August has continued to see markets at record highs. Ever since the trump bump of November last year, many investors anticipated a correction – a 10% drop in market prices – to occur but there has been no sign of this yet. It appears as though the market keeps powering upwards regardless of valuation, regulatory and political risks. And this has got me nervous.
It has become exceedingly hard to find investments that will produce double digit annualised returns. And it is for this reason the cash portion of my portfolio sits at 30%. It is important to note that cash is not held as a hedge. It is also not held because I am predicting some sort of downturn (I can’t predict the market’s near-term direction).
Whilst I continue to be patient and await excellent companies to be priced at reasonable valuations, I continue to drip money into the market via my monthly stock purchase programme (the advantages of this approach has been highlighted in a previous article ). This months, I have made purchases in two stocks that offer terrific value in the current market environment. The two stocks I bought are as follows:
- Imperial Brands – Bought 14 shares at £31.80 each. Total holding is now 90 shares with an expected annual dividend income of just over £150. Find my write initial write up on Imperial brands here.
- Shire – Bough 6 Shares at £37.50 each. Total holding of 34 shares with dividend income of £7. Find my write up on Shire here.
From my perspective, adding to existing positions in these two companies is logical. On a valuation front, they both have free cash flow yield of about 10% making them an anomaly in todays highly overvalued markets. Imperial and Shire are cheap and unloved by the markets. Tobacco and Pharmaceuticals are not en vogue right now. The two sectors are muddled in regulatory issues at present and this has produced opportunities for long term holders waiting for the issues to play out – have a look at my last article to see why market beating returns occur when you ignore near term prospects. But these two stocks have had their stocks pushed down more than their compatriots for one big reason: Debt.
Both Imperial Brands and Shire have a fairly leveraged balance Sheet. Imperial currently has close to £14 billion of debt on its balance sheet compared to approx £3billion in FCF and Shire has £21 billion in debt compared to $4billion in expected FCF. Looking at FCF to Debt ratio figures, both the companies have ratios which are slightly higher than what I am usually comfortable with. But I also understand that the two companies are defensive in nature and have predictable and growing free cash flow figures. The defensive nature of tobacco and healthcare ensures the companies will continue to provide copious amounts of cash-flow whatever the macro outlook. To me, the debt load on both companies is manageable and the depressed valuation the market has assigned these companies is not warranted.
But I am not complaining. The low valuation placed on these two companies has meant that I am getting a terrific deal. As I’ve written before, people who are in the wealth accumulation stage of their life – like me – should wish for falling prices as they are able to snap up a greater ownership stake in a company for the same price. In this instance, the market offered me a chance to buy into two excellent companies at depressed valuations and I took my opportunity.