VALUE INVESTING
Mechanical Value from the FTSE 100

By Stephen Bland (TMFPyad)
March 2, 2001

Last September I carried out an exercise on the FTSE 100 index by testing for three common value ratios, namely Price/Earnings, Yield and Price/Tangible Book Value. I took the top ten lowest P/E, highest yield and lowest P/TB and found only one share that appeared in all three tables: Scottish & Newcastle (LSE: SCTN).

At the time the shares were around 410p: they're now around 533p, up 30%. It is interesting to note that S&N lost its membership of the FTSE 100 in the interim. The index went on to fall quite a bit and S&N went on to rise nicely. Leaving the index appears to have done it no harm, but it is probably a false correlation to link its good performance to that event.

I thought it might be worthwhile repeating the exercise.

Top ten lowest forecast P/Es

Old Mutual (LSE: OML)                 8.8
British American Tobacco (LSE: BATS)  8.8
Invensys (LSE: ISYS)                  9.4
Rolls Royce (LSE: RR.)                10.3
Smiths Group (LSE: SMIN)             10.3
Imperial Tobacco (LSE: IMT)          10.4
Blue Circle (LSE: BCI)               10.7
PowerGen (LSE: PWG)                  10.7
United Utilities (LSE: UU.)          10.7
Anglo American (LSE: AAL)            10.9

Top ten highest yields

United Utilities                      8.2%
PowerGen                              5.9%
Scottish Power (LSE: SPW)             5.7%
BA Tobacco                            5.6%
Alliance & Leicester (LSE: AL.)       5.5%
Lloyds TSB (LSE: LLOY)                5.3%
Royal & Sun Alliance (LSE: RSA)       5.3%
Invensys                              5.2%
Scottish & Southern Energy (LSE: SSE) 5.1%
Bass (LSE: BASS)                      4.9%

Top ten lowest P/TB

Lattice (LSE: LAT)                    0.8
Land Securities (LSE: LAND)           0.8
Vodafone (LSE: VOD)                   1.0
Bass                                  1.3
United Utilities                      1.3
Railtrack (LSE: RTK)                  1.4
Marks & Spencer (LSE: MKS)            1.4
CGNU (LSE: CGNU)                      1.4
Royal & Sun Alliance                  1.5
Associated British Foods (LSE: ABF)   1.5

Several features are apparent by comparing these lists. What we are looking for of course is multiple appearances. So if we take the P/E and yield series, you can see that four companies show up in both, in order of descending yield they are United Utilities, PowerGen, British American Tobacco and Invensys.

Similarly if we take the P/TB and yield series, you can see that three show up in both. In order of descending yield they are United Utilities, Royal & Sun and Bass.

Finally if we take the P/E and P/TB series, you can see that only one share, United Utilities, shows in both.

The overall winner though, the share that appears in all three series, is United Utilities (LSE: UU.), and it is the only one to do so. A small company by the standards of this index it has a capitalisation of £3.2b at 583p. In fact it is so small that it must be in danger of losing its place in the index at some stage. Oddly, as I mention above, that is exactly what happened to Scottish & Newcastle last time I did this.

However United is a very different share from brewery group S&N. Not just because it is in a completely different industry, but because as a water and electricity conglomerate it suffers from regulation over a lot of its activity. No doubt due to a great extent to this regulation, earnings per share are forecast to fall heavily from a normalised actual 88.3p in the year to 31 March 2000 to a consensus estimate of 54.1p for 2001.

Despite this, the dividend is forecast to rise from an actual 45.2p in 2000 to 46.4p for 2001, putting the shares on a very high forecast yield of about 8%.

Debt is enormous at 115% of shareholders' funds given by the 2000 annual accounts.

So is United an attractive play? Well I would not buy it, but then I am notoriously choosy. The method outlined here is purely mechanical, using the three value ratios mentioned. Over the last five years the shares have been up to 957p and dropped to 531p, so they are near the bottom of their range in that time. But that is to be expected on the back of the forecast EPS fall.

There is no obvious value "outer" because the 2002 forecast is flat compared with the 2001 figure and I cannot see any special factors. Comparing with S&N as chosen by this method, that too had flat EPS forecasts. The possible outer for S&N, which I mentioned at the time, was the substantial disposal of underperforming businesses, but there does not seem to be any action of this sort at United.

Hard to see, then, what the attraction might be for value players. But an interesting exercise anyway and perhaps it has some merit for those that might play value totally mechanically, particularly if they stick with large cap companies. I prefer large caps, generally speaking.

It may be worth mentioning here that United features in my suggested high-yield portfolio, the latest update on which is here.

The author owns shares in Scottish & Newcastle.