The Two Shares You Should Buy Now
Dear Fellow Stock Market Investor,
I'm delighted to present to you this very special report.
My name is Maynard Paton, and I've been looking out for individual investors like you since 1999, the year I joined The Motley Fool UK.
My mission back then was the same as it is today -- to help the Motley Fool members build real wealth by investing in world class companies ahead of the masses. It's the reason I jumped at the opportunity to head our flagship premium stock picking service, Motley Fool Champion Shares, back in 2005.
The past 18-odd months have been a tough time for stock market investors. Very few investors have been spared, including the great Warren Buffett. If you think your losses were bad, Buffett's net wealth shrank by a cool US$25 billion in 2008.
But rather than run away from the market, I've redoubled my efforts to pick what I consider to be the very best shares for the months and years ahead.
The two shares I've chosen are amongst my favourite companies for new money today. They are solid companies, with strong competitive advantages, excellent management and low on debt -- just the way I like all the companies I recommend to Champion Shares members to be.
I hope you enjoy the report.
Sincerely,
Maynard Paton, Chief Investment Analyst
Motley Fool Champion Shares
Tip 1:
The Commercial Property
Operator
Daejan (LSE: DJAN) is a FTSE 250 property group.
I believe Daejan is one of the most attractive operators in the bombed-out property sector. Important features of this recommendation are reliable executives and what must be one of the best dividend records in the stock market.
The current boss has served on the board since 1971 and the payout has been lifted every year bar one -- when it was maintained -- since 1979! Similar to many other property shares, Daejan's latest balance sheet has a value well ahead of its current market capitalisation.
Executive Summary
Daejan is not without risk of course. In particular, the outlook for commercial property valuations is not great and the company's estate may suffer further devaluations. A sector downturn could become protracted, too. Daejan is also a low-profile business and a future share-price re-rating may be hard to come by.
Still I think the group's conservative finances put it in a good position to navigate through these difficult times. While I don't think these shares will set your portfolio on fire in the immediate future, I'd like to think they can deliver a very acceptable return for long-term investors.
The Business
Daejan was established during 1935 and initially operated as an Indonesian plantation business. By the Fifties the group had become a 'shell' and in 1959 was transformed into a property business through a reverse acquisition. Initially focused on London residential sites, the same family management has since built a diverse property empire that now encompasses a mix of residential and commercial assets throughout the UK and the East coast of America.
Daejan has a very low stock-market profile. Regulatory announcements are few and far between and the company's annual reports and website do not reveal too much about the business. Yet Daejan has little to be embarrassed about.
As I intimated earlier, the company must surely have one the most distinguished dividend records in the market. Old annual reports claim shareholders have always received a payout and that it was lifted every year between 1979 and 2008. Importantly, this record has been overseen by the current board (see below) and encompassed the property crash of the early Nineties. Between 1989 and 1992, the dividend gained 14% to 25p per share. For 2009, the payout was one of the few in the sector to be maintained (at 73p per share) and not cut.
Daejan has grown almost entirely without the help of rights issues and other shareholder injections. The company claims it has "operated for many years in a conservative manner" and employs a "carefully balanced approach to risk".
Financials
Evidence of that "balanced approach to risk" comes from the balance sheet. Unlike many other commercial property landlords, I can't really see Daejan becoming involved in much debt trouble. At the last count, net borrowings were £160m and were dwarfed by more than £1bn of freehold assets. It's worth noting that Daejan is one of the few commercial property shares that has not required a rights issue to shore up its balance sheet during the current downturn.
Daejan's rental and service-charge income cover its costs very well. For the last few years, profits before disposal-related profits have represented well over 30% of group turnover. I'd like to think Daejan's margins give the group enough room for manoeuvre should rental payments come under pressure.
Daejan does not operate a final-salary pension scheme and as such should never become burdened with long-term retirement obligations.
The Boardroom
Daejan's two executive directors offer bags of top-level experience. Both are sons of the group's founder, with one having joined the board in 1971 and the other in 1986. Both have therefore delivered a significant part of the aforementioned net asset and dividend record. The executives are also under 60 years old, so I'd like to think they have the opportunity to extend the group's record for some years to come.
In a business that could easily be a 'fat cat' fiefdom, I'm pleased basic director pay has tracked dividend growth over the years and that there are no options and no bonuses.
Valuation
Not surprisingly, Daejan's property portfolio has come under pressure courtesy of the global recession. It has already written down the value of its assets by £268m and further asset write downs may come as tenants default and more units stand empty.
