Cutting our losses on Dominos Pizza and Dignity

[TheMotorcycleBoy]

Hi folks,

As many of you already know Mel and I started private investing back in March 2018. We are happy with many of our purchases - even though the first few were made with insufficient analysis - obviously said with the benefit of hindsight.

Back in March we purchased about £1000 worth of Dominos Pizza (DOM) shares for 331p per share. This purchase was our first equity purchase and we bought because they seemed to be well spoken of at the time, for example they were cited as being highly cash generative and had high margins in Phil Oakley's "How to pick Quality shares" book and we did also refer their recent annual reports and their profitability was corroborated there. In the first months after our purchase they actually rose to a peak of 385p in June and we were fairly chuffed with them.

The trouble, well for us, least in our opinion, occurred around August when the stock price started to descend quite markedly. I believe the main reasons cited were "execution issues" in their attempts to expand abroad, in particular in Scandianavia. I did look for a decent covering article, but this seemed to be the best I could find in a hurry:

https://www.independent.ie/world-news/d ... 92059.html

we decided that there was no call for concern and held. Indeed we quickly forgot about price drop, and our attention was next caught a month or so back when we noted, what we believe to be a share buy-back campaign. Our only thoughts at the time were that the buy-back would add value to our holding.....

Until at the beginning of last week, we saw a drop of about 10% (in about a day!), and read up on the IC news about franchisee unrest, and complaints from them that they were carrying the bulk of the costs. Indeed it seems the unrest has been well publicised for sometime:

https://www.telegraph.co.uk/business/20 ... sees-grow/

So we decided to cut our losses on this holding, selling last week for £725 (239p per share).

We didn't sell up, due to the fall in the market price. The real kicker for us is a firm that is quite happy to throw money at a share-buyback when it's employees/operators/whatever are quite clearly in revolt. Not a very good way to run a business in our naive opinion.

Our next loss-cutting story idea concerns that of Dignity (DTY). We bought these in June for 1000p per share without sufficient research, speculatively, based the assumption that they were undervalued, and that their business (funeral) was fundamentally sound. We were aware that they carried a lot of debt, but had assured ourselves that the debt was fixed in cost and would be covered by profits. We also noted that whilst the dividend is not particularly large it was about 2.2% at the time of our purchase, we reasoned that this was better than nothing whilst we waited for recovery. Fortunately we only spent about £750 on this holding... since we realised that it never was a particularly "risk-free" holding.

We then proceeded to forget about Dignity until we noticed the large (about 24% by the time we'd noticed!) drop occurring over a couple of days from the end of November. After reviewing the reason behind the fall (the CMA investigation into funeral costs):

https://uk.webfg.com/news/broker-recomm ... 19804.html

we decided that DTY would be under pressure to reduce prices, would need to start to conform to a lower price regime, and in combination with a large debt, this firm no longer seemed to fit the kind of criteria we would wish for one of our equity investments. We sold our DTY shares (shortly before selling our DOM shares) for 761p per share.

We lost £275 (DOM) and £187 (DTY) due to these sell offs.

We would be very interested to hear what you people think of these loss-cuts of ours. Perhaps some of you think we should have hung on? I guess you never really know when the price drop is reasonably marginal (e.g 25-30%); they could of course recover, but we have tried to base our selling decisions on a combination of the facts that we don't think the businesses are as profitable as previously thought, and in the case of DOM, not particularly well managed.

Matt and Mel

[Walrus]

Personally I only sell if something has fundamentally changed from why I invested in the first place.

The less research you do, the more likely you will find yourself getting twitchy fingers with 10 percent falls. Additionally if you had a strong investment case for said share your be more inclined to buy more rather than looking to sell following these falls.

I don't know much about either of those shares specifically but have seen them tipped in IC previously. Terry Smith has been in and out of Dominos on valuation grounds. I think he might be buying again through Smithson currently, on these lower valuations though it may be some other Dominos company.

[ADrunkenMarcus]

We would be very interested to hear what you people think of these loss-cuts of ours. Perhaps some of you think we should have hung on? I guess you never really know when the price drop is reasonably marginal (e.g 25-30%); they could of course recover, but we have tried to base our selling decisions on a combination of the facts that we don't think the businesses are as profitable as previously thought, and in the case of DOM, not particularly well managed.

