VALUE INVESTING
Financial Engineering

By Stephen Bland (TMFPyad)
April 20, 2000

Several centuries ago, after leaving school and generally arsing around for a year, I decided to go to university and study mechanical engineering. A sandwich course. Dunno if they still exist or not, but the idea was that over a four-year period you studied for your degree, interspersed with work periods in an engineering company. The reason for this being that in order to join the Institution of Mechanical Engineers, the professional body, you required a degree plus practical experience. By the end of the four years you had both and could join.

I did the first semester at university. Me, four hundred other blokes and maybe two girls. By the end of those few months I was desperate for a change. I hated it, it bored me rigid. However I decided to embark on the first practical engineering experience period, and found a place at Rolls-Royce in Derby, aero engines not cars. I still remember the road – the oddly named Sinfin Lane. At least I think that's what it was called: apologies to any Derby people if memory deceives.

I learned one thing at Rolls, where I stayed about five minutes; argonarc welding. Does it still exist? What a turn on! Wonderful stuff. Argon, an inert gas, provides the atmosphere for the welding torch. I loved wielding welding torches. But I'd resolved after a very short time to give up engineering. Not, though, before I'd had a great time with the local Derby people of my age that I'd met. I was only about nineteen or something and having a good time was about the only thing on my mind. I would say that they knew how to party. Four hundred years later and I still haven't recovered. What is it about Northern birds and Londoners?

They thought I was a cockney, which I'm not, just a Londoner. In return I couldn't tell whether they were from Derby, Yorkshire, Lancashire or the North Pole because no true Londoner can tell the difference between the accents that arise north of the North Circular Road. Always be suspicious of a Londoner who claims to know these things; in my experience there will be something dubious about him.

Anyway, I resolved to chuck in engineering for something with a little more excitement to it, no welding torch perhaps but I wanted to study a discipline where I could wake up each morning, desperate to go in and do whatever it was I did. The wild world of accountancy proved irresistible and you know the rest. Friends became successful business people, writers, rock stars, fighter pilots. Far too tame for me.

You may be wondering what this has to do with value shares? Nothing, I just felt a little muse coming on and it is the start of a public holiday after all. Traditionally I tend to take leave of my financial senses at such times and ramble on about nothing in particular, the aim being a test of the boredom threshold of our Foolish readers.

Oh alright then. Engineering led, via accountancy, to financial engineering, making money out of shares by using a particular approach. What got me going on this concept were one or two comments from readers over the last few days that appreciated the kind of analysis and the general way we look at shares on the value board, in contrast to the way they are sometimes considered on the dedicated company boards, where they exist for a value share under discussion.

If I am in a particular value share, then the dedicated company board will not interest me much. I might have a look at it sometimes but will rarely post there. I don't think I have mentioned this before, but the comments from our readers that I mention above made me more conscious of it.

Some people may find this odd, but I don't want to know every little fact about my share. I don't want to analyse it too much, because I find overanalysing counterproductive. It leads to the possibility of emotional involvement. I've said it before, but it has long struck me that people who produce very lengthy reports and analyses on companies may be doing so because they are already in love with them. On dedicated company boards there tend to be two kinds of comment: those strongly in favour of the company and those against. This happens because people on these boards may have become emotional about the share. They can become too interested in what the company does for a living and how it does it, this then arousing strong positive or negative passions. Objectivity may be lacking in some cases. This possibly works well for people who are long-term investors in a share, but with value shares I am not in it for the long term; my interest in the shares is pretty ephemeral.

A share to me is a financial engineering device with which to make money. A clever one, perhaps, but just a bit of paper, a bit of computer storage these days maybe. Sure, I need to know something about the company, clearly, even if only to see whether it satisfies my value tests and I like the smell of it. I'm not talking about buying blind here. But have you ever seen a broker's report on a company? The sort of thing that requires a small crane to move it around. Very boring, and to me at least giving a highly excessive amount of information.

Things like quality of management, return on capital employed, mean little to me and I know that many readers will find this strange, but that's how I see it. These things will be far more important to the long-term holder and are likely to be discussed on company boards. But with value, I stand back, look at the share fairly superficially really, and just ask myself whether I think the market has undervalued it, and if so whether it is likely to rectify that situation over the next year or two. And the test of undervalue is simply the ratios and features that I have written about. I don't want to know too much more about the company than that, generally.

And this is what appealed to our readers who were looking at our views on the value board and contrasting them with the views on the company boards. I think the sheer simplicity and unemotional analytical structure of our approach is what struck them. And it is precisely the same thing that has struck me as well if I compare the value and company boards.

Occasionally it works the other way round and reader from a company board seeks our views and then becomes somewhat offended if they disagree strongly with his. But where this happens it is because we are coming at the share from two different angles. Value investors are simply looking for a bit of financial engineering to add to their wealth structure. Others though may have become attached to the share, they are beyond the mere engineering stage and possibly feel that they are involved with it as part owners in some way.

Incidentally, the latter concept is yet another one that I don't follow. I am not interested in being a part owner of a widget maker. I am interested only in making some money out of owning shares in the widget maker, without giving a damn really about the underlying company other than whether it says value to me. This is not the same, emotionally, as feeling like a part owner, even though technically it is the same of course.

Have a good holiday!

Related Links

• Value Investing discussion board