Which sector has cheap shares bouncing back like rubber balls?
It's a cliche worn smooth by its passing through many hands that novelists should "write about what they know." It's an injunction worth following, especially for a novice writer. Closer to home, "invest in what you know" will save many share pickers a lot of cash unnecessarily poked into the brazier.
After a few years' working the value investing bellows it struck me that one sector has given the quickest and most reliable yield of dying coals coaxed back to a healthy yellow glow. Unlike say using software for designing suspension bridges or taking delivery of ten thousand tonnes of copper ore, it's something most of us get involved in many times each year. Even I do it, though some have said I don't do it often enough -- it's buying clothes.
Reversion to mean
Clothes retailers often give a textbook reversion to mean performance. The reason for this would be an investing red light in most businesses -- rapid product change.
Enter a newsagent and you'll be faced with a Panzer division of magazines designed to stimulate clothes buying. Each copy of What You Must Wear Right Now and Fashion Fascist is a manual on how not to be so-last-week. The buyers at Next
(LSE: NXT)
, Top Shop and Primark must guess what will be in demand three to six months hence. Most of the time these Nostradamuses get it right or near enough, with the dregs sold in end of season sales.
However even a tennis god like Bjorn Borg in his prime wasn't able to anticipate every serve and so nearly all retailers will fail to put their racquet on the fashion ball eventually. Shoppers will go elsewhere and profits will plunge. I've watched the share prices of Arcadia Group, New Look and Peacocks (all now in private hands) plunge, and then enjoyed the ride on their coat-tails when the business turns around, making around 200% in each case.
If you are lucky, the shops will be rainbow bright with the right fashions the very season after you buy. Marks and Spencer
(LSE: MKS)
on the other hand has had a seven year slump, needing two sets of new brooms in the boardroom to get shoppers back in force, and the share price back to nearly 600p again.
In the worse case, a company can go bust but this is rare for large high street chains with strong brands to weather the storm. Most clothes chains do get it right after a bad patch, the only question is how long will it take?
Four point plan
The way I've played this sector is:
· Choose a retailer using your favourite value metrics -- I normally use historic or forward P/E <8 but not lossmaking. Leave it alone if the debt is high.
· Get an edge from your own eyes and visit one of the stores. How does it compare to other retailers? Is there more stock on sale? Does it seem quiet? If you have an eye for fashion all the better.
· Wait until you see signs of recovery either in like-for-like sales or from your shop visits
· Buy and hold patiently until recovery and forward P/E is at sector average. Sell if the like-for-like trend worsens or a reconnaissance leaves you cold.
If your pick recovers well you should get a double whammy where profits rise and the market smiles on the company by re-rating it to a higher P/E.