I've held DOM since 2010. Even today, the share price is more than double my book cost; the dividends received since purchase amount to 44% of the book cost; the dividend yield on cost is 8% and rising; and the dividend has risen at over 13% CAGR. I agree with you it's going through a rough patch, however I think it is a quality business fundamentally. (As an aside, DOM might now qualify for inclusion in some HYPs.) There was always going to be a time when UK growth slowed and international will take time to get going. Recent capital allocation decisions have not been great but it's now on a free cash flow yield of about 6.5% which might indicate they can better buy back shares at today's levels.

An option might be to invest instead in the US-listed Dominos Pizza Inc., which is the worldwide company: 94% return on capital employed if we take an average of the past ten years; and almost 44% return on invested capital in cash terms.

Best wishes

Mark.

[TheMotorcycleBoy]

Thanks for the feedback so far. All points seem valid. We did umm and ahh about whether were being hasty re. the DOM sale, but like I remarked the gusto for the share buy-back campaigns combined with the reported neglect of the operations side seems like a poor management philosophy.

I've held DOM since 2010. Even today, the share price is more than double my book cost; the dividends received since purchase amount to 44% of the book cost; the dividend yield on cost is 8% and rising; and the dividend has risen at over 13% CAGR.

But having said what you've said, Mark, I can appreciate that for you is probably a good source of income.

Terry Smith has been in and out of Dominos on valuation grounds. I think he might be buying again through Smithson currently, on these lower valuations though it may be some other Dominos company.

EDIT: Sorry Walrus, I've only just re-processed your last remark. Did you say Terry Smith, has recently sold out of DOM?

thanks again,
Matt

[Dod101]

Terry Smith via Smithson has I think bought the US brand of Domino's but on the general point of your query, I suspect that 9 months is really too short a period to make any real judgement but otoh you need to do what you feel most comfortable with. I think we have probably all done what you have done early in our investment careers. I know I did and I put it down to experience or tuition fees.

You need to know and maybe record somewhere why you bought a particular share and if the story materially changes then you may wish to sell but again make a note of why. These notes will stand you in good stead in the future. Do not beat yourself up about this sort of thing.

For instance, I bought SSE many years ago (probably about1994 or so) and have held them until this year. I had no expectation of ever selling because in the early years especially they did very well and kept producing excellent dividend increases and so the price followed. They were conservative, in a geographical area I know something about and were getting into renewables. They are pragmatic and willing to change.

However, for the last few years the dividend increases have been modest, their finances have looked a bit shaky and now we have the threat from Corbyn. I decided to sell, have done so and not regretted it as the price has continued downwards. The yield is very attractive though but too bad. Things had changed and not for the better. That is when I sell. I never look back at a share I have sold at least not with regret if I have a properly thought out reason for selling.

So your sales are OK. Just move on.

Dod

[tikunetih]

We didn't sell up, due to the fall in the market price.

I expect the odds are strong that if the same newsflow and events had occurred but the shares had on average climbed by 20-25% over the period rather than slid by that amount you'd still be holding them, and would have subsequently dismissed (rationalised) the newsflow and events as irrelevant.

Do not underestimate the extent to which the attractiveness you perceive in an investment is influenced by the attitude of others: you want the things that they appear to want and you don't want the things they don't appear to want.

[westmoreland]

for domino's the UK business is as strong as ever. there are some problems with norway, but this is a very small part of the business, and thinking longer, term, it can be a success.

i too bought at around £3.30 a couple of years ago now, and during that time the business has made a large investment in its UK operation, continued to grow sales on a like for like basis, while opening around UK 150 stores during that time.

sentiment is down on the stock, and i am thinking about doubling my shareholding.

[TheMotorcycleBoy]

We didn't sell up, due to the fall in the market price.

I expect the odds are strong that if the same newsflow and events had occurred but the shares had on average climbed by 20-25% over the period rather than slid by that amount you'd still be holding them, and would have subsequently dismissed (rationalised) the newsflow and events as irrelevant.

Do not underestimate the extent to which the attractiveness you perceive in an investment is influenced by the attitude of others: you want the things that they appear to want and you don't want the things they don't appear to want.

I hear what you are saying. But I'm the kind of stubborn git, who would definitely sell the position if it was up, and I'd heard the same newsflow. (We sold our CCC - Computer Centre holding when it was up 25% earlier this year - basically because we re-analysed it's numbers and saw that it was low of one the criteria by which we'd to measure it - it's operating margin)

Since we've been on TLF, we've been advised to read up on the writings of Warren Buffet, and one of many messages I've picked up from his words, is to figure out what the Management are like. Screwing down the operations base for the sake of implementing share buybacks just feels wrong - and bad management.

