VALUE INVESTING
Bad Timing

By Stephen Bland (TMFPyad)
February 25, 2000

A reader posted an interesting message on our board during the week on the return of value investing. A popular post, which attracted quite a few recommendations.

I responded that I was never aware that it had gone away in the first place. But of course we were talking about different parts of the value spectrum. I mess around at the lowest end of it, which contains very few good shares at all.

Our reader, though, was referring to value shares much higher up, with only a few of the filters through which I strain my shares, like breweries for example. That particular sector has been in a thorough depression for some time. Property rich, earnings poor, might describe these companies. Stagnant, ex-growth, a lot of them. Not surprising that they hold little interest for investors right now even though many trade below book, particularly the smaller ones. But they have been in that situation for some time. A trawl through a database on price to book value (P/BV) under 1, will usually throw up a few breweries at present.

The idea was, though, that if the "technet" sector cracks, then there will be a flight to more traditional shares, and specifically to value shares in the sense our reader meant it, which is in a much milder form than my fundamentalist one. Shares with plenty of assets, good yields, low price to earnings (P/E) ratios and so on. Banks might be considered to fall into this category as well, perhaps property companies too, and some others. I think our reader is quite possibly correct but it is a highly generalised view.

The real problem, though, with this kind of generalised advice is one of timing. People have been saying for a long time that technet will crack. It probably will, but who knows when? I don't. A switch into the kind of value to which our reader was referring, say six months ago, for someone who was heavily invested in technet, would have been a complete disaster. A double disaster. First, you would have missed out on further tremendous growth on your technets and secondly, to make it worse, you would have suffered substantial losses on your brewery shares.

And yet if you look back at comments six months ago there would have been people saying about technets that it is overdone, can't go on, must be mad to buy ARM on a P/E of 500 or whatever it was then, all that kind of stuff. How wrong they were! Many are saying this again now, like our reader. Not me. I am not going to comment on when technet will break because I don't know. And since I am not invested in that sector, nor in any sector particularly, it doesn't interest me anyway except in a remote academic sense of seeing human nature hard at work, always something worth studying for those interested in market psychology.

But logically, it makes sense to advise people on sector switching only where the person doing the advising is a great timer. That talent is exceedingly rare. One of the Foolish principles is to avoid trying to time the market – simply because hardly anyone possesses the trading skill to do it. Many think they do, perhaps through a bit of early luck, but few will be able to make the call repeatedly. And repetition is the real test of any successful investment approach. Can you do whatever it is you do over and over again? Anyone can get lucky a couple of times.

If I were a growth share player, betting everything on technet, I would be concerned as to when to get out. My colleague Nigel Roberts (TMFNigel), for example, has written about wrestling with his emotions over Baltimore Technologies (LSE: BLM), an outrageously successful investment for him, now up an amazing twenty times or something in a year. I used to tell Nige never to fall in love with shares because they won't love you back. It seems in the case of Baltimore that I was wrong. His bit on the side here has requited his interest in grand style. I have never had a share that remotely resembles that kind of growth. Of what use would it have been to Nigel to listen to comments that technet was overvalued and that he should have sold and gone into breweries, banks or properties? And yet people give such advice without the skills to back it up.

So here's a few points on things that work and things that don't:

1. The oxymoronic "contrarian fashion" strategy. It's not my game, but it is quite possible to make money from shares that are overvalued on traditional value criteria, simply because they become even more overvalued. And when everyone says they are overvalued, hang on, because everyone is usually wrong and there may be a lot more mileage in them. And when the last technet bear is flushed out, and even he is playing technet, then is the time to think about making for the exit. Perhaps "shoeshine" – when even the shoeshine boys on Wall Street are buying shares in a fashionable sector – is the classic exit signal for those playing sector fashion. But I can say from experience that even shoeshine can also go on for quite some time. It is probably the last stage, though.
2. The false value approach. Some shares are good because people always need their products. People always have to eat, people always die, people will always drink, bank and so on. Therefore breweries, foods, undertakers, banks and so on must be good bets. A certain way to lose money, but an often heard beginners' comment on why certain shares are superficially attractive. A complete fallacy. True in the sense that people will eat, but the pretty obvious flaw is that competition exists to sell them these products and services. That competition can make it hard to generate good profits. It is very easy to lose heavily in the supermarket game, as a good example. Somerfield (LSE: SOF) investors will be aware of this.
3. Buy what you know. Another fallacy. How many Marks & Spencer (LSE: MKS) investors bought what they thought they knew? This belief, often propagated by other than mere beginners, surprisingly, together with the "people have to eat" school of investment, has lost wads of money for small investors. It is often used by those buying retailer shares because they can see them. The underlying business of most shares is invisible, but retailers are highly visible. It is easy to become seduced by the sight of a fancy store in your high street or mall that has a lot of people in it.
   
   The eminent investor Peter Lynch mentions this idea in his writing. But people have perverted his thoughts on this. Some investors have taken that as being the only feature to consider, which is something Lynch never meant. At best it can be only a finishing touch to some analysis, unattractive though some people find even simple analysis. If a share looks good on the usual appraisal, then if you know it personally, that may help your decision. But to buy a share just on looks is fatal. Yet people do this.
   
   My colleague Alan Oscroft (TMFAlan) puts it well. He has written on the matter of "buy what you know", in criticism of it, that is put better as "Don't buy what you don't know."
4. The premature timer. Whenever there is a major move in a sector, up or down, or in the market itself, out come the pundits saying it has gone too far, time to play the opposite strategy and so on. Just like those who have been saying for months that technet is overvalued. These comments are always far too early. Clever timing is a talent that is distributed extremely rarely over the investing population. Nearly all get it wrong. Of those who get it right, most do so by luck and cannot repeat the call, even though some may claim prescience in getting it right.

And following on from this one of my aphorisms, since I am of a mood to annoy people:

The market will always do what the majority least expect, and it will do so when they least expect it.

Comments on the value shares board please.

Related Links