Targeting Latchways

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Nifty and thrifty, what could go wrong?

Latchways, which manufactures fall protection equipment for people working at heights, is the third niftiest and sixth thriftiest company in my screens. The screens rank companies by four related factors; profitability, value, financial strength and timing. Highly profitable financial power-houses are rarely cheap, particularly if business is booming and they are currently doing well, because investors notice and buy the shares. That’s the problem presented by Latchways. According to data from Sharelockholmes its average Return on Equity (profitability) over the last 10 years is an extraordinary 30%, especially considering leverage appears to be so low (the assets it owns are mostly funded by equity, not debt). A perfect F_Score of nine out of nine implies the business is doing very well. The problem? Investors know it, since the shares cost more than four times book value, the value of the company according to its accountants. Even if Latchways continues earning a 30% return on equity over the next, say, ten years, I have to pay more than four times the value of that equity (book value) to include the shares in the Thrifty 30. So I can only legitimately expect a return of about 30/4.3, or 7%. Seven percent is below my minimum return of 10%, so unless the statistics I calculate when I paw through the annual reports say differently I can tell you now I’m unlikely to be adding Latchways at  the current price of 1065p. But the combination of high profitability, sound finances and a niche business that makes something really useful but not particularly glitzy is very promising. It could be a hidden champion and should events conspire to knock the price down to the point at which it does offer investors a 10% return, I might be first in the queue to add it. Once I’ve confirmed the figures and familiarised myself with the company, I’ll be in a position to set a price target. Correction In the commentary on the Nifty and Thrifty screens posted earlier in the week I implied Latchways’ profitability was in part fuelled by leverage. Bit embarrassing really, I read the ratio the wrong way around. Leverage is very low at Latchways, so its a small factor in profitability.


I think you'll find that if you pay 4x book on something that is compounding at 30% it's a bit more complicated and beneficial than dividing 30/4 to get your return.
£100 compounding at 30% will be worth £1,437 in 10 years, £400 compounding at 14% will be worth £1,482 in that time frame - so you'd be getting an annual return of just under 14%. Better hurry if you want first place in the queue.

Can you explain that a bit more Trident? I don't understand the logic behind your point. Why is £400 being compounded at 14%?

What Richard is referring to is (I am presuming as I use a similar formula):


Rearranging this you get:


where PBV is price to book ratio and COE is cost of equity. To put it simply, if you bought 10% at 1x then your making 10% (if your point was about compounding generally then apologies for missing the point). What have I missed?

All I'm saying is that £100 compounding at 30% over 10 years will equal about the same as £400 compounding at 14% over 10 years.

So if you're paying 4x book - you'll get a 14% return, assuming of course that the ROE can maintain these high levels over 10 years.

I love reading Richard's blog but I find the approach too mechanical for me. It's scored highly on his screens and is the market leader in its field. I think Richard should spend more time thinking about the growth of this market, because I'm sure that if there's growth in the market Latchways will benefit hugely. And the market is Health and Safety - how can it not grow?

Latchways is a hidden champion in my view.

Hi Trident, Calum, thanks for your comments. Yes the difference is compounding, and the misunderstanding is my fault because I should have made it clear I was talking about the expected return in a typical year - i.e. uncompounded. Since Latchways doesn't promise 10% in a typical year, I'm probably out.

While I haven't yet looked at Latchways in detail, my default position is I wouldn't expect a company to maintain an unblemished record of very high returns into the distant future as, due to competition, ROE tends to revert towards the mean (there are always exceptions!). So relying on continued high levels of ROE to deliver the desired return is risky.

However I accept I rely heavily on the statistics. My method is to validate and interpret them, and rarely to overrule them. That reflects lack of confidence in my own business acumen. There will always be people who know more about individual businesses and markets than me, because I'm not a specialist in any of them.

However I think its quite likely (especially with markets the way they are) that there will come a time I can add Latchways at a price I'm comfortable with, and if I've already investigated the company I'll be able to do that unhesitatingly. That's the plan, any way.

Despite your misgivings Trident, you say you love the blog, and that means a lot to me. And I agree with you, at first glance Latchways looks like a hidden champion.

I think the problem with that approach is growth is uncertain and its hard to quantify (the orginal PBV formula is ROE-g/COE-g anyway). More practically, its very difficult to find out about market size. The only people who are going to know this don't want to tell you (esp. if the information would be useful to you).

I use Datamonitor 360 quite a lot (supposedly the leading resource on stuff like market sizes) and the only good data is for very large industries i.e retail, health or food and drink. So if you start looking at market size you move from looking at something very transparent like ROE, margins and asset turns to stuff that you don't know market size, demographic/consumer trends or aggregate capital expenditure. My general view is that in this instance given the way the UK economy is structured, macro trends are far more pervasive than I think is obvious.

Richard - it's a great blog. And you've given great links to other sites, which I've found both helpful and interesting, I'm currently wading through the Gannon blog which I found courtesy of you.

I just think that if your screens have thrown up a contender that scores so highly, and it's a market leader you have to have start looking at the fundamentals of the business.

Latchways isn't cheap and if it has been compounding at 30% a year for 10 years it would be very rash to assume that can continue for another 10 years.

Callum - I think it's bonkers not to look at things like market size and the industry that the company is operating in. Buffett said something like you can put great management in a poor business and mediocre management in a great business, and in both cases it's the dynamics of the business that will be most responsible for the outcome. It ain't easy - but as his sidekick Munger said - why should it be easy. Buffett also said to ignore the macro economy.

That wasn't my point (if you've read my stuff on the pub/dairy industry you would find I look at industry in great detail). You should look at an industry but the problem is that, by logical definition, you won't have access to any useful information (in most cases). Its fine to say you should look at the industry but getting access to that information means either paying or having serious amounts of money.

Unsuprisingly, I don't think you should ignore macro conditions. I am not going to go on about it apart from saying that someone who was investing through the most profitable period of any stock market, in any country of all time would probablly say you don't need to worry about macro conditions. Its also tremendously misleading as Buffett is a perma-bull on the economy (Look at what he does, not what he says. Remember what he said about derivatives). That is his choice and it may be right or wrong but he has a view. Either way, you just have to look at Japan to see that bad stuff happens. Rant over.

Interesting choice of words Calum "you don't have access to any useful information".

I look at businesses mainly to confirm they have a future - that they're not, for example, being mullered by new and virulent competition that is so different the company would have to change beyond recognition to prosper. That's why I find retail and publishing so difficult, essentially they're having to become IT companies.

I don't feel I have the information to make more fine grained decisions, for example about growth, so I tend to discount growth prospects. That's led me to miss out on some fantastic opportunities: Abcam and ASOS come to mind. I ejected XP Power from the portfolio too early. All because I lacked confidence in continued growth.

That's the price I pay for playing it save and avoiding all those growth companies that don't meet expectations.

Incidentally, I believe you could have ignored the macro situation in Japan and profited by value investing - James Montier backtested value portfolios to demonstrate it.

[...] Its PE is about 16, and its PB is about 4, which means I didn’t consider it for the Thrifty 30 portfolio almost a year ago. [...]

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