This is a transcript of David Kuo's podcast with Stephen Bland.
You can listen to or download this podcast here.
David:
This is Money Talk, the weekly podcast from the Motley Fool. I'm David Kuo, and it is often said that the secret of successful investing is to buy low and sell high, and with the stock market looking as cheap as chipolatas, how do we separate the sausage and mash from the pigs in a blanket? Here to have a butcher's at the best and the worst of value investing is Stephen Bland, alias TMFPyad. Welcome to the podcast, Stephen.
Stephen:
Thank you, David.
David:
Right Stephen, you are one of the leading experts (as far as I know) in value investing, so can you explain to the listeners what exactly is "value investing"?
Stephen:
Right, value investing means, as far as shares are concerned, buying shares that are cheaper than others, which are unreasonably cheap. The cheapness is measured by popular ratios, such as price earnings, price to book, yield, and other factors about the company like the level of its debt, preferably none, so if you can buy a share that's cheaper than other similar shares, and there is no obvious reason for that cheapness other than perhaps market sentiment, then you may have a share which I would call value, in that it's being sold unreasonably cheap and may therefore offer above-average growth prospects, so with a near term.
David:
So why do you think value investing is better than other styles of investing? – I mean, we have momentum investing, we have technical analysis – why do you think yours is a superior form of investing style compared to others?
Stephen:
OK, I think you'll find that most of the people who've made serious money in the stock market long term, the well-known names, have done so by value investing, and I'm not just saying that because I wish to copy them, I think that's the only real way to make money in the market long term.
The other styles you mentioned which was momentum, TA or whatever, may work, and if people are shrewd enough and make it work for them, that's fine, but I don't believe that you can make big money long term by these other styles, because there's no real rationale for it, but to me, buying something cheaper than other similar products has to be attractive, if you can buy something less than other people are paying for it, and then sell it for the same as other similar shares in future, then you've made money.
It's the same as in life generally, if you want to buy a car, and if you can get one cheaper than other people, the same car, then obviously you've effectively made money on it, or a property, or anything.
David:
But it could be an old banger though, couldn't it?
Stephen:
It could be an old banger, but if you take ten old bangers, which have a price, and one is much cheaper than the others, and yet there's no good reason for that cheapness, then you've got a bargain, so it's a question of unreasonable cheapness, not just cheapness – cheapness isn't value, it's whether the cheapness has no good reason behind it.
David:
But that is the mistake that people sometimes make, isn't it? – they compare value with cheapness.
Stephen:
No, I mean cheap rubbish is still rubbish; a share isn't valid just because it's cheap. If there's good reasons for it to be cheap, like people suspect it's going out of business due to some disaster that's about to happen that's known, then that's not a value share. A share on a high yield or a low P/E, for example, isn't necessarily value – you have to just ask yourself, well why is it standing on a lower P/E to its peers, or a higher yield – why? – and if there's a real reason for that, or what you see as a real reason, then it's not a value share; but if there's no good reason, and people are not rational, the underlying cause for value shares is that people are not wholly rational, things will be undervalued because of sentiment, the human race is not a totally rational species.
David:
So apart from yourself, who do you admire in the value investing field?
Stephen:
Well, the guy I admire most, because I knew him vaguely, is Jim Slater, who actually went through a couple of disasters as well, it didn't always work, but when I first qualified as a chartered accountant in the very early '70s, my first job was working for Jim Slater as the second in charge of polishing his boots, or whatever it was at the time, but he wouldn't remember me now, but that's where I learnt the trade, but also, from an early age, this idea of buying something cheap, it's sort of ingrained, I mean my dad was a small businessman, and in business that's what people do, they always look for the cheapest ways of doing things whilst at the same time obtaining quality, so apart from my adult life, it was in my family anyway, this whole idea of business and value is linked to a business approach to life generally, like if you want to buy a property, you don't buy the first one you see, you'll try and knock the price down, and so on, it's a general approach to life. It's not a skinflint approach, it's not being tight – it's obtaining the best value wherever you go, and that applies to what I do with shares as well. It seems totally logical to me, whereas the other methods you mentioned, TA, momentum or whatever, don't have investment logic, in my mind, behind them.
