Penny Share Profits in the Book Trade?

My quest for dividend paying shares to provide income for my rapidly receding retirement took me to London’s Commercial Road, a street as dreary as its name suggests. There I found myself in a room lined from floor to ceiling with books. But confronting me across the table was not the pince-nez of a stern librarian, but Michael Mousley, the affable and long-serving finance director of The Quarto Group.

Quarto is a book publisher. There are several reasons one might expect that its share price would have held up rather well in recent times. First, the book trade has never previously been much affected by recession. Second, Quarto benefits from an appreciation of the dollar versus the pound. And third, it has increased its dividend every year for the last seven and in August reported a double figure increase in revenues and profits. What’s not to like?

Investors have steered clear of this attractive sounding share

But all of this has not made investors like it. In the general market malaise, Quarto’s share price has slipped and slithered from 182p a year ago to 100p now. At this level they trade on a meagre four times forecast earnings, at less than half analysts’ estimates of their true asset value, and they yield over 7%.

Musing upon these numbers I glanced around the room at the many titles upon which the fate of Quarto and its shareholders depends. ‘The Art of Drawing Dragons’ I noticed. ‘The Connoisseur’s Guide To Herbs and Spice’. ‘The Chrome Cowgirl Guide to the Motorcycle Life’ and ‘101 Tricks For Dogs.’ Hmmmm. Not a novel amongst them. But this, in fact, is the secret of Quarto’s success and longevity which sees it now in its twenty-third year as a public company on the London stock market.

Throughout that time Quarto has been run by its two founders, the sixty-six year old Chairman and Chief Executive Chairman, Laurence Orbach, and Creative Director, Robert Morley, as well as Mousley. Orbach’s commentaries, provided at the time of annual and interim results are always detailed, interesting and unsparingly honest. The consistency of his views has been reflected in Quarto’s adherence to non-fiction, which has several advantages over the novel.

Here’s why non-fiction is good business

Publishers of fiction must often pay high advances to authors, with absolutely no guarantee of success. This is a hit and miss affair. For every Harry Potter there are numerous titles that flop. By sticking to books for hobbyists, enthusiasts and the handyman, Quarto is addressing a market that it knows exists. It exists not only in this country and America but around the world and it is a market that will endure. Because it does not have to pay its authors excessively, Quarto keeps production costs to a minimum and because it has a back catalogue that can be exploited over time it ensures a stream of earnings into the future.

But there is one other aspect of Quarto’s business model that makes it very low risk. This is the ‘co-edition publishing’ that accounts for about forty per cent of sales. What happens here is that Quarto comes up with an idea for a book, and presents it to publishers. It spends £1500-£2000 on each dummy, half of which are rejected. But if it can secure enough orders to cover the cost of the first print run it will go ahead, retaining ownership of the content while the publisher takes responsibility for distribution and marketing. The remaining sales come from books that Quarto publishes itself, but with titles such as ‘The Complete Guide to Home Improvement’ and the ‘Orvis Birdwatching Guide’ these are books of a similar type that can be updated and reprinted over many years.

Worth more than twice the current share price?

Quarto has nine thousand titles in its back catalogue and reprints account for more than half of total sales. Clearly these titles have a value, and analysts argue that this is not properly reflected in the balance sheet. Based on recent transactions in the publishing industry, broker Edison believes that each title could be worth £5,000, making a total value of £45m and on this basis it calculates that the true net asset value per share is 213p, more than twice today’s share price. But the danger is that the book industry will go the way of the music industry, where the difficulty of controlling the distribution of music has eroded its value.

Will the same happen to the book trade? Will all books become digitalised and read in selected chunks on PCs or mobile screens?

Orbach is firmly of the view that this will not be the case. As he points out, ‘The book publishing business, over a very long period, has consistently survived the predations of most other media and prophesies of its imminent demise.’ People like to own books. They have a value that goes beyond their content.

As the author Anthony Powell put it, ‘Books Do Furnish A Room.’ So Orbach expects book sales to hold up well in recession. As we head towards Christmas in a world where other forms of digital entertainment, often free, are becoming ever more popular we should find out whether this optimism is justified.

I’m not buying these shares right now, but I’m seriously thinking about revisiting them in the future.

Regards,

Tom Bulford
for The Penny Sleuth

P.S. The Bank of England has today slashed interest rates by a whopping 150 basis points. That’s bad news for sterling. Playing currency markets is not my thing – I’m a shares man. But my colleagues over at The Fleet Street Letter have a way to play it. I’m not talking about leveraged Forex trading either. In fact, their recommendation is to use one “staid” investment to protect your wealth – but also as a way to make money as the pound falls. If you’re looking for a way to hedge your share portfolio, this could be it. I’ll send you details tomorrow.

P.P.S. If you want to follow the insights of a small company investor, and uncover the hidden gems of the stock market, find out more about The Penny Sleuth by clicking here.

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