VALUE INVESTING
Anatomy of a Value Play

By Stephen Bland (TMFPyad)
September 10, 1999

My first four articles in the series were the introduction to value investing, both generally and from my personal angle. As I have mentioned, there are many ways to approach value investing and mine takes a much more restrictive view of what may be a good share than some other versions. This is because I like to eliminate as much of the risk as possible. I need to do that because I like to focus on a tiny number of shares at a time, often only one.

If you're going to bet the farm on only one or two shares, you would be well advised to be as certain as possible, given the risks attached to equity investment, that they are far more likely to go up than down. Swinging the risk/reward ratio in your favour as much as you can, minimising and maximising the downsides and upsides respectively.

I'll go back to around September 1998. It had been a quiet year for me, following taking a nice profit out of NatWest as a crisis play some nine months or so earlier. I'll write about crisis investing in a future article. For nine months my money had sat in a bank deposit earning me 5%, or whatever it was.

I trawled continually for value plays through that period, using REFS and one of my long term favourite sources, the Investors Chronicle company results pages. Nothing really grabbed me. As often happens during the waiting period, the temptation arose to dilute my criteria in order to throw up more choices but I did not fall for it. I never do any more although there was a time many years ago when I might have done so. But my obsession with minimising risks, coupled with hard experience, has led me to be pretty rigid on this. Reduce the criteria and you increase the risk. But why bother? I am almost certain that I would make less money that way because there would be more losers as the also-rans squeezed through the enlarged holes of my sieve.

But you need patience to wait it out for the right moment. Remember my war analogy? You're armed to the teeth with value weapons of the highest quality. You will need them, all of them, to take on the market and stand a much better chance than most players of winning. So you lie in wait, ambush if you like, patiently, for the right one, often months if necessary, whatever it takes. Take your time and choose your target with care. The right one will always come along, so don't lose heart and don't weaken. As long as you have the patience to wait you will be rewarded.

Look at cats, big and small, as they hunt, watching the likely prey for a long time before they pounce. But they don't just want any old deer from the herd or bird from the flock, they wait and they choose. And when the time comes they go in totally. No turning back, absolute commitment. And then they rip the guts out of their victim. "Sorry mate", a lion might say to a deer, "No hard feelings and all that, it's just business." A killing machine in action. So you must deal with value shares.

Once you have found your share, hang on until it has no value then murder it. Remember, you believe that you are right and everyone else is wrong. You have conquered your doubts and fears, you will capture your value share, tear the life out of it as it rises and then toss the entrails away for someone else to enjoy the remains, maybe even lose money on it, whilst you move on to fresh kills.

And in September 1998, Barratt Developments (LSE: BDEV) was my first kill of that year. Here is the full monty on it. I would like to thank the Investors Chronicle for kind permission to use the following extracts from the company results pages in their issue of 25 September 1998.

• P/E 6
• Yield 6.0%
• Assets - P/BV just under 1
• Debt nil
• Net cash £46m
• Cap at a price of 167p per share £389m
• Strongly rising EPS forecast
• 12 month high/low 341/158, so it was around its low
• Chairman's comments were bullish about the business.

A check on REFS showed strong relative weakness to the market over the last year; a feature which I find attractive provided the other value criteria add up.

Barratt is a housebuilder, one of the largest in the country. Immediately I noticed that the company exhibited the basic pyad features upon which I insist. Coupled with a decent market cap, pots of cash and rising EPS I felt the old adrenaline rise as the company almost begged to be bought. The shares were being given away.

Hang on a minute, what did it smell like? OK, stand back, take a deep breath. Every value share needs an appraisal other than just the raw data. What's my opinion of the industry? Well, housebuilding is highly cyclical. But I knew from knowledge of what was going on around me that houses were selling very well. I believed that the industry was still in the rising stage of the cycle. The chairman's comments confirmed this. In the year just finished, according to the IC report, the average selling price of their houses grew by £8,000 to £95,000, a strong performance. I did not think that the house market had peaked and was pretty sure there was a lot more mileage in it. It passed the smell test effortlessly. I made my decision.

The market had got Barratt wrong, I knew it. This was it, the one I had been for which I had been waiting for some nine months. I was going in. The price in the IC was 167. By the time I bought, very shortly after reading the report, it had risen to 180.

Perhaps rashly, I remember writing about the company in a Fool message, saying something like it was the greatest value play I had seen in a long time.

For some reason which I can't really explain now, I did not bet the whole farm on Barratt, just half of it. The shares went on rising over the next few months and the interim report was due out around March 1999. Note that the rise was not in a straight line, but went ahead then fell back a bit and so on. This is quite common with shares. I believed I was right, but a weaker holder could have been flushed out because they almost fell back to just above my buying price at one point, if memory serves correctly. Patience is always required after going in, same as when waiting and studying the markets for prey. There was no news to push the price down, so I concluded it was just market noise. And "Ignore the Noise" is one of my annoying little bits of advice.

Eventually, after the first couple of months of 1999, the price rose to well over 300 and I decided, shortly before the results were announced that the deep value had been realised. Taking my own advice to leave something for the next guy, but leaving him a much higher risk factor, I exited with a profit of around 70% in about six months. Barratt had done the business as I believed it would.

As an interesting aside, Barratt had been a very successful value play for me many years ago in similar circumstances. And no, I didn't buy it again this time round on sentimental grounds. Never fall in love, remember?

Next week, API – where the other half of my farm went in 1998.

Comments and questions to the Value Shares board, please.