David:
Some people might disagree, because there are different investing styles in there, so can we just sort of focus on the four main criteria that you use for evaluating a value share? – the first one being the P/E ratio?
Stephen:
Yes, the ratios I pick are not necessarily because I think they're the most desirable for share analysis, it's because they're the most common, I want to be playing the same game as anyone else in the market, and the most common ratio by a long long way for evaluating shares is the price earnings ratio, the P/E. Whatever I think of its merits, the fact is that almost everybody uses it, so even if I think the E part, the earnings, can be manipulated by accountants and so on, I am trying to compare the shares I'm looking at with others, and because people generally use the P/E ratio, I use it as well, and so if the market average for P/Es at the moment is, I don't know, eight, nine, something like that, then a share standing on a P/E of say five or six, on the face of it, and subject to a lot of further investigation, appears to be cheap, and may offer value.
David:
But isn't the problem at the moment that the E is so unknown? – companies are finding it very difficult to project forward a year, to say what are they going to be earning next year, so how reliable is that E in the P/E ratio?
Stephen:
It's not just now David, it's always unreliable, it's never a reliable figure, and if you're looking at forecasts, then what we're using for the E part of the ratio is analysts' consensus forecasts, the large the company, the more brokers and analysts follow it, so with a very large company, you may get 20, 30 opinions.
With a tiny company, and that's a problem actually, you may only get one analyst, and that may be the tame house broker's analyst, the firm that's charged with marketing the company's shares, and that's very unreliable. So you're right, it is very unreliable, but it always has been, it's not necessarily a product of the current economic situation, the E part has always been unreliable, the E can and does go wrong, and I've stressed this to my readers all the time.
But it's only one measure, you don't buy just on a low P/E, but you have to go on something; if you're using value, which means looking at company fundamentals rather than momentum or TA, then you have to get your fundamental information from somewhere, and if you're looking at forecasts, which you have to because the historical figure may be of little use, then you have to use something, you have to go on something, so one year's forecasts is all we have, taken with a large bucket of salt, of course, but you don't much else, if you want to look at P/E at all, and I do.
David:
So what about the next criteria, the yield? – we're seeing so often now companies just cutting their dividend, which means that what you thought was a six percent yield suddenly turns into a three percent yield, so your second criteria for valuing these shares is also suspect now?
Stephen:
It is suspect, and again it always has been, but if a company's got decent forecast earnings, then the yield is likely to be maintained. The yield will only be cut if the earnings forecast turns out to be wrong, and yes, that can happen, but in the same way as you rely on the E part for the P/E ratio, it follows that you're relying on the yield, because the dividend paid is a function of the earnings - if a company's earnings fall dramatically, the company will very likely cut its dividend, so relying on the PE automatically means you're relying on the yield, and you do take the risk it might be cut, that's one of the risks you have to take, the same as the earnings might not materialise as forecast.
David:
So what about the assets – because this is another area that is so suspect at the moment, because you think you've got a building that's worth £100 million, only to find that somebody's revalued it, and it's gone down from £100 million to £70 million?
Stephen:
Indeed, well of course cash is the best asset of all, and that can't go down, so if a company's rich in cash, which is not so much the case with very large companies, but small company, small value shares, often their main asset is cash, and you can't argue with cash, recession or no recession, cash is cash.
If it's property, as you rightly point out, property values can and have collapsed, and that's why property shares have collapsed as well, because Land Securities recently, for example, one of the largest property companies in the country, announced the dramatic fall in their underlying assets, which trashed the shares frankly. So yes, that's again, that's a risk you have to take.
