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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to On The Money, a weekly show that aims to help you make the most out of your savings and investments. So in this episode, we're gonna be covering how to find sensible stocks, which is no mean feat. However, I think it's particularly pertinent at the moment given a number of stock markets are at or close to record highs, including in The UK, in The US, and in Japan, and that's at the time of this recording, which is the October 13. Joining me to discuss the three rules he lives by to pick sensible stocks is Mark Niznik, full manager of Artemis UK Smaller Companies and Artemis UK Future Leaders Investment Trust. Mark, great to have you on the podcast.
Mark Niznik:Thanks very much for having me, Kyle.
Kyle Caldwell:So, Mark, your first rule is to favor companies that don't have any debt. Could you talk us through that?
Mark Niznik:I think the first point to mention is that companies go bust through having too much debt. So if you don't have debt, you tend to avoid companies that collapse. The other thing is that I found that having cash or strong balance sheets give you options for the future. So you could choose to invest more in your company with the cash that's on your balance sheet. You could choose to make acquisitions that would further enhance your earnings into the future, or which has been more recent phenomenon, you could choose to buy your shares back if you thought they were cheap in the stock market.
Mark Niznik:So having cash on your balance sheet gives you options. Having too much debt can lead to problems if the future or your outlook tightens and your and your profits dip. That leads into into serious problems. So I like to avoid highly indebted situations and invest in companies with cash.
Kyle Caldwell:Have you learned the hard way by experience? Have you invested in any companies in your career or certain sectors where there've been high leverage and it has come back to to bite the company?
Mark Niznik:Absolutely. Most of the lessons I've learned have been have been the hard way over over over a long career. I I would say, I mean, while we seek to invest in companies that have very strong balance sheets, there's always one or two that that that that have some debt. There's one currently in the portfolio. It's only a small holding, but a company called Vedendum.
Mark Niznik:They have too much debt, and that came out of a a Hollywood writer's strike where they sell film equipment into that industry. When when all the writers were on strike, they weren't they weren't making the the films, and the the debt built up to a level that, you know, really spooked investors, caused the profits to dip, and the shares, to to collapse. So, you know, it's it's always there as as a kind of a a sense to try and avoid that situation where you can.
Kyle Caldwell:Let's now move on to your second rule, and that is to look for companies that are growing at a sustainable rate and are leaders in their niche area. So what sort of qualities or attributes does a company need to possess in order to be a leader in their respective field?
Mark Niznik:So the the idea behind investing in companies who are leaders in their little niches is that over the decades, I have found that to help companies with better buying power and pricing pry or pricing power. Pricing power is important when you have inflation that's that's kind of kicking back into the system. So we've now got a government with slightly inflationary policies. If you think about the budget last year where national insurance was increased in quite a material way for companies, companies need pricing power to to improve the prices to offset that cost push from from the from the national insurance or whatever the the the new cost pressure is. If you've got a market leader, they tend to be able to do that more than not.
Mark Niznik:If I could say an example. So with the budget last year, that was particularly painful for companies that had low operating margins and lots of UK staff. For instance, in our portfolio, we own JD Weatherspoon, the pub company. They have 40,000 staff rough roughly. When you add on the national insurance increase and the national living wage increase from last year, it was about an extra £60,000,000 of costs that they had to cover off to, just to keep the profits the same.
Mark Niznik:Now while Weatherspoons isn't a market leader, I would say they are absolutely a market leader in the value end of the pub market, and they were able to push their prices up such that in the in the year just gone, they managed to to make £81,000,000 of pretax profit, which was 10% above last year after absorbing some of those cost increases. So that's what I mean by having better pricing power for niche market leaders. And pricing power hands companies the ability to be in control of their own destiny? Correct.
Kyle Caldwell:And in terms of what companies need to have pricing power, is it a strong brand or a royal or or a loyal customer base? Are they the two main things?