A quote from Richard Branson:

“Clients do not come first. Employees come first. If you take care of your employees, they will take care of the clients.”

But anyway, thanks again for sharing your views.

Matt

[TheMotorcycleBoy]

Help me out a bit here, Mark,

international will take time to get going...

An option might be to invest instead in the US-listed Dominos Pizza Inc., which is the worldwide company...

I don't understand. You say that "international will take time to get going" i.e. the international angle of the DOM, but when you said "US-listed Dominos Pizza Inc., which is the worldwide company" has that one not already saturated the global pizza market?

(I'm not trying to be confrontational - I'm just curious regards the business)

Matt

[TheMotorcycleBoy]

Not wishing to flog a dead horse, just more about David Wild.

https://www.standard.co.uk/business/dav ... 92426.html

The bit about the three CFOs?

[ADrunkenMarcus]

I don't understand. You say that "international will take time to get going" i.e. the international angle of the DOM, but when you said "US-listed Dominos Pizza Inc., which is the worldwide company" has that one not already saturated the global pizza market?

I don't think the world market is saturated, no. In any case, even existing stores still have a good 'growth runway' ahead of them IMHO. Same store sales have shown a very good increase in like for likes, going back twenty years. The financials of the US company are better than the UK one, if we look at ROCE, CROIC and projected dividend growth for the next few years.

The issue is less the business model, but the idiocy of the UK group's management. When you have the global company, you're less exposed to one local company's poor capital allocation or management. At current levels, I would argue that buybacks for the UK company might be better placed than they have been previously.

Best wishes

Mark.

[dspp]

I'm useless at selling, so take everything that comes next as really being about buying.

1. Re funerals. OK, so this is a steady state predictable profit making business that has been operating in a stable market for a very long time. There is no GOOD reason for it to have significant debt. Therefore it has been loaded with debt for a reason. The responsible people will have long since fled the scene. The point is that if a business that is stable and profitable and has no particular reason to carry large debts, but nonetheless does, then think how it got into that position and where did the debt go to. Someone else has bought their yacht, and left the bill behind.

2. Re pizzas. This is a growth stock, but is also a favourite traders' stock that is relatively small (mkt cap £1.1bn) and has highly incentivised mge team. Therefore it is large enough to pay for a serious amount of public relations activity that is aimed at the investment community. Therefore whatever you read in the media is being 'placed' and spun, and will seldom be a warts-and-all account of the reality. The point there is that you need to recognise this up front and filter accordingly.

I have no opinion on selling (or not) your losses at this stage as I have not researched either of these two companies sufficiently to comment on that aspect. If nothing else it is a lesson identified re value of diversification. And of considering what - if anything - makes you an above average investor (or car driver), and therefore able to identify an underpriced share (which is what one is implicitly doing when buying). The truth is most humans always consider themselves to be above average in both those matters, and that of course cannot be correct.

You are quite right to raise these issues for discussion. Very well set out.

regards, dspp

[TheMotorcycleBoy]

Thanks for your thoughts, Dave,

1. Re funerals. OK, so this is a steady state predictable profit making business that has been operating in a stable market for a very long time. There is no GOOD reason for it to have significant debt. Therefore it has been loaded with debt for a reason. The responsible people will have long since fled the scene. The point is that if a business that is stable and profitable and has no particular reason to carry large debts, but nonetheless does, then think how it got into that position and where did the debt go to. Someone else has bought their yacht, and left the bill behind.

I believe the reason for the debt (they are massively levered), is that a few years ago, they gradually bought up lots of the other smaller providers in the same game. Presumably on the basis of an attempt to grab market share.

Alas (this is my conjecture) they assessed their ability to shoulder that debt, and still reward their investors based on predictions of UK death rates (presumably easy enough to forecast) and estimated inflows from pre-paid and future funeral plans. The problem is that the CMAs recent review on this sector has presumably kiboshed all this. And that's why we decided to sell this one up - our perception of the future profitability of DTY has changed.

2. Re pizzas. This is a growth stock, but is also a favourite traders' stock that is relatively small (mkt cap £1.1bn) and has highly incentivised mge team. Therefore it is large enough to pay for a serious amount of public relations activity that is aimed at the investment community. Therefore whatever you read in the media is being 'placed' and spun, and will seldom be a warts-and-all account of the reality. The point there is that you need to recognise this up front and filter accordingly.