If you think property is a value that's going to fall, if you look at the share, and it's got a certain asset value, then you can build in a discount, if you like, if you think that property values are going to fall. So if a company has £10 million worth of property, and you think it might fall 25%, well value it at seven and a half, and that then gives you a margin of error – you can still go wrong, but that's one way to do it. The same with earnings and yield, you could undervalue the forecast earnings to make it more conservative, or undervalue the dividend.
David:
So what you're saying is, you need to build in a bigger margin of safety now?
Stephen:
If you think that property – I mean right now, I doubt property values are going to fall much further personally, in the next year or two, so you don't need to, but it means being prescient, you have to be aware that property values might fall, nobody thought a couple of years ago, or few thought, that they'd collapse as much as they did, so it requires you to take a few on these things happening. Now we're probably OK, it's unlikely we're going to see any further major collapses, I think the worst is behind us. A year ago, it's easy to say now, I'll build in a discount for property values, but how would you know that, unless you really are smart, or a couple of years ago you probably wouldn't have seen it coming, not as bad as it turned out to be.
David:
You're almost sort of trying to look at things through a kaleidoscope, rather than trying to look at things through a telescope, because you have no idea what is going to be around the corner now.
Stephen:
The whole point of value investing is to minimise the downside, it's one of my little pet sayings about value is minimising the downside, the whole point of looking at low P/E, high yield and good asset cover is precisely to try and, not avoid, but lower the risk of things going wrong. For instance, take two companies – one's got no asset cover, and one's got some decent asset cover, in other words, the asset's worth more than the share price.
Well, if property values collapse, the one with some property is going to be better off than the one with none, so value provides some defence, but not an absolute one, this is a risk strategy, there's no absolute guarantees here; the whole idea is to try and limit the damage done, if things go bad.
The first step for a value investor is not looking at how much money they can make, but how much might they avoid losing if it turns out wrong, and of course in a major recession like we've just seen, there's nothing you can do, I mean if you get hit with it, and you didn't see it coming, and I certainly didn't see it coming as bad as it turned to be, then that's the risk you take.
David:
So let's have a look at this fourth leg of the value stool, I mean this thing called debt – now you like companies that have got no debt whatsoever?
Stephen:
Yes, to me debt stinks, all debt stinks.
David:
But some people are arguing that, as we go into some form of inflationary environment, possibly huge amounts of inflation, you do want some debt?
Stephen:
Sorry – I never agreed with that view, I've heard this view all my life, it's the sort of view promulgated by people in the City, chief accountants – why, because they like raising debt, you make big fees as a merchant banker, if you can provide corporate loans, now that makes a lot of money.
I've never seen this – I've heard tax arguments, I've heard inflationary arguments, I've heard every argument under the sun about how much debt and equity should be in a company, and to me it's always 100% equity, I never understood the point of debt. It's the same in your personal life, why would you borrow money? – I mean usually you can't help it, if you're going to buy a house, if you were to have to get the sort of cash, so you have to do it, but short of having to do it, if there's other ways of raising money, and in business there is through equity, why would you want to borrow money?
It imposes a risk, all debt involves risk – the more debt a company has, the greater risks it runs, and we've seen in the recession it was what ultimately drives companies bust. If you didn't have any debt, you're not likely to go bust, however bad the economic times, if you don't owe any money, who's going to make you bust? – there's no creditors, trade creditors could be, there's no bank round your neck.
David:
So you're quite firm in your opinion?
Stephen:
I always have been, quite apart from value, as a business thing generally – debt stinks. As a business person, as I was, I had my own accountancy practice for many years, and if you can't avoid it, you can't avoid it, but to take on debt voluntarily, as companies are often encourage to do by professionals like accountants and merchant bankers, I don't see any point – if you don't need to have debt, what's the point of it? I don't agree with the tax advantages, and I don't like the risks it creates, and we've seen how that risk has materialised into disaster for many companies.
David:
OK, you just touched on bank a few seconds ago, you're talking about merchant banks in general, but I'd like to turn the focus now onto high street banks – I remember you writing a while ago, when you were valuing banks, you said "A bank is a bank is a bank, but all banks are exactly the same". Now some people might say to you, Stephen, not all banks are the same – we have a couple of banks here that have remained standing, whilst the others have collapsed quite spectacularly, so have you changed your mind about banks?
