VALUE INVESTING
Investment Aphorisms

By Stephen Bland (TMFPyad)
May 4, 2001

This article is something for complete beginners. Old hands at value should stop here.

Aphorisms are not some kind of strange affliction caused by listening too much to the outpourings of the investment bullshit industry. With a bit of imagination, I guess, it could be a Latin term used by fiscal physicians meaning "thinning of the wallet caused by paying excessive heed to bad advice".

I refer however to those awful little sayings reputedly emanating from the stock market. "Sell in May and go away," and similar dumb comments. Nobody ever uses such expressions, of course, it is just press talk.

There is one saying, though, that I have to admit through gritted teeth of opposition to this sort of  general nonsense, makes sense to me. It is "buy low and sell high." Totally obvious, obviously. You make money trading anything by buying at one price and selling for more. Forget shares for the moment, but if you were trading second hand cars, you wouldn't be able to buy too many sheepskin coats if you kept selling the cars for less than you bought, even though that may happen occasionally.

Not so a large number of people who dabble in shares, where it appears that many investors are following a "buy high and sell low" approach.  If you want to reverse this trend and not end up as one of the herd having your wallet culled by financial foot and mouth you must stop following the Judas goats and think about the key question with regard to an individual share: what is low and what is high? How do you know where you are at any particular point? Is Kaynine Plc (LSE: DOG) cheap at 95p or dear?

To discover this you need a measuring system, something which relates the share price to some fact about the company and the compares that measurement with the market or perhaps a sector. Typical examples of company facts are sales, profits, dividends or assets.

The most common ratio is the Price/Earnings figure. Other common ratios are Price/Sales, Yield and Price/Book Value. Across the market there will be averages at any moment. On the FTSE 100 index right now for example the P/E ratio is around 20 and the yield around 2.5%. It follows that on the face of it a share on a P/E of 10 and a yield of 5.0% is valued at half the market on these measures.

That does not necessarily mean that it is a good investment but it is a starting point for further investigation. By restricting yourself to shares on relative ratings like these you are forcing yourself to buy low. That is what "low" in share terms means. Shares that are selling a lot cheaper than the market or sector on typical investment criteria like these are low. They may be low for a good reason but that will be revealed by your further investigation which enables you to form an opinion upon whether the share deserves to be much cheaper or not.

This is how value players will approach the market: filtering initially on common share measurement ratios so as to discover shares that are cheap, or low, in order to produce a list that merits further enquiry. Simply by taking this first step you are ensuring that you will never again buy a share that is high relative to the market or sector or whatever you are measuring against; you will always buy low. It does not mean that you cannot lose money, far from it, but it does mean that you have improved your chances of winning. And improving the odds is what it is all about, as I see it.