Stephen Bland outlines his personal definition of value investing.
A dumb title? Perhaps, but lately on the value board some newcomers have been questioning exactly what defines the strategy. I've written extensively on this in the past but perhaps some may find it useful for me to reprise the approach as we use it here on The Fool.
Inevitably what I'll say will be my personal view because I'm not trying to write an investors' dictionary definition or give some sort of balanced opinion. Just my own view.
I can see the difficulty some newcomers have because value, although talked about a lot all over the place, can suffer from very different definitions which can be confusing.
Let me say what it's not.
It's not about trying to work out the net current value of forecast earnings in the years ahead, and then comparing that with the current share price to see if the share is undervalued. This is often perceived as the Warren Buffett approach.
I believe this is a discredited approach in which I have no interest for the simple reason that I just don't believe that forecasts several years out are worth anything.
There's too much that can go wrong. Even a current year forecast quite often proves wrong before the year is completed as demonstrated by the frequency of profit warnings issued by companies.
In fact that is what is meant by these warnings, namely that the company's actual profits for a year will be lower than the amount predicted by analysts.
Those forecast profits will very frequently have been agreed by the company itself with the analysts. So in a real sense, it is also the company's own expectations, not merely those of outside analysts', that prove to be wrong. Given how often that happens in the very short period of a few months, the value of longer term forecasts is virtually nil.
It's not about the ugly acronym GARP, growth at a reasonable price, often quantified by the PEG ratio, which means P/E divided by the earnings growth rate.
At least not about all versions of the PEG ratio. The problem can be that if the PEG is used indiscriminately without other filters, it might select high P/E shares with very high forecast growth rates.
A PEG of, say, 0.5, which might be considered attractive, could arise from a P/E of 20 and earnings growth of 40%, or a P/E of 8 with earnings growth of 16%. The former ain't no value share that I recognise whilst the latter might well be.
So PEGs in my view can only be part of a value approach where the P/E bit of the ratio is itself low and only a short term view is being taken of the growth. In any event one would likely use it as part of a range of other filters, specifically, low P/E as I say. Incidentally, PEGs work best with large caps where the forecast is likely to be more reliable due to the presence of a number of analysts.
Value investing is also not about technical analysis (TA). Some value players may use that as an additional aid, though I have no faith in it myself, but on its own, TA can't reveal any value.
And as I wrote last week, it is not about trying to locate ostensibly good management either. Although it may well be about bad management or at least, perceived bad management, if that has the effect of temporarily depressing a share price.
That's enough in my limited space here about what value is not. What it is about, is cheap fundamentals. Typically, P/E, P/TBV, low debt, high yield, low price/cash flow, low price/sales and so on.
There are many measures. All rely on a quantitative assessment of a company with a minimum of futurising though there is inevitably some because near term forecasts are used in some of the ratios like P/E and yield. The general idea is to find shares that are cheap but critically, cheap for reasons that the investor considers unreasonable, not cheap because they deserve to be cheap.
Following on, some have queried whether a single value criterion such as, for example, high yield could be acceptable as a value method rather than employing a range of factors.
Yes, definitely. The range of value measurements investors require to identify targets varies in number. One is obviously the least that could be used, my pyad approach uses four. I've been using one, high yield, in some recent trades of my own. There's no rule about how many filters one needs to employ.
As long as it's using cheap fundies to locate and trade shares, it's value investing.