Mark Niznik:It it could be many things. It could be a strong brand. So, for example, we invest in Greg's, the on the go the on the go food company. That has an incredibly strong brand, so it could be brand. It could be intellectual property, so it could be some kind of technology that gives you an edge over others in the market.
Mark Niznik:It could be just the the pure market size relative to others in the market that give you better buying power so you can buy better than your competitors. You can invest more than your competitors. It could be a number of things, actually, but, yeah, we're we're always on the lookout for what is what is that niche ability to give that company better buying power than others.
Kyle Caldwell:Your third rule is to pick companies that are making money today rather than focus on companies that are promising future growth. So could you talk us through that?
Mark Niznik:Yeah. Certainly, in the world of smaller companies, it's very easy to get carried away with a a really sexy growth story. So the company might not be making much money or any money, but they promise very good growth into the future. And that's really easy to get kind of excited about. The problem with that is the expectations that are then on that company to deliver are very, very high, such that if they fail to deliver or if there's a wobble, the shares can fall dramatically.
Mark Niznik:We prefer not to invest in companies with very hyped future expectations. We prefer to focus on companies that are producing good profits and especially great cash generation Because it is still the case that profits can be easily manipulated to suit the company. Cash in the bank is much more difficult to manipulate. So we like companies that are growing their cash each year into the future at a at a modest predictable rate. It is cash that pays the bills, that pays the debts, that ultimately pays dividends, and that's what we focus on when others may be focusing on profit growth and earnings growth.
Kyle Caldwell:And how do you strike a balance between a company paying out a certain level of dividends but not overprioritizing the dividends? When companies do overprioritize dividend, then that can stunt the long term growth of a business.
Mark Niznik:Yeah. We we tend to focus on the cash flows before the dividend payments. So it's important for us, at least, for my colleague Will Tamworth and I, to look at companies that are paying out a great cash generation. And then, again, going back to the question of of too much debt and and cash, that cash generation gives you options. You can either pay it out as dividend if if you want.
Mark Niznik:You can reinvest it in more CapEx to grow the company's capital expenditure to to grow the company. You can use that to buy your shares back. You can use it to make acquisitions. We would always look at companies that pay out too much of their cash flow by dividend a little less favorably. We you know, we I mean, it depends on the company, but we prefer companies to reinvest for the future growth of of of the business.
Kyle Caldwell:And once those free rules are applied, seen in a recent investor notes, you pointed out that you're seeing plenty of opportunities at the moment in the area of the market you invest in, which is UK smaller companies. Before I ask you about some of the opportunities you're seeing, I firstly wanted to find out your observations on why The UK stock market as a whole is so unloved. We've seen the top end of the market to the 4,100 surpass 9,000 points in mid around July. Yet, we're not seeing a lot of investors return to The UK market. And, indeed, if you look at the fund flow statistics over the past decade, in the vast majority of months, UK funds have been experiencing outflows.
Kyle Caldwell:So what needs to happen for that tide to turn? I I did have it put to me by some managers that needed to see a sustained period of strong performance for The UK stock market. We've already seen the 4,100 have a very strong six to nine months, and yet we're not seeing buyers return.
Mark Niznik:I think it comes down to confidence in the domestic UK economy. If you look at what Will and I do in small cap land, about 60% of the revenues of those smaller companies are derived from The UK market. In large caps, that's only 20%. So in small cap land, we're much more directly attuned to the domestic UK economy. And as you said, over the last decade, The UK stock market and the economy has been on the kind of investor naughty step.
Mark Niznik:We've had we've had Brexit. We've had, you know, the threat of a Corbyn government. We've had the Kua Chang trust budget. We've had a lot of negativity in investors' mind thrown at that market, and that's caused significant worry. We think that's about to change.
Mark Niznik:That there are, I suppose Will and I would frame frame it as a as a kind of an each way bet, an investment in small caps at the moment. On the one hand, if we're right, as employment doesn't collapse, then consumer confidence should grow. As consumer confidence grows, the consumer is about 60% of The UK economy, that should help grow The UK economy. At a time when US investors are kind of questioning the growth in The US, the valuations there are much higher than The UK. So it wouldn't take much for a small shift from one out of The US into The UK to make a significant difference to UK market as a whole and to UK small caps, especially.
