Imperial Brands (IMB) Stock Purchase – Topping Up On an Existing Position By Exiting Dunedin Income Growth Trust

Imperial Brands (IMB) is a company I talked about glowingly a few months ago when I first purchased shares in it. It is easy to see why. The company has strong free cash flows, a recession resistant business model, a disciplined capital strategy and a history of double digit dividend increases which look like they are only going to continue. But for all this blue chip’s strength it is often overlooked by many an individual investor. This is because Imperial’s biggest money spinner is tobacco and people are averse to owning tobacco-related shares for obvious ethical reasons (I have written about ethics and investing before so have a look there if interested in the topic). I was once told by an older and wiser gentleman that cigarettes may be hazardous to your health, but not investing in cigarette stocks may be hazardous to your wealth. Have a read of the wonderful economics of the tobacco industry here.

In a market where it is increasingly hard to find value of any sort, Imperial Brands stands head and shoulders above the rest. At my purchase price of £36.60, the P/E ratio of the firm stands at 13, the free cash flow yield is close to 10% and the forward dividend yield is 4.67%! These numbers are simply amazing considering other defensive companies share prices have been bid up to the sky due to low interest rates.

I have thus used the recent weakness in IMB’s share price to buy 29 shares in the company. This adds to my existing 35 shares owned in the company bringing my ownership to a grand total of 64 shares. Over the coming 12 months, the company is expected to pay £1.71 per share in dividends meaning I am set to receive £109 in dividends from this company alone. My portfolio now brings in a total of over £1,500 in dividend income a year and I will be writing about this in my upcoming monthly stock purchase post.

To fund my purchase of IMB shares, I sold my entire position in Dunedin Income Growth Investment Trust (DIG). I sold shares in DIG for more or less the same reasons I sold shares in Merchants Trust. The correlation between the underlying holdings of DIG and that of my own portfolio has increased in recent months. Looking at the Trusts Top 20 holdings, I own 9 of them in substantial quantities – Glaxosmithkline, Unilever, Royal Dutch Shell, AstraZeneca, Vodafone, BP, Sage, National Grid and Imperial Brands.

Another aspect of Dunedin Trust which worried me in recent months is the high leverage used. It is common for trusts to take on debt (leverage) in order to juice returns for investors. But having debt also means that in a downturn trusts like DIG will be hit harder, all things equal. With markets at all time highs, the risk reward ratio for juicing returns via leverage is something I am not comfortable with. This made my decision to sell the stock all the much easier. As Warren Buffet Famously said “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

Having this attitude of only buying stocks I would be happy to keep for the long-term helps in ensuring no junk companies make it into my portfolio. (In theory, there is a set of circumstances, a price, and terms, at which sub-standard companies could get added. I recently made money trading in shares of Lamprell, for example. I wouldn’t have wanted to own them forever, but I was comfortable the value far exceeded what I paid and there was little to no risk of bankruptcy. When the price is cheap enough, sub-standard companies can really propel your returns providing you know when to sell. On the other hand, wonderful businesses don’t require the selling decisions as they have the ability to compound over long periods).

I sold all my 331 shares in DIG for 264 each. Having bought the shares at 246p each, I have made a small profit of £57.5 (or 7%) including dividends.

Since I sold my shares in DIG, the share price has climbed a little to 270p. But I am sure glad I sold the stock and moved the money into IMB. With Imperial Brands, I am getting a better valued company, with stronger cash flows and a higher dividend yield than that of the underlying holdings within Dunedin Income Growth Trust. In short, IMB offers better risk-adjusted returns than DIG. Switching my funds from DIG to IMB seems like a good deal to me.

Another takeaway from the above is that if a wonderful asset came along at a great price , don’t be afraid of a little horizontal risk shifting. Let’s say that BP went to 650p tomorrow while crude still looked like it was going to be at $50 for whatever reason and Unilever were, again for whatever reason, at 3500p a wonderful price that would have me tap dancing. BP isn’t cheap at that point, on a present basis, anyway. Unilever would be. Provided I don’t have cash in my portfolio I’m going to sell my BP position given that it’s in a tax shelter (ISA), and buy into Unilever. I don’t really advocate selling shares in great businesses because someone who doesn’t know what they are doing won’t treat it as a risk management strategy or, alternatively, a rebalancing opportunity but rather, try to time the market. It goes from being about intelligently adjusting the overall exposures and risks in the capital pool to, “BP went up and he sold it to buy Unilever, which went down” and gets dumbed down from there. I know it’s not my responsibility to keep fools from being foolish but I’d prefer not to contribute to their misunderstanding by sidestepping the topic altogether. Nonetheless, I hope this explanation of horizontal risk shifting makes sense.

In the end, it is up to you as an individual to compose your portfolio in any which way you like. Personally, I like quality and whenever a ‘forever company’ is trading at a reasonable valuation, I will press the buy button. As the market has been over-pricing many quality companies, I have been buying sub-standard companies such as Essentra, Devro and Lamprell as they became unnecessarily cheap – though these stocks have provided me with excellent returns so far. But make no mistake, if any of my ‘forever companies’ come within striking distance, I will have no hesitation in selling sub-standard companies os that my money can be better utilised.