourage more active investment strategies, such as buying and selling when it makes sense to do so.
I don't know whether I "flipped" or "flopped" last September when I finally decided to buy Games Workshop Group PLC ( GMWKF ), and in that time the shares have returned a gain of about 74% against a gain of about 11.1% for the S&P 500. A more wise man than I would refrain from bragging about that return. Anyone who knows me knows that I'm not that wise. So, hop into your Dreadnought, buckle up, and get ready for some industrial grade bragging. I get so few opportunities to do this, so please indulge me. Now, as I try to ignore that pesky little voice in my head spouting some nonsense about "pride goeth before destruction" or whatever, I want to make a serious point. In the article before last, I eschewed the shares for a few reasons that you can read all about in that article if you're interested. The returns from the time I wrote that much more cautious article are exactly half what they were since I wrote most recently about this business. So, when I decided to buy the stock cheaply, I earned twice the return in about 60% of the time. I think there's a lesson we can all glean from this example. Being a bit patient, and only buying shares when they go on sale can be quite profitable. Stepping down from my soapbox, it's time to have a look at the shares to see if it makes sense to hold them or not. I'll make that determination by looking at the most recent financial results, and by looking at the valuation. Going into this article, I'll admit a certain amount of caution. Europe represents about 42% of this company's business, and it's plain that Europe is heading into a recession. Such would be a troublesome macroeconomic environment for such a company as this in my view. That written, I'd be happy to weather any storms assuming the shares remain inexpensively priced.
Welcome to the "thesis statement" portion of the article. This is where I tell you in very broad strokes what my thesis is, so you can then leave the article and go pursue more enjoyable activities than dealing with my constant bragging and tiresome jokes. You're welcome. I'll be selling Games Workshop this morning. I think the company has come off of a wonderful year, and I think the dividend is reasonably well covered. Additionally, this is one of the strongest capital structures I've seen recently. At a time of generally rising interest rates, that's quite something in my view. The problem is that the good news is already priced in. The shares are more optimistically priced than they have been for a while. That's troubling, in my estimation, because there's growing evidence of weakness in the European economy. As importantly, the shares are no longer offering a positive risk premium. When I turned bullish, the risk premium on offer here was over 100 basis points. Today, an investor can earn 110 basis points more risk free than they can with these shares. In the relativistic game of investing, that's significant in my view. As of written, and said to a tiresome degree recently, "TINA is dead, and there very much is an alternative." Nothing against the company, but I'll be taking my profits now.
Financial Snapshot
The financial results over the past year have been outstanding in my view. Relative to the previous year, revenue, and net income have grown by 15.15%, and 4.9% respectively. When we compare the most recent results to the pre-pandemic era, things look even better in my view. For instance, revenue and net income for the most recent year were 74% and 105% (!) greater than they were in 2019. The company has achieved extraordinary results in my view. Additionally, the capital structure is one of the cleanest I've seen, given the absence of debt, and a cash hoard on hand of about £90.20 million pounds (about $116.2 million in real money). Cash generated from operations was also up by about 46%, from £159.20 last year to £231.70 this. The year 2023 was very good for this company, and it shows in the fact that the dividend grew by an eye watering 46% from last year to this.
In my view, the dividend is the one potential fly in the soup, but it's not a very large fly. The company generated earnings per share of about £4.09 and spent about £4.15 on dividends, pushing the payout ratio above 100%, obviously. That written, cash from operations was about 72% higher than net income, so I'm not really that worried about dividend coverage here. I'd be happy to buy more of this very profitable business at the right price.
The Stock
I think the phrase "at the right price" lacks specificity, and so I owe you a bit of an explanation of what I mean. The "right" price is one where I'm compensated for the risks present in the future execution of the business, and the risks present in the company failing to meet future expectations. Expectations are very important, in my view. Given the great financial performance recently, an investor might expect this trend to continue, and that expectation causes the share price to rise. At some point, even the most wonderful businesses falter, at least in the short term, and if expectations are high when that happens, shares can collapse in price.
So, in this exercise, I want to try to work out what the crowd's "thinking" about the future here, and if they're too optimistic, I'm going to sell.
Additionally, in my experience, the only way to profitably trade stocks is to spot the difference between expectations of the future and actual future results. This is obviously easier written than done, but if you can swing it, you'll do well. When the crowd is too pessimistic, it's time to buy. When the crowd becomes too manic, it's time to sell. You may watch shares that you sold continue to rise in price, but remember that what the market giveth, the market taketh awayeth.
Another way of saying "when the crowd is too pessimistic, it's time to buy" is "buy cheap." I measure cheap in a few ways from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like earnings, free cash flow, dividend yield and the like. I eschewed the shares when they were trading at a PE of about 21.75 and backed up the proverbial "truck" when they started trading hands at 16.4, and when they were sporting a very respectable dividend yield of about 4.35%. At the moment, they're trading hands for significantly more, and the yield is significantly lower, per the following:
I'm not normally a fan of paying more, and getting less. It seems that the shares are much more optimistically priced than they've been since at least the beginning of 2022. Additionally, the dividend on offer for new investors coming to this business today is about 110 basis points lower than an investor can get on a 10-year risk free investment. In my view, this optimism is misplaced, given the increasing evidence of a recession in Europe.
There IS An Alternative
I became bullish on these shares last September, when the 10-year Government Note was yielding about 3.3% and the stock dividend was about 4.3%. Today, that position is reversed, and the dividend stream that a marginal buyer will receive is 110 basis points below what they could receive risk free. I think this is a powerful reason why we can no longer simply buy and forget. In my view, everything in the world of investing is relative. When you buy "X" you are, by definition, eschewing countless "Ys." We are always looking for the best risk adjusted alternatives, and in my view, at current prices Games Workshop now represents more risk, and offers less reward than alternatives.
In my experience, "buy and forget" has been a failed strategy for many investors because they buy, watch their investments go up in value, and then passively watch their investments drop back down in value as the relative environment changes. Having once worked on Bay Street (Canada's very insecure answer to Wall Street), I can tell you this "buy your investments and forget about them" is a narrative sold by financial professionals because it allows them time to pursue other things than pesky portfolio maintenance. In my view, though, it's necessary for investors to be more active, and buy when it makes sense to do so, and sell when it makes sense to do so. In my view, it makes sense for me to sell Games Workshop, so that's what I'm doing this morning.
For further details see:
Taking Profits In Games Workshop