VALUE INVESTING
Beginner's Luck, Techs and Shorting

By Stephen Bland (TMFPyad)
November 26, 1999

Paul Marshall (TMFJonnyT) decided to stir things up a bit on the value board a few days ago by asking the rhetorical question of whether we slightly deranged value players had got it all wrong. He related the story of a colleague, a novice investor, who made several times his money in a short space of time through tech stocks – a return that I doubt I could ever beat or even approach.

Some of us on the team, and many readers also, have a habit of dropping in stirrers on the boards from time to time. I am an old hand at this myself. For example I might look through the company boards for a nice safe quality company that never puts a foot wrong and has been a wonderful source of creating rising value for its shareholders over the years, just to have a go at it and annoy people. Let's say MFI (LSE: MFI), just for a random choice. I'll come on and say something like "What, are you guys crazy buying this share? I'd rather take out an endowment policy"

Right back will come the defence telling me how great the share is, "Whaddya mean it's crap, it's only lost 80% of the share price in a couple of years, what's wrong with that?" or "Course it's got value, everyone knows the sheds are worth ten times book, Americans are having to fight back orgasms at the thought of taking them over" and so on.

Not that I've got anything against MFI, of course.

Back to Paul's colleague.

I don't have a clue how to play tech stocks. So I avoid them. I invest only when I know (or believe I know anyway) exactly what I am doing. Someone asked me on the value board about when to sell a company called Pace Micro (LSE: PIC), which has apparently rocketed in the tech stocks boom. This followed my piece last week on when to sell. But I was writing primarily about selling value shares.

Tech stocks don't give me any signals. They usually have little in the way of fundamentals essential to my way of investing. So I don't know how to buy tech stocks, let alone sell them.

It's not that I am not a techie. I'm not, but also I'm not one of those people who is absolutely ignorant on tech matters. So if I wanted to, I am sure I could learn what it is the company is trying to do. But I don't want to buy on faith because the product appears interesting. I doubt I could work up the necessary sexual energy to get excited about it as an investment. Sure it might be innovative and all the rest of it, but will it make money by the ton? I don't have the means to know, really. I tend to lose my normally reliable sense of smell with these shares.

And I've noticed that tech investors buy the shares because they like the product. But often they like the product from a tech point of view, not from a business point of view. There is a dichotomy between clever technology and the folding stuff. I doubt the abilities of a lot of tech investors to connect the two; to really have a shrewd idea whether or not a good tech idea is also a good money making idea. I'm not knocking tech shares, I'm just saying they're not my style because they don't give off the same exotic scent as a pyad share in heat. Anyone who can win repeatedly with them is doing well.

Many people have difficulty in determining when to sell. I understand that. I find it much harder to advise people on selling, even with value shares, than on when to buy. The indicators are far less clear. I personally have little difficulty in knowing when to sell. It is conveying the concept to others that can be hard. With a rising value share, it is based primarily on the deep part of the value having been driven out – the low risk, high early gain part of the graph. I am happy to leave the higher risk of any further gain to the next guy. Maybe it will rise further, I don't care. I want only to be in the lowest possible risk situations. With rising P/E comes danger, in my style.

As I keep on saying, the first step in successful investing, repeatedly successful long term investing, is to minimise loss. That doesn't mean leaving your money in the building society. It means minimising risk, given that all equities involve risk. You have to accept that if you want to be in the game. But individual shares don't all have the same risk of loss. To me, a pyad value share has a vastly lower risk of losing you money than a specialist retailer on a P/E of 30.

Yes, the tech stocks, or any other highly rated shares, may do outstandingly well, as Paul's friend discovered. Especially if you are lucky or skilful enough to get into the early stages of a sector boom, and equally lucky or skilful enough to get out at the right time. I don't recall ever having been in a value share that quadrupled whilst I remained in it. But can the trick be repeated in many future years? If you take a load of people buying shares like this the odd one will be very lucky. The key to whether this is luck or judgement is repetition. The more times an investor can make money backing his judgement, the more likely it is that this is down to skill and not luck.

Going back to Paul's question on whether we, value players that is, have got it all wrong, I am in no doubt as far as my particular version of value goes that I have got it all right. I am happy with the returns so far. And so far is quite few years. More importantly, I am happy with the belief that as far as I can tell, I can repeat the returns.

Can Paul's friend? Well, I guess we won't know for many years. But I am certain that buying tech stocks alone just because they have boomed is a fatal investment philosophy. All booming sectors attract people on the historical rise. The more they rise the more are attracted. When they turn down a lot of small investors lose a lot of money. If you are a skilful trader you will have got out before. But how many small investors are good at trading? Very few, I think.

In fact in the US I recall reading a long time ago about a short selling strategy based on watching small deals in company's shares. If a load of small investors got interested in a stock for a long period this was a great bear signal. As more and more piled in, the shorts would watch, then they would slaughter it, making serious money at the expense of naïve small guys. The shorts tended to be skilled traders, pros and heavyweight amateurs, well versed in market tactics. The mug punters were no match. You couldn't short in the UK then and it's still very difficult, unlike the US where it is considered little different to buying shares – being long.

I regret in some ways the inability to do long-term shorting here. Reverse value, if you like, as a reader suggested some time back on our board. Think of all those specialist retailers we could have murdered, the fadstocks and the trashstocks, the list is almost endless. Are tech stocks ready to short now if you could? I'll leave you to deal with that one. Suffice it to say that enormous profits could await serious bear raiders in this sector, taking out the reverse value, if one could hold a short position for sufficient time, say a year or more. You could of course go wrong on timing. These shares will fall but who knows when?

What is reverse value? Negative EPS, no yield, no assets, truckloads of net debt and a forecast of even more negative EPS. Brokers pushing the share for a nice contrarian aspect. Directors' comments about "next year may be a little difficult but we believe that in the longer term the company is well placed to take advantage of the new market for that black box that sits on top of your TV and does absolutely nothing at all." And perhaps many Fools on the company's board justifying how wonderful it really is and that the demand for no-purpose black boxes will go mega next year. Questions and comments to the Value Shares board, please.

I really must learn to be a little less cynical.

Sticking to a strategy you believe absolutely will work, even through the occasional bad patch that we all have, is very important. The same applies to mechanical schemes as well. The problem is that the bad patch can cause people to question whether the strategy is still working. You can never be certain. Emotion may convince you that the whole concept has had its day. It is possible, of course, that that could be true. But investing is about likelihoods not certainties. Turning the odds in your favour as much as you can. But you can't eliminate them.

Questions and comments to the Value Shares board, please.