But at a share price of around £28, it seems to me Daejan's shares expect an enormous rent setback. You could buy this company outright for £456m and, after paying an additional £160m to clear all its debts, enjoy an 'ungeared' gross rental yield of 14% through last year's £84m rental income. Throw in £12m of service charges as well and the gross rental/service charge yield comes to 16%.
Summary
Daejan must be one of the least known companies in the FTSE 250. But hiding behind the low profile is a long-term record that would shame many more familiar shares. It's not often investors can back a management team that has delivered nearly thirty consecutive years of rising dividends. The same team is one of the few in the industry that have not had to launch a rights issue, eitherIt all makes the company classic material for Champion Shares.
The main drawback to Daejan is the outlook for the property sector. Daejan's estate has already been devalued, and more might come. But in my view the share price already anticipates plenty of bad news and lower property prices across the board. If anything, I'd like to think Daejan's first-class executives will be able to capitalise on any downturn by buying properties on the cheap.
I admit Daejan is not the type of business that will make us overnight millionaires. But if the company can repeat anything close to the growth it has achieved in the past few decades, I'm sure patient investors can look forward to very acceptable returns.
Tip 2: The Small
Specialist Insurance
Company
Abbey Protection (LSE: ABB) is a provider of legal expenses insurance to small businesses.
I reckon Abbey is one of the more appealing shares to join AIM during the last couple of years. The main attractions for me include veteran management with substantial shareholdings, a track record of organic growth and some cash-generative accounts.
Executive Summary
As with every investment, there are always some negatives. The main risk with Abbey is that insurance can be quite an unpredictable industry, and there's no guarantee Abbey's underwriting will always make a profit.
Nevertheless, I hope further earnings growth, a substantial cash pile and some useful dividends can in time help shareholders outrun the wider market.
The Business
Abbey Protection was established in the early Nineties to sell specialised insurance for small businesses. The group's policies cover the costs of professional fees arising from legal actions and tax investigations. Abbey also operates an advisory division, which provides employment consultancy services and manages the Law Society's personal injury compensation scheme.
Abbey is a market leader with proven underwriting history. I'd like to think Abbey's status and certain features of the legal expenses market can alleviate some of the risks.
The November 2007 flotation document says Abbey is an industry leader with a fourteen-year record of profitability. The document also claims the firm operates in a "non-cyclical" sector that enjoys a "stable claims environment" and covers risks limited mostly to £100,000 or less.
Abbey has cited various opportunities for growth. The firm claims the "increasing burden of legislation and red tape on businesses, together with an increasingly litigious society, ensures an expanding latent demand for the group's products". According to the flotation document, half of all UK businesses do not have any legal insurance cover and further take-up could help the market grow by 25% by 2010.
Financials
Operating margins: I'm very impressed by Abbey's level of profitability, with operating margins at a very healthy 20%+ during 2008.
Cash flow: The bookkeeping backbone is a pile of net cash and investments that stands at £15m. Other financial features that should help Abbey beat the crunch include zero debt, no pension obligations and generous cash flow.
The Boardroom
Abbey's boardroom offers the long-time experience and high insider ownership that I like to see at my smaller company recommendations.
The chief executive, the group managing director and three senior managers have each been involved with various parts of Abbey for at least ten years and all appear to have partaken in a management buy-out during 2004. At the last count, these five employees controlled 53% of the company -- an aggregate £36m shareholding.
The board's remuneration suggests a shareholder-friendly team to me. Basic salaries appear restrained while bonuses are straightforward and based on a percentage of group profits. Representing less than 2% of the total share count, staff options look under control as well.
Valuation
Abbey's shares currently trade around the 71p level. Trailing earnings of 6.1p per share support a P/E of 12, while a repeat of the 3.5p per share dividend would provide a 4.9% dividend yield.
I view Abbey's current rating as relatively attractive. I hope further earnings growth, a favourable P/E re-rating plus some useful dividends can in time combine to produce a total return ahead of the index.
Summary
I feel Abbey is a good quality small cap. Key features for me include an owner-orientated leadership team, high profitability, net cash in the bank, decent cash flow and an optimistic outlook. I feel the small amount of director selling at the float is a good sign, too.
Abbey is not perfect of course. For a start, insurance can be an unpredictable business and there's always the chance too many claims could hit earnings. Another potential drawback perhaps is the prospect of greater competition. Abbey's margins may feel pressure if the Legal Services Act prompts new rivals to enter the market.
While a P/E of around 12 may not be the single-digit multiple currently applied to many small caps at the moment, I feel Abbey's superior levels of profitability, those cash-packed accounts, a management team with a 53% shareholding and a modest valuation tell me to buy.
