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We explain why family-run businesses are attractive and the stocks and funds to explore
Thursday 29 Jun 2017 Author: Steven Frazer

By: Steven Frazer, Daniel Coatsworth, James Crux, Tom Sieber

Buy family-run businesses if you want to beat the market. It’s a bold statement and credible one, according to various bits of research we’ll discuss later.

Many of these studies categorise a family company as one where the family owns at least a 20% stake in the business and has at least one member on the board.

Global brands such as Heineken, Volkswagen, Mars, Novartis, L’Oreal, Estee Lauder and Canon are classed as family businesses of one stripe or another. Although none of those names are listed on the UK stock market, we have identified plenty of other good companies that are quoted on the London Stock Exchange. We’ll get to those names in a bit.

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Those findings sprang out of exhaustive research by Cristina Cruz Serrano and Laura Nuñez Letamendia of the IE Business School, which looked at almost 2,500 European stocks between 2001 and 2010.

‘The study findings leave no room for doubt: listed European family businesses created more value for their shareholders during the period 2001-2010,’ said the authors.

Even when examined for other factors that might affect value creation in all its aspects, such as size, debt level, risk and sectoral distribution, the results ‘clearly point to the existence of a family effect which has a positive impact on creating long-term value for shareholders’.

Three generations walking on the farm.

Why are many family-run firms so good?

Fundamentally, the best family-owned firms are unlikely to make rash decisions. They want to ensure the business is around in 10, 50 or even 100 years’ time so their children, grandchildren and so on will still have a future running a solid company.

Two years ago, Credit Suisse analysis of 920 public companies around the world found better share price performance by family-run companies had stemmed from outperformance in operational metrics.

Being patient is also likely to be a key trait among family firms. Analysts at investment bank Credit Suisse conducted a study into this area and found 40% of the first to fourth generation owners of family-owned businesses viewed their typical time horizon for the payback on a new investment to be between five to 10 years. That’s much longer than most firms would desire.

‘Attitude towards risk appears to be an important factor in the long-term success of family-owned companies,’ explains Glen Finegan, head of emerging market equities at Janus Henderson.

Workers In Family Business Standing Next To Van Smiling At Camera

Clear evidence of outperformance

Mid cap and smaller companies controlled by one family significantly outperformed their peers in the 10 years to 2015, according to UBS.

It says family-owned mid cap businesses increased by 345% in value globally in this period. This far outpaced the global mid cap index during that time, which gained only 72%.

‘A year later, we have updated our statistics – and they show that performance has also been favourable in the past 12 months. Family-owned companies are up 11% versus global indices up 5%,’ UBS said in September 2016.

Portrait of senior man with his grandson devoted their life to pottery

Founders alone don't count

Global giants such as Google’s parent company Alphabet, Facebook, or China’s Alibaba could conceivably be called family-run, but we beg to differ.

Founders retain huge stakes in these businesses and are very hands-on with day-to-day operations, yet we believe a measure of generational handover is required to qualify. None of these companies have yet to pass on control to another family member.

That goes for several UK-quoted companies where, for example, fashion chains Supergroup (SGP), French Connection (FCCN) and Ted Baker (TED) are still run by the founders; Julian Dunkerton, Stephen Marks and Ray Kelvin respectively.

Metrology kit maker Renishaw (RSW) (36%-owned by chairman and CEO David McMurtry) and recently floated asset management software supplier Alfa Financial (ALFA) (68%-owned by founder and executive chairman Andrew Page) are also discounted for the same reason.

Which UK stocks do quality?

Popular UK-quoted companies typically associated as family-run that have delivered for investors include LED lighting group FW Thorpe (TFW:AIM) (54% owned by the Thorpe family).

Other examples with a good track record of making money for shareholders include components maker Dewhurst (DWHT:AIM) (circa 50%-owned by the Dewhurst family) and James Halstead (JHD:AIM) (more than 30% owned by the Halstead family), the near-£1bn construction materials firm.

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It is important to understand that being a family-run business does NOT guarantee positive stock market performance.

For example, engineer Goodwin (GDWN) (48% owned by the Goodwin family) has seen its share price fall by nearly 22% over the past year. Similarly, car dealer Caffyns (CFYN) (about 25% owned by the Caffyn family) is down 9% in the past 12 months.

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What are the main risks to consider?

An IE Business School study notes higher liquidity risk in family-run firms – where freely trading stock may not always be possible.

Other potential pitfalls include excessive compensation, expropriation of assets and related party transactions, all examples of exploitative behaviour. These sorts of issues are often mitigated by a strong and independent board of directors.

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Nepotism is another possible threat to family-controlled companies – keeping a level of control within a family probably should not be exercised to the detriment of a meritocratic workplace.

‘While family ownership can help to align shareholders’ interests with those of management, this should not be seen as a determinant of success,’ believes Simon Rowe, manager of Henderson European Growth Fund (GB0030617707). ‘Of far greater importance is the business strategy and how this is applied.’

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FUNDS     To play the family-owned business theme


 

SCOTGEMS (SGEM) 102p 

As an asset manager, Stewart Investors likes family-controlled companies who are investing today so the next generation owners assume control of a solid business.

The desire to preserve intergenerational wealth can result in a board being very careful with regards to pursuing growth opportunities and not making rash decisions in order to hit short-term performance targets.

This investment preference is likely to play a key role in the Stewart Investors-managed ScotGems. This investment trust is expected to have a large bias towards family-owned businesses once it gets to work deploying £50.3m raised at this week’s stock market flotation (26 June).

