VALUE INVESTING
The Price Fallacy

By Stephen Bland (TMFPyad)
May 18, 2001

Some thoughts this week on the relationship of the past share price to the consideration of whether or not a share might make a good value play at its current level. It is something about which I have always had a view but it came to my attention again because of my recent involvement with Inchcape (LSE: INCH), in which I have invested.

When this company was being discussed on the value board and other boards, following my article on it in this slot a few weeks ago, I noticed that some readers had a problem with the fact that the share price had already risen strongly over the last few months and as a result felt that it was played out. It is this on which I would like to comment today.

If I filter across the market and a likely candidate crops up, does it matter what the recent share price movement has been? My answer is no. Ideally I prefer relative weakness over a recent period but if it is neutral or has shown relative strength this is not going to put me off. It is a very minor factor. The ideal situation of relative weakness is overcome by the value attractions at the current price. Inchcape was at  260p at the end of last year. Following the involvement of active value players Guinness Peat the price had risen to around 350p when I wrote my article, thus showing great relative strength against a market that had fallen in that time. Some readers believed this alone to be a reason to avoid the share despite the attractive fundamentals.

I don't believe that the recent price action should make any difference. Here's why. Either a share is a good value play at the current price in the opinion of the investor or it is not. That may sound harsh but it is the kind of thinking that is needed to win with value. For example imagine a situation where all you have is the current price plus all the fundamental data and forecasts, but the one thing of which you have no knowledge is previous share price movement. You are then forced to make a decision whether or not to buy. This is the way to consider a value investment.

Yes, people (like Guinness Peat in this instance) who got in much earlier will have made more money. Equally people who get in much later than you will probably make less. Who cares what anyone else has done anyway? This thinking in isolation is a key feature, I believe, of successful value investing.

I know that it is difficult to ignore extraneous factors like previous price action and what the company actually does, especially for beginners, but clearly from some messages much more experienced investors here also have a problem with this. Of course if you actually believe that past price action is important to the value approach then you will need to consider this kind of stuff, which I guess is a kind of chartist view. But I am not addressing this article to those who believe that TA has some merit in value investing, I am addressing it to the purists who wish to play a share solely on its numbers. Maybe there aren't any out there, in which case I am talking to myself, a state which seems to become more frequent as I get older.

As I have often propounded, a share has no real value at any point other than its current price. Inchcape was worth about 260p last December and now it is worth about 440p. Those were its actual valuations as decided by the stock market. Tomorrow, who knows? Whatever the investor might think, that is all he can ever get for his shares, the market price. Consequently it is fantasy to think that a share has a real value of x. This idea sounds odd to many value novices and even some of the old hands disagree with me as well. Surely the whole point of value investing is to find shares whose true value is above the current price? Not really: you want to find a share whose future price is above the current price. What the "true" value is you will never know.

And that is why past price action is misleading and should be ignored. It matters not what valuation, i.e. price, was put upon the shares a few months ago. That valuation was done in a different market at a different time for different reasons. What matters is that given the usual price-based ratios and other information like forecasts, do you have sufficient grounds to believe that there is great upside while at the same time only limited downside? The classic low-risk value play. When -- fairly rarely -- this opportunity presents itself, go in and do not be put off by a recent strong rise alone.