Mark Niznik:So that's that's on the one hand. On the other hand, if we're wrong and The UK economy continues the kind of mediocre, you know, bumbling along as we've had for the last decade, then a return in UK small caps will be more of the same, I would suggest. We'll continue to get outflows, and the returns from small caps will be a diet of takeovers and share buybacks. Now I say it's an each way bet because in that environment, that's that's kind of what it's been for the last decade. Our fund has managed to return over a 100% in that decade.
Mark Niznik:That's an 8% a year return when the return in large caps has been 7%. So that's not a it's not a brilliant outcome, but it's not it's not bad. So it's it's kind of not not too bad on that bet as opposed to the the first expectation of of of a very good growth.
Kyle Caldwell:And within UK smaller companies, are there any particular sectors or types of businesses that you would point out are offering outstanding value?
Mark Niznik:Yeah. Well, Will and I are stock pickers, so we don't we're not kind of top down macro people. But because of that worry over the domestic UK economy, a lot of domestic cyclical companies have been put on such good value ratings. So we've been able to invest in market leading companies such as Dunelm, the the market leader in home furnishings, DFS, the market leader in sofas, Hollywood Bowl, the market leader in 10 pin bowling Jet two in holidays Moonpig in online greeting cards Victorian Plumbing in online plumbing. All of these companies are market leaders in their little niches, and they're on very low valuations because of the negativity surrounding the the domestic side of The UK economy.
Mark Niznik:So we've invested in those, and we hope as that negativity subsides, the share prices of those kind of companies should improve.
Kyle Caldwell:And as you've mentioned, The UK stock market, it's trading on a much cheaper valuation than across the ponds. When you compare The UK smaller companies with its own history, how do the valuations compare today?
Mark Niznik:I would say The UK small cap market is pretty reasonably priced. It's it's not the absolute lowest that it's ever been. That would be wrong for me for me to say that. It's certainly a lot cheaper than many of the other western stock markets that you could invest in. So on a relative basis, absolutely, it looks it looks good good good value.
Mark Niznik:Will and I are very excited about the prospects here because there's so much negativity around investing in in The UK at the moment.
Kyle Caldwell:And it's a area of the market that I know you're putting your money where your mouth is. As I understand that you invest your whole pension in the funds that you manage, although you you do caution that this isn't for everyone. Could you talk us through that?
Mark Niznik:Absolutely. So when Will and I meet new companies, we always like to see the directors of those companies owning a decent amount of those companies because it aligns our interests as shareholders in the company with the directors' interests in in the company. We're we're financially aligned. And so the same way, if we're if we're if I'm sitting here with with you, Carl, and and saying, yeah, we Will and I are really excited about the prospects for UK small companies, yeah, we think it aligns interest. But I would say the real reason is that we think we're gonna make a lot of money by investing our I mean, my pension and and Will's pension in this area.
Mark Niznik:So Will and I have bought just over 2 and a half million pounds worth of shares in the Artemis UK Future Leaders Investment Trust in recent months because those shares are on a 15% discount to the underlying value of of of the trust asset, and that company is about 90% the same as our larger U Unit Trust. So to me, if if we're excited about the future for UK small cats, we can buy this company on a 15% discount. That that's that's why why why we've we've invested out our money.
Kyle Caldwell:That's all we have time for for today. My thanks to Mark, and thank you for listening to this episode of On the Money. If you enjoyed it, please follow the show in your podcast app. And if you get a chance, please do leave us overview or a rating in your podcast app too. We love to hear from you, and you can get in touch by emailing otm@ii.co.uk.
Kyle Caldwell:And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the Interactive Investor website, which is ii.co.uk. And I'll hopefully see you again next week.