Stephen:
No, if you look at the big banks – Lloyds, Barclays, RBS …
David:
HSBC, yeah?
Stephen:
… HSBC has done better than the others, I'll have to admit, but Barclays, Lloyds and RBS all collapsed to a greater or lesser extent, obviously RBS is the worst, I think, Lloyds is the second worst, Barclays is the third, HSBC has done better than them, but who could have known which was the better bank a few years ago when banks were desirable, low P/Es, high yields, I couldn't tell one from the other. It's easy to say that now, but HSBC is still standing.
Actually RBS and Lloyds haven't actually gone bust, and there's a good chance in my view, especially now they've survived the worst, that in a few years those almost penny shares, like RBS and Lloyds, will go on to do well, resume paying dividends and rise. I wouldn't know which one to buy now – would you?
David:
I haven't got the foggiest.
Stephen:
And they're all the same, the fact is that it so happens, and it may be more by luck than judgement, HSBC and Standard have survived better than the others, but who could have known that before? – it's the only way that that could have been seen beforehand; people were saying RBS was the share to buy, I remember reading the Motley Fool boards years ago, everyone was going on about RBS, and RBS has been the absolute worst, apart from those that have gone completely bust, like Northern Rock and Bradford & Bingley, the small mortgage banks, of the big banks, RBS has done way way worse than the others, they went down to 10p at one stage I think, and RBS was seen as the darling of the banking sector by many. So I maintain that you can't tell the difference, so I still am of the view that there's nothing to choose between them. And now you would say HSBC, but why? – RBS will probably do better or Lloyds for a long-term hold, in my view, maybe Barclays because they've gone down so much, so I still maintain there's nothing to choose between them, or if there is, it's not visible to most of us. I couldn't see then which was the better share, and I'm not sure I can see now either.
David:
I think I agree with you, because had events turned slightly differently, say for instance that the Far East had collapsed, rather than Europe and the western democracies had collapsed, then we would have turned round and said, "Yeah, RBS would remain standing, HSBC and Standard would have gone down the pan".
Stephen:
Yes, so it's just chance, so I still think you can't slip a cigarette paper between them.
David:
Right, so let's have a look at the recession overall – I remember you once saying that, if you found yourself a good share, you would bet the farm on it – now, has the recession changed your view about this? If you do find a good share today, knowing what has happened over the last year, would you still be prepared to bet the entire farm on one particular share?
Stephen:
Yes I would in theory, David, but what's happened to me personally, quite irrespective of the recession, is I've gotten older, and as I've gotten older, I'm less willing to take the kind of risks involved in sticking everything into just one share.
I would have done it years ago, and if I lost the lot, so what? – I knew I'd make it again, because I still had my business and I was doing quite well, but now I'm getting on, I would think twice, and probably wouldn't do it at all any more. But that's nothing to do with the recession, I don't think the recession changes the bit about betting the farm, it's my personal circumstances, so for a young person, I'd say go for it, that's the way to make money.
The more shares you've got, the less money you're likely to make, but of course the lower risks you run, so a portfolio of, for instance, David Dreman, a famous value writer, recommends quite large portfolios of value shares, 15, 20 shares, the obvious reason being to lower risks – if a couple go bust, so what? – you should make it up from the others. But if you want to make big money, the sort of Warren Buffett style, or if that's your aim, you won't do it by holding large portfolios, you've got to be willing to take huge risks, but at my age, I'm no longer willing to do that, I suspect – I say that, I haven't come across the right share, perhaps – but I recently mentioned IG Group, which I only put a small amount of money in, but I think that's quite a good share, but it hasn't got the asset cover.
