VALUE INVESTING
Back To Cash

By Stephen Bland (TMFPyad)
February 11, 2000

Last week I exited from London Pacific Group (LSE: LPG) at around 800p, for a profit of some 139% on my buying price of 335p in August 1999. I got out because I felt that the deep value part had now been realised and the share was now into higher risk territory. I had also started to become slightly nervous about all the various bulletin board messages, not just on the Fool, which went on about how wonderful and cheap this share was. And that was at prices of 600-plus. To make matters worse, someone on the board drew my attention a few weeks ago to the fact that some British tipster had mentioned them. That, for me, was the beginning of the end.

I was already showing a pretty decent profit when they crossed 600 and more people started to take notice. It always makes me nervous. I am being churlish really, because I should welcome the attention I guess. But there's a fine balance in my mind between welcoming publicity for a share that I hold, and deciding that it has gone too far, when my contrarian instincts start telling me that we are into higher risk territory. A territory to which I long ago tore up my visa, not wishing to venture there. At 600 the eulogies about LPG were still valid in helping to drive the share up further, I felt; at 800 the balance had tipped the wrong way, for me.

I'll look at the reasons why I bought this company. LPG is a financial share. Primarily insurance, with fund management and a venture capital arm. I like financials. I find them easy to read. I like their volatility, quickly reacting to events like interest rate changes, the state of the economy and so on. As one of our readers remarked, though, when I first brought the share to the attention of the value board, LPG is a rather exotic entity. Its business is in the US and it is nominally based in Jersey. For some years the shares had been held down to a very low level by extensive litigation which was terminated in 1999.

I discovered them, as so often happens, in the Investors Chronicle; issue 1642 in August 1999. By chance I had made money in LPG many years previously as a value play when the company was known as Govett. However, that was pure coincidence. I never look back and there was no trace of sentimentality in my picking them out now.

Here's what I found:

• Share price 325p
• P/E 5
• Yield 5.5%
• Net assets 642c, equal to about 400p
• Net cash $50m, about 31m
  
• Market cap 210m
• 12 month high/low 507/155p

A pure pyad play, then, on the four basics. Looking further, it was hard to find EPS forecasts. Because of the company's location and not being a fully listed share in London, there was little broker research available. But what I did find was encouraging. EPS looked set to rise – a critically important consideration. The IC mentioned that the company managed $4.3bn of funds, equal to about 2.7bn. This immediately told me it was too cheap. A company managing funds of that size has to be worth more than a mere 210m. If you look at the P/E ratio at which fund managers are taken out, for example M&G by Prudential a while back, you can see it was around 20, I believe.

I stood back for a few seconds. How did I feel about it? The numbers added up but that is not enough. It's a financial – good. But it is all offshore, giving it a slightly questionable quality. I don't buy foreign shares and this was a bit like that. Overall, though, I experienced a nice warm glow at the thought of attacking LPG.

It all smelt real good to me and I went for it with the lot.

I was sitting on a cash pile from the last exit, Fairview (LSE: FRV). Cash is always the climax of a value play. The whole reason for the existence of the game. First you hunt, then you go in, then you become gradually more and more excited if it works, or despondent of course if it doesn't. Finally, you reach your climax, your financial orgasm if you like, as you withdraw gracefully into cash, leaving others to rummage around in your leftovers.

In fact my most recent financial orgasm had only just happened. Fairview had been good and I had made around 50% on going cash after holding around five months. In fact the whole eleven months since September 1998 had been exceptionally good. Prior to that I had been wholly in cash for quite a time, not having found any good value shares, as I've written earlier in this series.

At first LPG fluctuated a lot. An unusually high proportion of shares are held by directors and other insiders, leaving the publicly-held float quite small. This means that it did not take much trading to have a quite a dramatic effect on the share price. It fell well below 300 at one stage, and I was briefly down 20% at one point. Some readers posted messages questioning the share. The thing is with a fall, that I cannot call the bottom, nor do I attempt to do so. I buy ultra-cheap. But that does not mean that it cannot go ultra-cheaper. There is no absolute definition of ultra-cheap and you have to face falls if you follow value.

This has often happened to me in the past and the only thing to think about is whether the fall is just market noise or whether there has been a change in the fundamentals. In the case of LPG I could not discover any of the latter, so I remained in. They then started a terrific bull run. Again, it was not a straight upward line, and showed a number of wave patterns. But broadly the mood was one of powerful optimism.

Interestingly, the motivation for this appeared to be not the undervalued insurance/fund management operation but the venture capital side, with several tech and Internet shares being floated off, or destined to be so, by the company in the US. Given the great interest shown by large numbers of investors in such shares, this is what was driving LPG ahead. I did not care why it was going up, of course – up is up in any language. But I was becoming increasingly concerned at this motivation, because if sentiment changed on the venture cap side resulting from a collapse of investor interest in tech/Internet shares, which could happen at any moment, then no doubt the price of LPG would fall too and it would do me little good that I still felt that the insurance/fund management business remained undervalued. But it was a great irony that the share was rising due to reasons for which I would never invest.

As I wrote last week, the real value of a share at any moment is what the market says it is. Not what I think it is.

And the real value was enough at 800 for me last week. I dumped them and it felt good. I love that point in a play. It is the safest part. The risk part, of course, is when you go in. You never know for sure what will happen. That makes it exciting but with that comes risk of loss. But coming out into cash is risk-free. Cash may be dull but it definitely has certain attractions. At present I do not know what the next share will be.

Upon going into cash in Fairview in August 1999, I wrote that I was 131% up since September 1998, the date from which I have been publicising my stuff on the Fool, although I have in fact been doing this for a very long time before that. The 139% gain in LPG has brought returns in my value shares since that date to a cumulative 452%. However, that period of about 17 months has been exceptionally good to me. These are not average returns, not by miles, in case anyone thinks otherwise.

I cannot see any particular reason why this period should have been so outstanding. The time scale to perform has been unusually short with the four shares I have traded in this time – Barratt (LSE: BDEV), API (LSE: API), Fairview and London Pacific – so it is probably just my good fortune. In earlier years I have often had quite a wait. Also, there have been no losses. These do though occur sometimes, and obviously hit performance.

On the value front, I still have a side bet running at present in insurance company Royal & SunAlliance (LSE: RSA) as I wrote on the boards a couple of months ago. Just a small crisis play. It was not sufficiently attractive to go in fully, but I saw some potential there, and a probably secure nice fat yield of well over 6% whilst I am waiting is better than I will get with my money on deposit anyway.

I am now waiting, patiently, for the next pyad share to find me.

Comments on the Value board, please.