ScotGems is targeting smaller companies in emerging markets and Asia Pacific. It plans to capitalise on existing relationships forged by its fund managers with family-run businesses, particularly in India.

Stewart Investors previously told Shares that its fund managers meet over 1,000 companies a year, seeking ideas for some of its other funds including Stewart Investors Asia Pacific (GB0033874214) and Stewart Investors Global Emerging Markets (GB0033873919).

The managers often come across interesting companies which are too small to be included at meaningful levels in the aforementioned funds, hence why ScotGems has been created in order to have stakes in the best of these smaller cap opportunities.


 

BRITISH EMPIRE TRUST (BTEM) 701.5p

Investors can gain an exposure to the advantages of the ‘owner’s eye’ through funds such as the British Empire Trust.

The trust’s objective is to generate capital growth through a concentrated portfolio of investments, with an emphasis on shares trading at a discount to estimated underlying net asset value (NAV).

Managed by Asset Value Investors’ Joe Bauernfreund, British Empire’s portfolio includes positions in family-controlled investment holding companies which have diversified portfolios, owning stakes in a variety of other businesses.

Many investors shun such holding companies, despite their strong long-term performance track records. They aren’t keen on this heavy diversification and the fact these family firms are less liquid.

These companies are less researched by analysts and therefore create mispricing opportunities which British Empire can exploit.

‘They tend to own businesses that are quite high quality with cash flow and dividends,’ explains Bauernfreund, an admirer of their long-term perspective, which is refreshing in an age of corporate short-termism. ‘And they are active owners of these businesses,’ he adds.

Exemplars held in British Empire Trust’s portfolio include Sweden-based industrial holding company Investor AB, a leading owner of Nordic-based international companies founded by the Wallenberg family 100 years ago.


 

STOCKS     To play the family-owned business theme


 

WATKIN JONES (WJG:AIM) 198.5p

Sketch House - Common Room

The student accommodation specialist is a ninth-generation family run-business currently led by Mark Watkin Jones who owns 30% of the shares.

The company was founded by his ancestor; Welsh carpenter Huw Jones in 1791. The company is still headquartered in Bangor, North West Wales and floated on AIM in March 2016.

Watkin Jones made the decision to move into student housing in 1999 and has subsequently built more than 28,000 student rooms on nearly 100 sites.

Revenue has grown from £227m in the year to 30 September 2014 to £267m in the year to 30 September 2016.

The company has a development pipeline of 31 sites worth £920m to be built by 2020. In June, the company announced it had forward sold six of these sites to institutional investor Europa Generation. As an asset class student accommodation has low volatility and does not react in the same way as commercial property. The company is also expanding into the private rental sector.

The shares trade on 13 times forecast earnings for the year to September 2018. The company has no debt and plenty of cash. A 3.7% dividend yield offers another reason to own the shares. Jefferies has a price target of 250p.


 

ASSOCIATED BRITISH FOODS (ABF) £29.13

Cologne, Germany - October 19, 2015: Primark store in the center of Cologne at night ......

FTSE 100 foods-to-fashion conglomerate Associated British Foods is controlled by the Weston family, whose careful husbandry of the business is evident in its strong long-term earnings growth and dividend track record.

The Weston family, spearheaded by ABF’s current CEO George Weston, controls 54.5% of the high-quality global foods, ingredients and retail giant.

ABF’s sugar businesses have been the main profit improvement drivers. Performance has been boosted by higher prices and the benefits of significant cost savings.

Its enviable cash flows are supported by a portfolio of British grocery brands with global potential, ranging from Silver Spoon and Kingsmill to Patak’s.

Yet the real excitement lies with ABF’s value-for-money fast fashion chain Primark, a beneficiary of consumer down-trading in the UK. The clothing chain is primed for market share gains as it expands in continental Europe and builds a presence in the US.

Recent half year results (19 Apr) showed ‘excellent progress on all fronts’, with adjusted pre-tax profit up 35% to £624m and the dividend lifted 10% to 11.35p.

ABF expects underlying sales momentum in all its businesses will continue in the second half of the year, albeit profit growth will be tempered by sterling’s devaluation against the dollar, which is creating a sourcing headwind for Primark.


 

FW THORPE (TFW:AIM) 385.25p

Light bulb concept. 3D render.

The lighting products designer and manufacturer dates back to 1936 when it was established by Frederick Thorpe and his son, Ernest.

At the time they made vitreous enamelled steel reflectors, sometimes called porcelain enamel. This is an integrated layered composite of glass and metal used as shades that powerfully reflect and direct light, often used in industrial settings.

The company floated on the stock market in 1965 and remains controlled by the Thorpe family, which has a stake worth about 55% of the shares. It is also still run on a day-to-day basis by the family. Andrew Thorpe, grandson of the founder, is both chairman and joint CEO.

The AIM-listed company has eight operating units including LED manufacturing arm Thorlux Lighting. The firm employs roughly 500 people.

Products are sold around the world and the business has a long track record for growing sales, profit and, crucially for the family and many private investors, dividends.

The firm made operating profit of £16.2m in the year to 30 June 2016 on £88.9m worth of revenue. It paid a 4.05p dividend, up 11% on 2015, and there was also a 2p per share special dividend, something the company has done frequently over the years when it builds up surplus cash.

No earnings forecasts are available. But extrapolating average growth of 11.5% over the past three years into the future, a back of notebook sum implies earnings per share of about 12.5p to 30 June 2017, rising to 14p in 2018. That makes the stock look pricey on a 2018 price to earnings multiple of 27.5. A 4.5p payout would indicate a 1.2% income yield. Expensive but shareholders evidently like the reliability, and so do we.

 

 

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