Which firms make it on to our watchlist and why.
In the introductory article to this series, we were a bit coy about what exactly constitutes a 'family firm' in our eyes.
And in two subsequent articles -- reporting on our first investment, Hunting (LSE: HTG), and our second, James Halstead (LSE: JHD) -- we made reference to our extensive watchlist, without going into any detail.
A spate of results from family firms this week provides a good opportunity to tell you about the particular characteristics we're looking for and to highlight some of the individual companies on the watchlist.
The quintessential family firm
When we think of family firms, what do we think of? I'd suggest that the following characteristics mark the publicly-quoted family firm in its purest form:
- the company has the name of the founder's family;
- the firm has been around for donkey's years;
- the family controls more than half of the company's shares; and
- family members dominate the boardroom.
A good example of a company with these characteristics is engineer Goodwin (LSE: GDWN), whose full-year results on Monday made a favourable impression on fellow Fool writer Owain Bennallack.
The firm was established in 1883 by Ralph Goodwin and his sons. Today, over 50% of the company's shares are in the hands of the Goodwin family, and the Board of Directors includes John W Goodwin (Executive Chairman), Richard S Goodwin (Managing Director), and Matthew S Goodwin (Executive Director).
Timber importer and distributor James Latham (LSE: LTHM), which I wrote about a couple of months ago, and which gave a trading update at its AGM on Wednesday, is another example of the quintessential family firm.
Founded as long ago as 1757, today the Latham family owns over half of the company's shares, and five family members work in the business.
Common-or-garden family firms
Companies with the characteristics of Goodwin and Latham are few and far between. If we restricted ourselves strictly to companies which possessed all the qualities I listed, we'd have a very limited universe in which to invest.
Most of the companies on our watchlist don't jump through all the hoops, but, nevertheless, most of us would probably agree that most of them are family firms.
Associated British Foods (LSE: ABF), for example, doesn't carry the name of the founding Weston family. Likewise Viscount Rothermere's family name is not reflected in the Daily Mail & General Trust (LSE: DMGT) -- a newspaper called the Daily Rothermere doesn't have much of a ring to it, I'm sure you'll agree!
The family silver
How large does the family shareholding have to be for the family to protect its 'silver' from the clutches of hostile predators?
Most of the companies on our watchlist, such as construction firm Henry Boot (LSE: BHY), which released interim results on Thursday, don't have an outright majority family shareholding.
In the region of 20-40% is quite common, families' majority stakes having been gradually eroded over time by some family members actively selling their shares or having their holdings diluted by, for example, not participating in a placement or rights issue.
Some firms, such as brewer and pub company Young & Co (LSE: YNGA) maintain a dual share structure, of voting and non-voting share classes, to help them maintain the family's stake -- and, in the process, send modern corporate governance aficionados into paroxysms of outrage.
In the academic literature on family firms, a family holding of 15% is generally reckoned to be the minimum requirement (provided no single outsider shareholder holds more).
At that level, a few big FTSE 100 companies make it on to our watchlist, including consumer goods giant Reckitt Benckiser (LSE: RB) and asset manager Schroders (LSE: SDR).
How small?
Many of the smallest family firms operate in niche and/or geographically limited markets. We've set no lower limit on size for inclusion on the watchlist, although the nature of these companies does make them riskier propositions.
Some of them, particularly, it strikes me, those that were once labour-intensive businesses, have significant pension-funding issues. Paper-maker James Cropper (LSE: CRPR), for example, has a £14m deficit, which is as big as its market cap and more than four times last year's operating profit.
Haynes Publishing (LSE: HYNS), which released full-year results on Thursday, and which fellow Fool writer Malcolm Wheatley feels is a bargain share, also has a £14m pension hole, to be weighed against a £42m market cap and annual operating profits of less than £8m.
Meanwhile, also making it on to the watchlist -- but off-piste for most investors -- are two or three regional pub companies, which are listed on the PLUS Markets (LSE: PMK) stock exchange.
How wide?
Middle East pharmaceuticals company Hikma (LSE: HIK), which I've written about this week, and Chilean copper miner Antofagasta (LSE: ANTO), which released interim results on Tuesday, probably wouldn't be the first companies on most people's lips if asked to name a family firm on the London Stock Exchange.
Nevertheless, a handful of 'foreign' family firms have made it on to our watchlist.
In summary
We've taken a fairly liberal view as to what constitutes a family firm, and have quite an extensive watchlist -- upwards of 30 companies.
Having said that, the companies fall into several descending tiers below the elite group of what I referred to earlier as quintessential family firms.
As the initial target for the Family Firms Portfolio is to invest in 12 companies over the period of a year, we are likely to focus on the top tiers, providing we can find a reasonably-valued company there at the time.
In teaching my son, Sim, the basics of investing as we construct the portfolio, we're concentrating on a different value approach or metric each month.
Having looked at 'crisis plays' and dividends for our first two investments, Sim is now learning about the ubiquitous price/earnings (P/E) ratio, ahead of our next investment on 7 September. Look out for our report the following week.
More family firms:
> G A Chester holds shares in Goodwin, Henry Boot, Hikma Pharmaceuticals, Hunting, James Halstead, Reckitt Benckiser and Schroders.
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