Interview With John Kingham Author Of The Defensive Value Investor
Defensive investing focuses on strong, steady companies that produce decent rates of income and capital growth, but with risk often coming from a lofty share price. Value investing, on the other hand, is focused on buying companies on the cheap, but the danger is that these companies are cheap for a reason. Defensive Value combines the two and involves buying relatively defensive companies at value for money prices.
In his new book The Defensive Value Investor John Kingham explains how to screen for shares with the best combination of quality, value, income and growth, how to conduct a thorough qualitative analysis, when to buy, when to sell, and how to combine investments into an easily manageable portfolio to reduce risk and increase returns. He also illustrates the method throughout with the help of real-life examples.
The Defensive Value Investor: A complete step-by-step guide to building a high-yield, low-risk share portfolio Paperback – April 4, 2016
Ahead of The Defensive Value Investor’s release, John Kingham was kind enough to answer some questions for ValueWalk about the book and value investing in general, as part of ValueWalk’s Value Fund Interview Series.
John Kingham is the managing editor of UK Value Investor, the investment newsletter for defensive value investors. With a professional background in insurance software analysis, John’s approach to high yield, low risk investing is based on the Benjamin Graham tradition of being systematic and fact-based, rather than speculative. His website can be found at: www.ukvalueinvestor.com
Rupert Hargreaves: Could you give our readers a brief summary of your book, The Defensive Value Investor?
John Kingham: I think the book’s sub-title is a good summary. It’s: A complete step-by-step guide to building a high yield low-risk share portfolio. Basically, the book is a detailed walk-through of the investment strategy I’ve been using and refining since 2011.
The defensive value name comes from Ben Graham’s The Intelligent Investor, where he uses defensive to describe investors who should be investing in large, high-quality, dividend-paying companies at reasonable valuations.
The book covers every aspect of the strategy from quantitative stock selection to qualitative company analysis, and about a third of the book is focused on portfolio construction and maintenance. The whole approach is quite systematic and rules-based. In fact, the book contains about 50 rules of thumb which I use on a regular basis to guide my decision-making.
RH: What was the inspiration behind the book?
JK: I’d thought about writing a book on and off for a while, but what really drove me to write a practical, step-by-step guide, as opposed to a more philosophical or principles-based book, was Howard Marks’ book The Most Important Thing.
The Most Important Thing is all about sound investing principles and useful ways to view the world and investment markets. That’s great, but I think having a practical step-by-step plan is just as important as knowing the underlying principles.
So I wanted to write a book that was kind of the opposite of The Most Important Thing (which is one of my favourite investing books, by the way). In other words, I wanted to write something that was practical and detailed, describing how I use a rules-based system to run my portfolio and pick stocks in the real world.
The other major inspiration was to share my ideas with other investors. It seemed to be a bit of a waste to have spent years thinking up a complete investment system to only have it used by one person.
RH: What do you hope readers will take away from the book?
JK: I hope each reader will be able to take at least one idea from the book and apply it to their own investment process. It could be a simple idea such as holding 30 stocks or having no more than 10% of their portfolio invested in any single industry, or they might see something they’ve never heard of before, such as using the premium to surplus ratio to analyse risk in insurance companies.
RH: There are hundreds of books out there on value investing, what makes The Defensive Value Investor stand out from the crowd?
JK: I guess there are a few things. I think the degree of systematization and use of rules is a bit unusual. There are a lot of unique metrics that nobody else uses. The breadth of the book is wider than most of the investment books I’ve read, where I cover just about every single rule I have for every situation I’ve run into so far, including adding new money to existing positions, rebalancing, doing post-sale reviews. There is just a lot of content outside of analysing companies because analysing companies is only a small part of being a good investor.
RH: Based on median forecasts, the UK market as a whole is trading at a P/E ratio of 14 and supports a dividend yield of 3.2%, while the US market trades at an average multiple of 16x and yields 2.8%, these are relatively high valuations, is the defensive value investor still able to find attractive stocks in these markets?
JK: As long as an investor is fishing for stocks in a large and diverse enough lake, there should always be good companies trading on low valuations somewhere. The FTSE All-Share for example, covers around 700 companies ranging from large-cap to small-cap. Even if 90% of those 700 companies are overpriced, that would still leave 70 companies underpriced. I think that as long as you have the tools to be able to find those 70 underpriced stocks the overall market valuation shouldn’t matter too much.
Today, for example, many companies with a significant emerging market or oil-related exposure are out of favour with investors. As a result, these companies are trading at the sort of low multiples that value investors like to see.
Having said that, an expensive market will make it harder to find value, and it is harder to find value today than it was in, say, early 2009. But difficult and impossible are not the same thing.
RH: Value investing is focused on buying companies on the cheap, but the danger is that these companies are cheap for a reason. I know this is something you cover in the book so, what qualities do you look for in a company that’s both cheap, but has a bright future?
JK: In an effort to avoid value traps I look for two things: 1) A strong company that can withstand an industry downturn or other crisis without keeling over and 2) a current situation which looks bad (thus driving down the share price) but is actually just a short-term blip in what will hopefully be a long and prosperous future.
In terms of finding fundamentally strong companies, I look for all sorts of things such as a long history of dividend payments, consistent profitable growth, good profitability, low levels of debt or other forms of leverage, and so on. I want a robust and successful company first and foremost, preferably one that is the market leader or is at least in the leading group within its industry.
After that, I run through a list of 19 questions which are designed to help me learn more about the defensiveness of a company, its ability to withstand a crisis, and whether the current negative situation is a major crisis, a bump in the road or something in between.
In an ideal world I would want to see a company with:
A consistent strategy focused on the company’s core competencies; a long-held market leading position; no large transformation projects; no need for consistently large capital expenses; revenues generated through the sale of a large number of small-ticket, repeat purchase items (rather than through large one-off contracts); no recent large acquisitions; defensive, predictable and growing markets; products that do not need to be replaced within the next ten years; products that do not compete purely on price; one or two obvious competitive advantages.
If a company can tick all of those boxes then I think the odds are that it will have a bright future. In reality, no company ticks every box, so as an investor you have to be willing to make a judgement call based on how many attractive features a company and its industry have, how bad its current situation looks, and how low its share price is. But by looking for the factors listed above you’ll at least be in a good position to make that sort of judgement.
RH: And finally, what would you say is the most important lesson, factor investors will take away from The Defensive Value Investor?
JK: The most important lesson in the book is that having a systematic investment plan is crucial. Most investors I speak to are far too ad-hoc in their decision making. W. Edwards Deming, a key figure in the field of Total Quality Management, said “If you can’t describe what you’re doing as a process then you don’t know what you’re doing”. I absolutely believe that, and writing down and continuously improving your investment process is more important than any individual investment decision you will ever make.
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