The secret to success? Focus on a few stocks, do your homework, then hold for the long term, says Craig Yeaman.
The Saracen Growth Fund has been going for 17 years. It has outperformed the UK market in 14 out of those 17, with an annualised return of 12.5% and a total return of 480% (see chart below). That’s the kind of thing that genuinely impresses us. So just before Christmas I went around to Saracen’s office in Edinburgh to ask Craig Yeaman, the fund’s manager, just how the firm has managed this.
High-conviction investing
Yeaman’s answer is that it comes down to good stockpicking (of course, it could be lucky stockpicking, but a track record of 17 good years does suggest some skill was involved). The fund runs a very concentrated portfolio of only 30-45 stocks and has an active share of well over 90% (meaning that the portfolio is almost entirely unaligned with the index).
Right now, Yeaman is holding only 30 stocks. He doesn’t like to “run long tails of stocks”, for the simple reason that it seems a little pointless. If you hold something that adds up to only 0.5% of the fund’s assets, then whether it doubles or halves is verging on irrelevant to the long-term performance of the fund.
Better to “do a lot of work at the beginning of the process; put in sensible risk limits” (no more than 7.5% of the fund can go in any one stock) and own a proper amount of each company.
You should also aim to hold for the long term. The average annual turnover in Yeaman’s fund is about 20%-25%, which suggests an average holding period per stock of four or five years. That’s much higher than the industry average: a typical equity fund in the UK holds each stock for between one and two years.
So far, so simple. But what makes a company stand out as one of the 30 best investments in the UK as far as Saracen is concerned? It is partly about valuations. Yeaman looks at net asset values if he is looking at property companies, for example, and he looks closely at the cash flow metrics for all his investments, but a stock’s price-to-earnings (p/e) ratio is key.
He isn’t particularly bothered about the current p/e – what he wants is stocks that are growing such that if shares stayed at their current price they would be “trading on a p/e of ten or less in five years’ time”. So he will buy stocks that “look expensive today if we can see the growth coming through with a five-year view”.
What about yield? The fund doesn’t focus on income, says Yeaman (it pays a yield of just less than 2% at the moment), but “like anyone else I like firms… that pay growing dividends”. It is a good discipline for directors and a sign of a healthy business. Not all of the fund’s holdings pay dividends yet (“a lot of my companies are pre-dividend, or just starting to pay dividends”), but on his visits to them he asks for five-year projections that include dividends (they all get visits – it is in conversation that managements are most “candid”). He also likes special dividends, as paid by a few of the fund’s holdings, such as homewares group Dunelm (LSE: DNLM) and chemicals company Elementis (LSE: ELM).
So where is he finding companies that meet these criteria today? Back in 2009, the answer was mainly in large caps. Today it is mainly in small and mid-caps. I ask if he has any bias towards certain sectors. By default, yes. Yeaman works on a stock-by-stock basis, but nonetheless “for many years we had no banks, we had no miners, we had very little in oil and that is actually still the case”.
That bias against these sectors – which are a major part of the wider UK market – has changed a bit recently, but only very slightly. The fund now holds Lloyds (LSE: LLOY), bought about five months ago, thanks to its increasingly strong capital position and resumption of dividend payments. “It’s a stock we think we’ll make a lot of money on over the next five years.”
Capitulation in the mining sector
It also holds one miner – Rio Tinto (LSE: RIO). That’s partly because of the full capitulation in the sector: “everyone to a man is against miners”. One interesting statistic on this? “The market cap of tobacco company British American Tobacco is more than the entire mining sector in the UK” – a sector that includes giants such as Rio, BHP Billiton, Glencore and Anglo American.
The market appears convinced that commodity prices will never rise again, but “we don’t think that is the case”. Eventually demand and supply will rebalance and prices will “snap” back. However, the investment is also about Rio itself, not just the sector. It is “in a very strong position financially” with low gearing, operating margins at 40% even with commodity prices on the floor, and a rising dividend – which “we think is not at risk”.