Yes thanks for this, too, Dave. Our main rationale for sale of DOM is probably more contentious, and I've already stated it above. Who knows? Still early days for Mel and I in this game.

Matt (and Mel)

[TheMotorcycleBoy]

And of considering what - if anything - makes you an above average investor (or car driver), and therefore able to identify an underpriced share (which is what one is implicitly doing when buying).

This is a very interesting point. I have not been investing for very long - but have been driving for about 33 years. I have (sadly) long since held the view, that the majority of the driving public arrive safely at their destinations, as driven as much by luck as by judgement. Many many times when people overtake, or pull away from a junction they unconsciously weigh up a certain balance of probabilities, and most of the time, the odds return favourably. As a commuter who undertakes a daily round trip of 60+miles (mainly on one of the worst roads in the Eastern counties) I feel that only too well!

However, another key point which this thread is drawing to my attention is that whilst it is fine to try to attain "Buffetesque" ideals in investing i.e. select companies only which possess strong, highly-principled management is a quite another thing, to actually find co.s with such management in our highly competitive marketplace, and then keep tabs on one's findings and act accordingly. (And yes, I'm aware of the convincing defensive argument, to "just buy into an index tracker!").

Matt

[ADrunkenMarcus]

However, another key point which this thread is drawing to my attention is that whilst it is fine to try to attain "Buffetesque" ideals in investing i.e. select companies only which possess strong, highly-principled management is a quite another thing, to actually find co.s with such management in our highly competitive marketplace, and then keep tabs on one's findings and act accordingly.

Matt

Very true.

I remember someone used to run a family firms 'folio. Part of the basis for their strategy was thinking that they had longer term, strategic cultures. Companies with that sort of approach arguably include Unilever and Brown-Forman Corp (the latter an example of Tom Russo's 'capacity to suffer' which is worth Googling).

You may wish to checkout Kone (ticker on HEL: KNEBV) if you're fine with holding Finnish shares and the family interest.

Best wishes

Mark.

[Dod101]

I remember someone used to run a family firms 'folio. Part of the basis for their strategy was thinking that they had longer term, strategic cultures. Companies with that sort of approach arguably include Unilever and Brown-Forman Corp (the latter an example of Tom Russo's 'capacity to suffer' which is worth Googling).

You may wish to checkout Kone (ticker on HEL: KNEBV) if you're fine with holding Finnish shares and the family interest.

Indeed. On the old TMF site there was a family firms portfolio which was reported on regularly. It seems not to have transferred to TLF.

I strongly believe in seeking out family firms because they tend to have a longer term outlook than most quoted companies, lower borrowings and altogether a much more conservative outlook. In a word they look at survival first and foremost. As I have said before, once a culture is established, any culture, good or bad, it is quite difficult to change it, which is why the family firms' values do not change very much from one generation to the next.

Dod

[SalvorHardin]

However, another key point which this thread is drawing to my attention is that whilst it is fine to try to attain "Buffetesque" ideals in investing i.e. select companies only which possess strong, highly-principled management is a quite another thing, to actually find co.s with such management in our highly competitive marketplace, and then keep tabs on one's findings and act accordingly. (And yes, I'm aware of the convincing defensive argument, to "just buy into an index tracker!").

The problem with looking at management quality is frequently management appears to be good when in reality they're mediocre or even worse a bunch of bull excrement merchants in smart suits. After a while you'll start to realise how good (or not) they are, but this could be an expensive learning experience. To quote Buffett, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

I find it much easier to find companies with decent moats than top quality management. Peter Lynch's "Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it" is one of the most important investment quotes I've ever come across. Put an idiot (or worse still, a greedy idiot) in a commodity business or one where it's easy to use leverage (e.g. banks, insurance) and they'll probably ruin it in fairly short order.

A good example is one of my larger holdings; Canadian Pacific (CP). For many years CP was run by mediocre management yet it still delivered reasonable results. Then in 2011 a hedge fund manager (Bill Ackman of Pershing Square) bought just over 12% of the company and, with the support of many other shareholders, installed his own choice for CEO. Since then the business performance (and the share price) have rocketed. A hypothetical business whose products are easily commoditized which was run by CP's previous management would have done very badly; CPs strength is its awesome moat (no-one is going to build another freight railroad in Central and Western Canada).

https://business.financialpost.com/tran ... keep-track

For a "family firms" investment trust look at Caledonia Investments (the Cayzer family owns just under 50% of the shares). Caledonia has a long term focus.

