14Jan 2017

Family Firms

Family firms

FAMILY FIRMS

This post is inspired by a recent article in MoneyWeek by Richard Beddard.

  • It was a good article, but in the end it featured just five family firms, and I was interested in putting together a portfolio of at least twenty.

I’ve seen a few articles over the last couple of years about such firms, and we’ve seen them in a few of the portfolios we’ve looked at (by Carmensfella / David Stredder, John Lee and M0by Dick / G A Chester).

  • So I thought it was about time that I pulled all the articles together to produce a master list of family firms.1

DEFINITION

Your definition of a family firm might differ from mine, but I’m going to use the one similar to that which the IE Business School uses in it’s annual survey of such companies.

  • For IE, a family firm is one in which an individual or family holds at least 20% of the shares, and there is at least one member of the family on the board of directors.

For some firms, there will be multiple classes of share, some of which have enhanced voting rights.

  • Under such structures, families might have 20% of control from a smaller amount of equity.

PERFORMANCE

IE has found that family businesses regularly outperform non-family businesses, using data going back to 2001.

  • The effect is found in the US and all major European markets, and is particularly strong in Germany and (luckily for us) the UK.

Family firms are also less risky, with a lower probability of bankruptcy(as indicated by their Altman Z-score).

  • They also have lower volatility (of profits and share prices).

The “ideal” level of family ownership to maximise outperformance was found to be 40%.

Hargreaves Lansdown also looked at the performance of family firms, which they defined as having 5% or more insider ownership.

Today's post is about family firms, which can make very good investments.

They found out performance over 3, 5 and 10 years, and on both the FTSE All Share and AIM indices.

  • Long term outperformance on the AIM was particularly marked.

Insider performance AIM

RATIONALE

The basic idea behind investing in family firms is that the large shareholding aligns the interests of the family (and the board) with those of retail owners.

  • It is also sometimes the case that extended family members rely on the dividends from the company for income, and so the dividend will generally be safe and will rise at least with inflation.

Family firms are likely to have lower staff turnover, higher productivity and a strong corporate culture.

Of course, some investors will avoid firms with controlling shareholders, as they can be unpredictable.

  • Mike Ashley at Sports Direct would be a good example here.2

The dangers of investing in family firms include the potential for excessive compensation, nepotism, related-party transactions and expropriation of company assets (or even the pension fund).

 There is also a risk of illiquidity.
  • If a large proportion of the shares are held by the family and never traded, there are fewer for everyone else.
See also:  Portfolio Tracking Spreadsheet part 7 plus SmallCap update 10

This in turn can put off institutional investors, which can mean that some family firms will have a permanently low PE rating.

  • But on the other hand, a lack of institutional investors can free a firm up to follow a long-term strategy without trying too hard to please such investors.

So the logic needs to be applied on a case-by-case basis, but in my opinion the effect will generally be favourable.

SIZE AND SECTORS

I’m particularly interested in this concept as it applies to smaller firms, and especially those on AIM.

  • These firms can be very volatile, and a large family holding can be very reassuring.
  • IE have found that smaller family firms (which they define as < €350M market capitalisation) exhibit the largest outperformance compared to their non-family peers.

In terms of sectors, those that require fairly high levels of capital investment over the long term (like manufacturing) were found to show the biggest effect.

  • So a long-term focus can be considered to be part of the mechanism for outperformance, along with a lack of risk-taking, cost-cutting or excessive debt levels.

HOW TO INVEST

There are no investment trusts that invest in family firms.3

But there is a unit trust: The March International Family Businesses Fund.

  • This is a global fund but has an annual charge of 1.5%.

The Liontrust Special Situations Fund and the FP Crux European Special Situations Fund are others that have been reported to prefer firms with family shareholdings.

  • Personally, I prefer to invest directly in the shares of family firms.

THE FIRMS

I’ve put together a spreadsheet of the firms mentioned in all the articles I could find (and in my earlier posts on the topic).

  • Here’s a snapshot of what it looks like:

Family firms top
Family firms bottom

There are 46 firms in all, with 19 from AIM and 27 on the main market.

  • You can find the live spreadsheet here.

I’ve added conditional formatting to indicate the following:

  1. a stock with a market cap below £40M (too small for me)
  2. a PE above 20, or a negative PE (too expensive or unprofitable for me)
  3. a share price below 60% of the annual range (poor momentum)
  4. whether the stock is listed on AIM or the main market

If you can think of any family firms that are not on the list, please let me know.

Until next time.

BY

Original article can be viewed here.

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