VALUE INVESTING
Noise Abatement

By Stephen Bland (TMFPyad)
January 7, 2000

One of my little mantras, dreamt up with the express purpose, naturally, of annoying people who are mantra-allergic, is: Ignore the Noise.

By this I mean that the value investor concentrates on the company in which they have invested and more or less on that alone, watching to see how the company performs after purchase, but, crucially, ignoring all external talk about factors which may make it a good or a bad buy. Especially macro-style general comment about the industry.

I am motivated to write about this following some interesting comments on the value board from readers about the insurance company Royal & Sun Alliance (LSE: RSA), a share in which I took a position a few weeks ago at around 380p, as I wrote about at the time. This, for me, was a side bet. Not one for the whole clichd farm, just that field at one corner full of bullshit. The company was not a pyad share, just an unfairly (in my view) depressed blue chip. What I call a crisis play. I've written about what I mean by this, and the specific charms of RSA, before so I won't repeat them here.

Anyway the points raised concerned fears about storms in Europe, millennium bugs, and to balance this out, takeover rumours and other gossip. Pure noise to me. The antidote to this is blinkers for the ears, earplugs but special ones that permit only clear information about the company to filter through whilst shutting out noise.

I saw RSA as seriously undervalued when I bought. The reasons, which to me were invalid, were the sort of factors I mention above. The point is though that the reasons do not matter as long as one believes them to be invalid and, of course, as long as one's belief turns out to be correct. Going against the market.

Similarly as the share began to rise, putting on some 20% in a couple of weeks, the talk was that perhaps the company was now too risky in view of all these factors again.

My response was that only one thing matters. If I'm in at 380 then I'm in until I perceive the crisis has been played out and the shares have made a good rise, which must happen if they merely return to somewhere near a normal valuation comparable with other general insurers. Or possibly, I've got it wrong and they deserved to be poorly valued on this comparison all along. That's the risk I take.

I have not the slightest interest in all the talk and rumour, positive or negative. This is what people must learn to control, to filter out, to ignore the noise. Judge the share upon its own merits alone. Following purchase, made because the share looked too cheap, is it still too cheap on yield, book, forecast EPS, comparisons with peers and whatever criteria led you to buy originally? If the answer is yes, then there is no reason to sell. As soon as it is no, get out. But do not be swayed by talk.

In the same way that it did not matter why its price fell originally, assuming the fall was unwarranted of course, making it attractive to you, it does not matter why it rises. This could be because of bid rumours, as in RSA's case, it could be because other value players have come to the same conclusion as you and gone in, whatever. Who cares? To me one of the very attractions of the whole value process is that the share needs evaluating constantly, but almost solely upon its own merits. You cut down dramatically on the amount of information required to form an investment opinion.

You don't want to know about macroeconomic factors concerning the insurance industry, especially in crisis plays which are designed to be short term. You don't need to know anything except the value tests that you use. These will tell you whether you should be in or out. Empty your head of extraneous matter and focus only on your investment.

Why do people not do this? Because it's too simple. A lot of private investors seem to think that investment has to be complex. That you need stacks of information. Well the value or crisis approach does not, in my view. No tricky maths. No spreadsheets, whatever they are. No relying on forecasts many years into the future.

I think it was Michael O'Higgins in his book Beating the Dow who put this phenomenon well. I mentioned it recently on the board but here it is again. He compares investment with the desire by many people to lose weight. Quite important for the sake of good health in the US, where obesity is a major question. It is quite obvious to anyone with half a brain that all most people have to do to achieve this is to eat a lot less and do a bit of reasonable exercise. An approach that costs absolutely nothing and is utterly simple. A good example of the KISS principle.

But no, a whole industry has grown up supplying slimming foods and devices, books, videos, clubs and all the rest of it. An enormous amount of money is spent on these things and the results are demonstrably ineffective. What should be a simple matter, requiring no money at all and just a bit of willpower has in fact had the opposite effect causing vast abortive expenditure. Why is this? I dunno. I am not a psychologist. But it appears to be an area where the public think that expensive complexity is superior to free simplicity and moreover – and this is the point that really amazes me – it is in spite of the evidence of their own eyes and what a little thought would reveal as the obvious.

As O'Higgins analogised, a lot of this seems to happen with investing. Many investors in general, not just some value players, demand enormous amounts of information. Share prices every ten seconds, reports from every different publication and so on. I believe this is counterproductive. For value investors, information overload is not necessary, it is even negative. All we require is detail on the company itself which is then repeatedly tested against the value or crisis benchmarks set, until it fails to meet such levels of them as you the investor decide. Then you head for the exit.

You should not be interested in talk in some Sunday paper about bid rumours other than as an amusement that will help the price. All that matters is if this does push up the price on Monday; then test whether sufficient value remains for you to hold or sell. Equally you don't want to know if the same paper rates the share a sell, thus pushing down the price on Monday. Provided the value remains, you stick with it, the paper will probably have got it wrong. Nothing unusual there.

There is far too much worry about general factors. They are mainly just noise. Ignore them in a crisis play and in a full deep value situation as well. I know that this can be difficult. But my experience has led me to believe that with value or crisis investing, listening to factors that have little bearing upon the specific investment in hand will hit your performance. They will confuse you as conflicting views assail your mind, testing your faith. You will buy the wrong shares at the wrong time, you will sell at the wrong time if you listen to the sirens of gossip. Or you may be paralysed into doing nothing at all by the conflicting opinions.

It took me a long time to turn off all the noise. Years. The value or crisis aim is the nirvana of pure concentration on the share itself for its own merits. It is difficult to achieve this. If you can get there I believe it will improve your performance. And all we should be interested in is just that.

All comments on the value board, please.

Related Links

• Crisis Investing