If I saw the perfect Pyad share, with all the features I seek, and there's absolutely nothing I can see wrong with it that's causing it to be sold cheap, it's just possible I might stick a great deal into it, but the older I get, tomorrow I might not say that any more, because I'll be a day older, and a day at my age is quite a lot. So yes, I still believe in betting the farm, but for a younger person, and that's nothing to do with the recession at all.
David:
But I think people do become slightly more risk-averse, the older they get. I remember on an earlier podcast, we had Jim Slater here, and he was talking about his allocation to gold now, he's actually allocating some of his portfolio to gold, because he just sort of sees it as being a stable part of his portfolio. As you get older, I mean Jim is over 80 years old now, and so he's not willing to take a great deal of risk. But can we just go back to the market very quickly before we wrap up? – at the moment, value shares are two a penny, compared to a few years ago, when they were very very difficult to find – is this nirvana for value investors?
Stephen:
Not really, because everything's gone down, so value is a relative strategy, a value share is compared to the market or to a sector or similar shares to determine whether it possesses value or not; if everything goes down, it doesn't necessarily mean there are better value shares around, because relatively, I mean I've had trouble finding decent value shares recently …
David:
Still?
Stephen:
Yes, still, for instance, the ones I mention on the Fool were Mucklow and IG Group, I wrote about in the last few weeks, and neither are the full monty, they don't possess the full Pyad characteristics, good shares, but so yes, still, I'm having trouble finding what I would call a full, real, genuine – the real thing; it was always rare, but although the recession might superficially appear to have made them more common, it's the sort of things you mention about collapsing property values and so on, doesn't in fact make it much easier to find them, I've found anyway.
David:
Is there hope for value investors out there?
Stephen:
Oh yeah, I mean value never goes away, as you said, at some certain points it's easier, at some points it's harder, it'll never go away because of human nature, value arises because humans are not rational, not completely rational.
David:
So is it going to take longer for the value to be outed in some way?
Stephen:
Yes, clearly, obviously in a rising market, as I think Warren Buffett and others have pointed out, all boats float, so almost any old share will rise, so yes, a rising market helps all shares, including value shares, in fact tends to help non-value shares more, because people go for more rubbish in rising markets, the sort of dot.com boom approach, but a falling market equally stops shares from rising, even good value shares, there's no reason to buy, if people aren't buying, you can have the best share in the world, and it may not go anywhere.
So value shares always take a long time and value investors have always needed to be extremely patient, it's not an overnight strategy, you may have to sit on a share for years, and if the market's falling, that almost certainly will add to the patience required before it does anything.
David:
I think the patience is the watchword, isn't it?
Stephen:
Absolutely, yeah. Well, it always has been with value, but even more so in a falling market.
David:
So are you a patient person, Stephen?
Stephen:
That's one of my problems – no, I get apoplectic in the supermarket queue, if some old lady's in front of me fiddling with her change, so no, I'm probably the least patient person in the universe, which is not good for a value investor, and I have often sold too soon as a result.
David:
Well, thank you very much for coming in today, Stephen, I mean you've been very patient with me, and as you know, I end each podcast with a quote, and I found one today from Andrew Carnegie, I think you'll appreciate this – Andrew Carnegie said, "The men who have succeeded are men who have chosen one line and stuck to it" – you've always stuck to value investing, haven't you?
Stephen:
Yes, because it works, and as I said, it's worked for all the big investors, so yeah, sticking to a strategy is one essential feature of any good investor, whatever the strategy is.
David:
How long did it take you to find value investing, by the way?
Stephen:
Oh, I was very young, I was still in my teens – I can't remember.
David:
So you've been a value investor for decades, then?
Stephen:
Oh yeah, it must be 40 years at least.
David:
That's very good. Well, thank you very much for coming in today, Stephen. Now, this has been MoneyTalk, the weekly podcast from the Motley Fool. If you have a comment about today's show, you can post it on the MoneyTalk blog, which you can find at fool.co.uk/podcast, and if you have a suggestion about future shows that you want to email me about, you can email me at moneytalk@fool.co.uk, and have a great week everyone.
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