February Stock Purchase – GSK, Experian, Sage, Shire, Fundsmith, Free Cash Flow

The big news over the last month was Kraft-Heinz failed takeover bid of Unilever. I remember Krafts initial approach and its subsequent quick abandonment vividly. On 17 February when the approach made by kraft was leaked to the media, I remember thinking that I hope management does not engage with Kraft at any level. Thankfully, that is what happened and the news of the deserted takeover on 19the February was music to my ears.

When it comes to investing, I do not look for quick gains. I don’t want to sell the wonderful companies I own for a quick buck. I don’t want to sell the golden goose for an instant profit. Instead, I want to hold on to my legacy positions like Unilever for years to come. I want these companies to keep sending me increased cash flows year ager year. Unilever is a well run company and let’s hope it stays independent going forward.

Furthermore, if Kraft Heinz successfully took over Unilever and the current owners of Unilever got Kraft Heinz shares in return, it would be value destructive. This is because Kraft Heinz being a US headquartered and listed company, any dividends received by UK investors (or any other non US investors) would be subject to withholding tax. For UK investors, withholding tax received from Ameican companies is 15%. This sure does add up over the years. As a UK based investor, I want the UK to continue to have strong dividend paying companies so that I do not need to pay any withholding tax.

What Stocks I bought in February

As the market shoots higher and sector rotation continuing to gain momentum, I have continued to focus on high quality companies.

The shares I bought in February are:

Glaxosmithkline (GSK) – Bought 10 shares for £15.98 each. The more I study GSK the more I kick myself that I don’t buy a truckload of shares when the stock price was £13 last year. The company has a strong vaccines business, an interesting pipeline of new drugs and a consumer staples business with so much potential. GSK is increasingly looking like a company that will be a permanent member of my monthly stock purchase list. Dividend Income : £8

BT – I bought 241 shares at the beaten down price of £3.09 each. Have a look at my post on this purchase. Dividend Income : £36.15

Shire – I bought 3 shares at £45 each. With so much uncertainty in the US healthcare market, Shire’s valuation is looking increasingly cheap. The stock price has jumped a little since my purchase but if drops back, I will look to invest more. The company has one of the best drug pipelines in the industry today. The company has grown by acquisition and with its low payout ratio of 11.6%, I wouldn’t rule out further consolidation by the company once it has extracted the synergies from the Baxalta purchase. Dividend Income: £0.65. This may be low but the company has been growing its dividend at over 15% over the last few years and I expect this rapid rate to continue.

Experian – I bought 12 shares for £15.80 each. Experian is the world’s leading global information services company. The company helps people and organisations realise the opportunities held within. As the world becomes more data oriented, the importance and influence of companies like Experian is growing by the day. With operations across four sectors – credit services, decision analytics, marketing services and consumer services – Experian is well diversified and will do well across different business cycles. Experian is a company that I am keeping a close eye on and will initiate a full position if the price drops to intrinsic value. Dividend Income: £3.95

Fundsmith Emerging Equity Trust (FEET) – Bought 14 shares at £14.50 each. It is no secret that I am a big admirer of Terry Smith. His Fundsmith Equity Income Fund has delivered returns close to 20% per annum since inception. This is simply amazing and that is why it is one of the only actively managed funds I am invested in. The FEET fund has not performed as well as the more popular Equity Income fund but I think the FEET fund will outperform over the next decade or so. Dividend Income: £0 (This is one of the very few investments out there in which I can tolerate a zero dividend yield).

Sage – Bought 24 shares at £6.58 each. What drew me to Sage is its string cash flows. Cash flow is the life blood of any company. Most people confuse cash flow and profits but it is important to stress that they are not the same; cash flow is arguably more important. Cash flows are used to check the quality of company profits and safety of dividends. It is harder to manipulate then profit figures so it is more important to look at. Dividend Income: £3.40

Free Cash Flow (FCF)  = Amount of spare cash a company has after all essential costs including capital expenditure (capes).

With any company I look to invest in, I want to ensure that FCF is increasing on a a rolling three year basis. With Sage, this is certainly the case with cash flows per share increasing from 23.61p to 26.66p per share.

The reason tech companies like Sage have robust cash flows is due to having little to no capital expenditure. Their business model is extremely scalable. If these companies want to to sell their products to millions in a foreign country, instead of spending large amounts of monies on a factory or raw materials, these tech companies simply need more server space. In highly scalable companies, the cost different between serving the 10th customer and the 100th customer is negligible. This is why I like these business models. There is little to no need for large essential capital outlay.

As well as seeing Free Cash Flows increasing, I look at other matrixes such as FCF to equity, operating cash conversation, free cash conversation and free cash dividend cover to see the quality of a company. Cash flows enable you to look deeper into a companies accounts. This gives you the opportunity to invest in companies that might appear not to be financially robust at first glance. One sample is Vodafone, on the face of it the company is not able to cover dividends from profits. But looking at the companies cash flow, you can see that the dividend is sustainable and will grow in line with inflation in the years to come.

Whilst strong positive cash flows are of the utmost importance to me, in rare circumstances, I look over negative FCF. I can tolerate negative FCF for cyclical companies where FCF is volatile over the economic cycle. When I bought shares in Shell last year, it had negative FCF. But as the oil price has risen, FCF has shot upwards. In investing, context is always important and this just proves it.

Over the past month, my dividend income took a hit when I sold Merchants Trust. But I have reinvested the proceeds of that sale and my dividend income is in a stronger position now. With the purchase of the above 6 stocks, I have increased my annual dividend income by just over £50. I’m slowly closing in on the £1,500 in annual dividend income milestone. I don’t want to get ahead of myself as I know I have a long way to go. My philosophy as always is to invest in quality companies at the right price and grow my passive income stream.