What does the Aviva experience say about value?
Time for a bit of navel gazing here. I'm not going to do the full value portfolio review because I did one last week. As I write though its value totals £64,488, up a little over 1% since then, despite my decision last week to go for crisis play BP (LSE: BP) which has fallen back about 15%.
Averaging down on Aviva
I want though to examine the situation with Aviva (LSE: AV) and its implications for averaging down value shares generally. I brought this one into the portfolio in a series of tranches which caused it eventually and deliberately to be highly overweight. To illustrate this, it represents 38% of the current portfolio's cost and 36% of its present value, though it is only one of ten shares.
I loaded up on Aviva because of my belief that it was ridiculously undervalued. And as the price fell after the first purchase, with no change to the fundies that I could see and therefore in my view due only to negative market sentiment, I bought more. But as we now know it subsequently went on to fall a lot further.
The average buying price including costs is 378p so at 336p, it is down 11%. It was though down a fair bit more a few days ago when the W recession explanation-compulsion disorder (ECD) sufferers, a different class of course from their equally disturbed V or U observers, held sway for a while.
I've got no time for ECD. What may be interesting though is why people suffer from it. Does everything always happen for a reason? No.
What to do when a share price falls
Anyway, going from the particular of Aviva to the general, should a value player average down on a share that has fallen a lot since purchase? In my view yes, but with a couple of conditions.
Clearly one has to be satisfied that the fall is just noise and not fundamental deterioration. It's not always that easy to glean this information however. There's often a "no smoke without fire" feeling that if a share has fallen seriously, especially where this is much worse than the background market, then there may well be some fundamental reason for it which has yet to be made public but which has leaked out to those in the know.
The other point concerns portfolio construction. If you are running a value portfolio of several holdings where you normally split the investment cost equally between them, you could be uncomfortable with going too overweight any share because of the excessive risks involved. In that case you may be uneasy with averaging down, however appealing it may look. But I haven't applied that thinking to this portfolio.
You have to consider the smoke and fire possibility. But how to test for the risk of it being present? There's no simple answer. You start by reading the company's own recent press releases. But there is unlikely to be much guidance there because if there was then it would be public domain.
There's also online discussion boards but they don't necessarily tell you that much really because there is often too much conflicting opinion. Also a lot of it is frequently just hot air from people commenting from a background of little real experience of the market or the matter in hand.
In the end, where you are open to the general idea of risking more money in averaging down a value play that has fallen a lot, it comes down to your own judgement call as to whether the share in question is genuinely even better value than when you first bought it.
The risk problem
Averaging down presents an interesting risk problem.
It could turn out to be good money after bad or, as you would hope, prove to be even better money after good.
The upside of doing this is twofold. First by lowering your overall purchase price, the share then needs to rise less than it did before to put you in the money. Second, because you have more cash invested in it, you will probably make much more money if it does the business. But the downside is that if it doesn't, then you'll lose even more.
My judgement with Aviva is that it was worth averaging down because the value increased on the lower price and I still believe this even though it has fallen further.
Nothing is safe from market sentiment for a time though ultimately such views evaporate in favour of the hard facts. I haven't seen anything yet to change my mind on this share though that does not mean that there can't still be some nasty in there somewhere waiting to expose itself and cripple the investment.
It's a risk but one I'm willing to take.
More from Stephen Bland:
> Stephen holds shares in BP and Aviva.
