Five FTSE 100 shares I'm avoiding
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
In amateur tennis, about 80% of points aren't won by the opponent but lost because of unforced errors, such as hitting the ball out of bounds.
The same is true of investing, in my experience. If you avoid losers, the winners tend to look after themselves.
Just as a good tennis player learns to anticipate where an opponent will hit the ball, I think a good investor can learn when companies send little warning signals. Avoid these businesses and you might stand a better chance of staying in the game.
The warning signs I look for
Debt can get companies – and investors – into a lot of trouble. It’s one of those things that isn’t a problem 99% of the time. But the 1% of the time it is, it can ruin a business.
Another key warning is a business you don’t understand. I try to steer clear of the complex and the esoteric. The FTSE 100 is home to plenty of these.
I’m also keen to avoid the squeezed middle: companies with no distinctive proposition and little to separate them from the crowd.
Cash is the lifeblood of business and it’s very different from profit. While many companies do a relatively good job at generating profits, they are less good at generating cold-hard cash. I try to avoid these companies like the plague.
Finally, I try to avoid businesses that serve industries in decline. I like to invest in companies with the wind behind their backs. A very stiff breeze today could easily fill the sails tomorrow.
Below I’ve listed four FTSE 100 businesses (plus one that's just dropped out on 20 June 2022): to me, they all currently show these warning signs. This is not a personal recommendation to sell or otherwise trade these shares, nor an opinion of the future value of the shares. I’ve listed them purely to show examples of businesses that don’t appeal to me personally from an investment perspective.
BT – dangerous debt?
Telecoms is a mighty challenging sector. There’s little to differentiate providers. Regulators and consumers are always demanding more for less. And dealing with a telecoms operator is rarely a pleasant consumer experience.
Then there are the huge cash demands. In the year to March 2022, BT invested £5.3 billion to maintain and upgrade its infrastructure, and it will have to keep the spending taps open to remain competitive.
Faced with this plethora of challenges, the last thing I want to see is lots of debt. And BT has plenty of it. About £18 billion to be precise. That compares to free cash flow (the cash leftover after deducting costs like interest and capital expenditures) of around £1 billion.
At the current rate, I calculate it would take BT about 18 years to pay off its borrowings. And that assumes any excess cash goes towards debt repayment, which I believe is unlikely, given the company’s desire to pay dividends.
In fact, the debt situation goes deeper. BT also has a pension deficit of around £1 billion or £8 billion, depending on which assumptions you use. So, the true debt is higher than the £18 billion figure suggests. Over the next decade, BT will likely have to pour several billion pounds into its pension scheme to try and plug the gap.
I’m not totally averse to debt. But when you layer debt onto a business with the cash demands of BT and throw a large pension deficit on top, I personally think it’s a reason to avoid.
Glencore – complex commodities
Before I invest in a business, I have to understand it. I need to know how it makes money and have a firm grasp of the company’s accounts.
Legendary investor Warren Buffett talks about a circle of competence. His advice is to only buy a company that fits squarely within your comfort zone. I’ve tried to do this throughout my investing career.
Glencore is a business I simply do not understand. It might be wonderful. The problem is if something goes wrong (like back in September 2015, when the shares lost about a third of their value in a single day), I won’t know how to react.
Most miners dig commodities out of the ground and sell them. By comparing the price at which they sell with the cost of production, you can get a good sense of the profits. Apply a multiple to those profits and you can estimate the company’s value.
But Glencore isn’t most miners. As well as mining for commodities, it trades in them. Think of it as a cross between an investment bank and a miner. The nature of the trades and how it makes money from them are largely a mystery to me. This makes Glencore impossible for me to understand or value.
The great thing about investing is you don’t have to play every hand. You can pass until the odds are in your favour. Glencore is so complicated I don’t even know how to assess those odds. It’s an easy pass for me.
Sainsbury's – a squeezed supermarket
I favour businesses that have something to distinguish them from the crowd, like a great brand or low prices. A premium offering means you can raise prices without losing customers. Low prices will always have appeal, but especially when customers are tightening their belts.
UK grocery shoppers have abundant choice – from premium shops like Waitrose, Ocado and M&S to Asda, Aldi and Lidl at the other end. In the middle is Sainsbury's. It does its job perfectly well but isn’t perceived as the cheapest or the best. To my mind there isn’t really a compelling reason for customers to keep going back, aside from maybe convenience and habit.
The UK supermarket sector is also fiercely competitive – and becoming more so. Aldi and Lidl continue to expand, with plans to open hundreds more stores over the next few years. Tesco, whose market share is almost double that of Sainsbury's, has responded aggressively with cheaper prices of its own. And then there’s Amazon. The e-commerce giant entered the UK grocery market in 2016 and has been making a stronger play more recently, eliminating delivery charges for Prime members, expanding partnerships and even opening its own physical grocery stores.
To be fair to Sainsbury's, it isn’t taking this lying down. It has lowered prices and significantly increased online capacity. But all this comes at a cost. It’s just such a tough industry. Price wars are common, consumers are fickle and margins are thin. I think Sainsbury’s will have to run very hard just to stand still.
Grocery Market Share
Rolls-Royce – paper profits
One of my favourite sayings is 'revenue is vanity, profit is sanity but cash is king'.
Cash is the only thing that matters to me when valuing a listed business – not revenue or profit. You cannot pay bills or fund growth with the other two.
Some businesses consistently struggle to turn their profits into cash. Rolls-Royce, the engine manufacturer, is one.
The chart below compares Rolls-Royce’s profit and cash performance over the last decade. I found it grim reading. Cash has exceeded profit in only two years out of 10. In every other year, cash flow has fallen well behind.
In total, Rolls-Royce has delivered £3.5 billion of profit in the last decade. Cash has been negative, to the tune of £2 billion. That’s a difference of £5.5 billion in aggregate.
When I invest in a business, I want one of two things: cash to be returned to me, or cash to be reinvested to grow the size of the pie. Rolls-Royce has achieved neither.
Dividend payments were suspended in 2020 and will not be paid until at least 2023 as part of its loan terms. As for reinvestment, Rolls’ profit and cash performance over the last decade makes it unlikely.
Could things get better from here? They may well do. But I don’t gamble on turnarounds, I look for businesses that are already well out in front with a history of cash generation and growth.
Rolls-Royce profit versus cash performance
ITV – vanishing viewers?
How much live TV do you watch nowadays compared to 10 years’ ago? At a guess, less – and, if you’re under 40, probably a lot less.
The facts are clear. The share of viewing hours for traditional broadcast television, whether live, time-shifted, or on-demand, fell from 73% in 2017 to 61% by 2020. By 2023, Deloitte predicts it will fall below 50%.
To ITV’s credit, it’s responding to the threat. The group hopes to double digital revenue to £750 million by 2026, aided by the launch of ITVX, a subscription-based streaming service.
It’s probably the right move, since doing nothing isn’t really an option. But it’s going to be very costly and puts ITV in direct competition with the likes of Netflix, Disney and Amazon, which have substantially deeper pockets.
Don’t get me wrong, ITV has some great content, but so do the others. It remains to be seen whether ITV can persuade consumers to shell out for yet another streaming service, to offset the mounting pressures in its traditional advertising business.
There are plenty of companies operating in industries with compelling growth prospects. Why invest in one fighting an uphill battle? Indeed, as it happens, ITV dropped out of the FTSE 100 on 20 June 2022.
Share of UK viewing hours of broadcaster content (live, recorded, and on-demand)
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