Given what we were saying about British American Tobacco, I wonder whether he holds any tobacco stocks? These have been exceptionally strong performers and remain popular with many well-known fund managers. He doesn’t – “purely on a price decision”. They’ve “been phenomenal in the past, but if you look at the valuations they are no bargain basement”.
A housebuilder in a strong market
We move on to talking about Yeaman’s favourite stocks at the moment. Lots of the fund managers that I interview tell me that just as they have no favourite child, they have no favourite stock – each has its own merits. Yeaman is less precious.
His first pick is house builder MJ Gleeson (LSE: GLE). The firm has two divisions. One buys land, gets planning permission for it and sells it on to the bigger national housebuilders. The other builds houses across the north of England, where land is considerably cheaper than it is in the south: the average plot comes in at around £10,000. So, of course, are the selling prices of the houses it constructs – Gleeson houses come in at an average price of £120,000-£125,000.
Yeaman likes the company for all sorts of reasons. First, the management own good-sized stakes (the chief executive has 4% of the shares), meaning that their incentives are well aligned with other shareholders. Second, they have “future proofed themselves” by building up a land bank that amounts to seven years’ worth of construction.
Third, they have cash on the balance sheet and are seeing some rises in selling prices. And finally they have initiated a dividend that “we expect to increase materially over the next five years” as the firm moves from building 800 houses a year to more like 1,500. It’s a “strong company in a niche area of the market”. When Yeaman bought the shares they were trading at £1.50. Today that price is £5.60. He isn’t selling.
Another company he likes is STV Group (LSE: STVG), which owns Scottish Television, the ITV franchise for Central Scotland and Northern Scotland. He bought it “too early” in 2010. But the share price rose 200% in 2013, 100% in 2014 and another 20% last year. Would he buy it again – even after that performance? He would. “Just think of a mini ITV. It’s doing very well and it’s on a single-digit rating, the debt is coming down nicely, it’s on top of the pension deficit and it looks like a very solid company.”
Next is pet supplies retailer Pets At Home (LSE: PETS), which he views as “a real category killer in what it does”. It is much larger than most of its competitors put together and it has moved away from just selling products into selling services too: there’s a “flourishing veterinary arm that will do very well over the coming years” and you can also pop into the store to get your pet groomed. Over a five-year view, the firm “looks very good value to us”, and so the fund has recently been building a position.
Finally, there is auto and aerospace components firm GKN (LSE: GKN), which is “doing very well in its own markets of automotive and air space”. It recently bought another company in the sector, margins are increasing, and Airbus and Boeing have long order books for theirplanes, which should keep demand high for the components that they buy from GKN. Yet “we are buying GKN today on a price to earnings ratio of less than ten for next year”. That seems like “extraordinary value to us”. It sounds like pretty good value to MoneyWeek too.
Who is Craig Yeaman?
Craig Yeaman studied economics and marketing at Strathclyde University, before joining Clydesdale Bank’s portfolio management arm as an analyst in 1997. He moved to Glasgow Investment Managers (GIM) in 2001 and served as deputy manager of Shires Income Investment Trust and Shires Smaller Companies Investment Trust. In 2007, Aberdeen Asset Management acquired GIM and Yeaman transferred to Aberdeen, before leaving to join Saracen Fund Managers in Edinburgh in 2008. He has managed the £25m Saracen Growth Fund since 2009.
Yeaman is a bottom-up value investor, meaning that he focuses on trying to spot attractively valued individual companies rather than trading on the basis of macroeconomic forecasts. The Saracen Growth Fund is intended to deliver long-term capital growth, rather than income, so he is currently overweight in smaller UK stocks, which tend to have better growth potential than larger ones.
Small and mid-caps currently account for 46% and 35% of the fund respectively, while larger companies make up just 18% of the portfolio. The fund has delivered cumulative returns of 64% over the past five years, compared to 34% for the FTSE All-Share index. Since Yeaman took over as manager in January 2009, it has returned 158%, compared to 100% for the FTSE All-Share.