[TheMotorcycleBoy]

I find it much easier to find companies with decent moats than top quality management. Peter Lynch's "Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it" is one of the most important investment quotes I've ever come across.

Hi Salvor,

I'm aware of the moat philosophy - and indeed since we have had a slight slump in equity prices Mel and I are trying to buy into some of the higher quality stocks, hopefully ones with moats (e.g. Unilever ULVR, Diageo DGE, Croda CRDA) just of late. I've also heard the phrase about "a business that any idiot can run". But surely, if you are actually trying to imply that businesses with moats and "businesses which an idiot can run" are both worth investment (apologies in advance if I have misunderstood your point), then is that not contradictory? Since a business which an idiot can run, is probably one which is easily reproduced - and hence will lose it's moat status very shortly....

Matt

[SalvorHardin]

I'm aware of the moat philosophy - and indeed since we have had a slight slump in equity prices Mel and I are trying to buy into some of the higher quality stocks, hopefully ones with moats (e.g. Unilever ULVR, Diageo DGE, Croda CRDA) just of late. I've also heard the phrase about "a business that any idiot can run". But surely, if you are actually trying to imply that businesses with moats and "businesses which an idiot can run" are both worth investment (apologies in advance if I have misunderstood your point), then is that not contradictory? Since a business which an idiot can run, is probably one which is easily reproduced - and hence will lose it's moat status very shortly....

"A business that an idiot can run" means that the characteristics of the business are so good that it will perform reasonably well even when it's badly run. It's hard to screw up a company whose products inspire tremendous customer loyalty and for which there are no substitutes (or at least no substitutes within a reasonable price range). But it's very easy to screw up a bank (e.g. excessive lending to bad risks, borrow short lend long needs careful management).

It doesn't mean that it can be easily reproduced. If it could be easily reproduced then you're back into the territory where you've got a business with poor characteristics (i.e. its products are becoming commoditised) so tremendous managers can't make much of a difference (unless they can create some sort of advantage, which is hoping for a lot).

An example of a product with a very strong moat where idiots have been put in charge is Star Wars (now owned by Disney), which has had a huge cultural impact around the world over the last forty years. They've made ten Star Wars films, several animated tv series, there have been numerous product tie-ins (books, figures) and Disney are putting a lot more Star Wars into its theme parks. It's really hard to find someone with a good word to say about "The Phantom Menace" yet it still made a lot of money (I know Star Wars fans who hate the film but still bought it on DVD (and Blu-Ray)).

But in the last few years management at the film studio has deliberately gone out of their way to pick fights with many of the franchise's most devoted fans whilst putting out poor films (and letting production costs run out of control). The most recent film even lost money at the box office. This is something that I thought I'd never see happen to a Star Wars film. It's an interesting experiment!

[Topidiotboy]

I think Dominos is a great business that maybe is being run by an idiot, but maybe not. It’s difficult to know. Turnover of CFO’s is not great, but could be bad luck rather than a systemic issue. Poor relations with the franchisees, maybe a case of special pleading, or a genuine grievance – it’s hard for an outsider to know. I can buy into the idea that franchisees are struggling to sign up to the split territories strategy, and may feel that it benefits DPG more than it does themselves, and this will put a brake on future expansion if management can’t make the case more convincingly.
UK growth is unlikely to be able to continue at the same rate it has in the past from here out. For me though, you can’t ignore the positives. International growth looks like a very promising opportunity. UK growth might slow, but there’s still decent runway, and like for like sales in itself is a good opportunity.
But most importantly, add the business model into the mix. Franchising of a popular brand is a brilliant model. Growing through other people providing capital, means you have an asset light business with high ROCE.
In summary, DPG is a great business, experiencing some short term difficulty and a slowing growth outlook, which is not good. On the other hand this has created a situation, where you can buy the business at a trailing 6.5% FCF to Enterprise Value. Even taking a pessimistic view of a future of low single digit growth going forward, I think the long term case for DPG is very convincing.
As a side note, on the point of Terry Smiths’s ownership, Fundsmith has never held DPG, it formerly held DPZ. However, the Smithson IT does hold it. It’s not a top ten holding, but the November factsheet lists DPG as one of the top 5 detractors for the month.