Put on your deerstalker and dig the dirt. What guilty facts would companies rather keep quiet about?
"I'm not cheap. I'm working my way up to cheap." Warren Buffett, parrying an insult.
The billionaire investor did nothing to dispel his reputation for giving his Dollar TLC by taking his new bride to the Bone Fish Grill in an Omaha mall in a combined wedding and birthday celebration last month. He does not however fit the old saw of a man who knows the price of everything and the value of nothing. Buffett's gift is having a telescopic sight for the value of a company. He even cautions against buying a share simply because it looks cheap. He calls low-priced businesses with intractable problems "cigar butts" -- you may get a couple of puffs out of them before casting them into the gutter but it's not a great way to invest.
That's not to say the honeymooning septuagenarian wouldn't still leap on a bargain price stock if he thought the company was sound. There's the rub. He'd want to know what he was getting.
If you saw a chainsaw for sale at £39.99 (e.g. at Aldi last week) you'd ask yourself "why is it cheap?" before putting it in your trolley next to the Del Monte look-alike orange juice and Louis Quatorze look-alike garden hammock. The answer is a) it's electric and b) Giant Redwoods won't be trembling in their roots at the sight of its puny sixteen inch blade. But as long as you know what you are getting, you're in a position to make an informed choice between that, a sixty inch two-man 250cc chainsaw and a hobby knife.
Digging for dirt
When you've spied a temping stock, say on a low the price-earnings ratio (P/E) or high yield it's time to get out your spade to dig below the surface. Take a look at these cases:
|
Company
|
P/E |
Yield
|
Business
|
Negatives
|
|
Alpha Airports
(LSE: AAP)
|
11.9
|
6.2%
|
In-flight catering and airport retailing
|
Accounting irregularities, three directors have resigned this year
|
|
Griffin Group
(LSE: GFF)
|
2.3
|
0%
|
Creating investment companies and floating them on Plus Markets (f.k.a. Ofex)
|
Directors' pay and bonuses at £3.6m are over 6x pre-tax profits and 34% of turnover. Chairman Stephen Dean is sole person on remuneration committee and company will not reveal bonus plan.
|
|
Electrocomponents
(LSE: ECM)
|
20.5
|
7.4%
|
Distributor of electronic components
|
Paying out more in dividends than they earn. Margins are falling and UK business struggling.
|
All data from Digital Look. P/Es are historic.
Sometimes the usual sources (Financial Express, Google News, Newsnow and ft.com) don't reveal any problems. This may mean that the share is a bargain but The Fool Discussion Boards are a great place to tap into specialised knowledge. There are hundreds of company share boards, or try a search. If you draw a blank why not write a post about your find and see if any skeletons rattle when the cupboard is given a good shake.
Whole sectors can be cheap on a P/E basis. Housebuilders' shares have done extremely well over five years because the feared crash in house prices (which pushed P/Es down to as low as six) hasn't materialised. If it had happened though, the low ratings would have been justified. Other stones in the investment shoe include persistently poor cashflow, intensifying competition, regulatory threat, recent large exchange rate changes and of course suspect management.
Once you've found why a share is depressed it's time to decide whether the negatives are reflected in the low price. That's when you have to put your keyboard aside and rely on experience.
