VALUE INVESTING
Will There Always Be Value Shares?

By Stephen Bland (TMFPyad)
March 31, 2000

So ran a thread of the same title on the value board over the last week. Our reader was not referring to my personal deep value style, but just value in general, shares possessing many of the usual value fundamentals like low P/E and so on. This has done well in very recent weeks, following a certain amount of investor tech shakeout: switching from those sectors to other types of shares, the so-called old economy (though I dislike that expression, there being only one, dynamic, economy in my view).

Thus there has been a surge in the prices of many traditional shares out of which anyone buying in the last few weeks has probably done quite well. There have been very quick gains of 25% in some of these shares. Take Royal & Sun (LSE: RSA) for example, where I have a chunk. It bottomed out at about 300 not long ago then went up to around 370 within a couple of weeks or so. Not that I got in at 300, my average price is about 355 after two purchases.

Some commentators have been saying for a very long time that techs were overvalued and all the rest of it. Just to spite them, as the market does, this sector kept on rising. Old economy kept on falling despite some great underlying business performances. Sooner or later it had to turn, but to try and call it is foolish. I went into RSA back in December for example at 380 with my first lot. I thought was too cheap then. It kept on dropping to 300. I recall posting a message at that point that the shares were going down the toilet. Value will always out in the end but the difficult bit is that you don't know when. Could be days, could be years.

I suspect then that anyone making their entry into oldecon shares over the last month and showing big rises already is more lucky than skilful. They just happened to get in at the turn. Wonderful if it happens but, if this has happened to you, don't believe that it was skill. It was skill in one sense, in having the belief and guts to go for oldecon whilst techs were still popular, but the timing is pure luck. Loads of investors perceived oldecon as too cheap and techs as too dear nine months ago, whereupon it continued to fall heavily whilst techs did the opposite.

It may hurt a bit not to get your timing spot on, for those that didn't get in exactly on 12 March or whenever the turn started, but no matter. Value will usually be successful in the long run, despite not getting in at the precise low point. Nobody does except by pure luck in my view.

So what of those, like me with RSA, who were not able to call the bottom? Can we still make money? Well, RSA at 360 is yielding a bit over 7%. The divi looks secure on a rising eps forecast. So whilst I'm waiting I'm getting a nice income. The shares trade at under book and on a forecast P/E of about 11. It is pretty close to being a FTSE 100 pyad share and those appear only very rarely. It has some debt though which rules it out as a pure pyad play and is why I haven't sunk everything into it, just a little side bet. It was cheap to me in December at 380 before the 1999 results were announced recently. It was cheaper still when I went in again at about 330 a few weeks ago, also before the results.

Having seen the preliminary results and revised broker forecasts for 2000 on the back of them, I have no reason to change my mind. The shares have demonstrated massive relative weakness over the last year as they collapsed from 600. I find this attractive in conjunction with the fundamentals I mention above.

I know some people find this hard to understand, given the success of the relative strength mechanical investment systems that we feature so much on the mechanical workshop board. But I have always liked the presence of strong relative weakness in a pyad, crisis or similar value play. It means the market has been dumping the shares. And since I believe that the market is wrong, the more it has been dumping the better for me. What I called emotional gearing in an earlier article a few weeks ago. I am taking a strongly contrarian view, always, with these shares. If I am right, the fact that the share has high relative weakness, means that there is even more recovery potential when, and if, the market decides it is worth looking at.

There are two likely reasons for the slump in RSA's share price over the last twelve months. Firstly, and probably most importantly, the general downturn in nearly all oldecon non tech blue chip shares over that time. Even those whose eps was rising did not escape, many of the country's leading companies halving in value for no reason other than negative fashion. Secondly, there is the sharp fall in reported eps in 1999 to 5.2p from 28.3p in 1998. The latter point didn't help any. However given the strength of anti oldecon investor sentiment in that time, I believe RSA would have gone down just as much if eps was rising instead of falling. This happened to many banks for example. No amount of good news was good enough to arrest the falls that occurred. So, if I am right in assuming that negative fashion was the prime mover behind the collapse of RSA, it follow that it possesses a high degree of emotional gearing. The potential to become a fashion victim instead of being ignored.

If and when that happens, I will of course be keeping a sharp eye on the exit. A couple of pointers as to when I might be out quick. Once a lot of the value is played out, indicated by a much reduced yield. At 5% for example, still a large yield to the market, RSA would be at around 500 and on a P/E forecast of about 15 for 2000. Still cheapish but not an absolute bargain any more. 15 is near space travel height by my standards. I'm looking only to strip the deep value out of it. Leave something, the higher risk play, for the next guy. Another indicator might be a preponderance of tipsters recommending it. This factor always makes me nervous.

Although I always counsel people to be absolutely, deadly unemotional with value shares, cutting them dead when value has evaporated sufficiently, never hanging on too long, whether they've gone up or down, never looking back, there are some emotional factors involved. The tipster element is a case in point. If you bought into a share cheap, and then tipsters start going for it, that can only do you good in driving up the price. But it's a question of balance. A share that has been driven up in this fashion is likely to become overbought, top heavy, and possibly ripe for a fall. An overtipped share is a bad thing, given the market's perverse love of doing the opposite, often, of what many people want. So the tipster factor needs careful consideration. But you can't weigh this up in numbers. It's just a gut feel, smell, emotion.

And in answer to the title question, yes.

Comments on the value board please.