VALUE INVESTING
Common Value Ratios

By Stephen Bland (TMFPyad)
August 17, 2001

As a final chapter in this short series on common fundamental ratios, I have a couple more to look at this week. Like the Price/Sales I commented upon last week, these are not ones to which I personally pay much attention but there are many people who are interested in them.

Firstly the PEG, namely the Price/Earnings/Growth ratio. This is the forecast P/E divided by the expected growth rate in earnings per share. Some may query the point of this ratio. Well, the P/E is probably the most popular fundamental share measure of all, both for value investors and many other approaches. Two weeks ago I showed the ten lowest P/Es in the FTSE 350 index. Now if you can find a share with low P/E and also a good forecast growth in earnings per share (EPS), then you have the best of both worlds, and this combination is highly desirable for successful value investing. In fact these two features are important to my own particular way of playing value, though I wouldn't necessarily combine them in the PEG.

Here are the ten lowest PEGs in the FTSE 350:

Company                               PEG ratio

Enterprise Inns (LSE: ETI)                 0.36
Persimmon (LSE: PSN)                       0.36
Wilson Connolly (LSE: WSNC)                0.36
Taylor Woodrow (LSE: TWOD)                 0.42
Bovis Homes (LSE: BVS)                     0.50
Royal Bank of Scotland (LSE: RBOS)         0.52
IQE (LSE: IQE)                             0.53
Berkeley Group (LSE: BKL)                  0.60
Aberdeen Asset Management (LSE: ADN)       0.61
Go-Ahead Group (LSE: GOG)                  0.61

Note the rather strange mix of companies. The five housebuilders are not unexpected in view of the fact that my lowest P/E list of two weeks ago was, quite remarkably, all housebuilders except one. But these apart, the remainder comprise a rather weird collection of businesses with no discernible pattern.

Don't forget that these PEGs are derived from analysts' earnings forecasts. They can, and sometimes do, go wrong.

Secondly, return on capital employed, or ROCE. Now this is one that I hardly ever consider at all though many do. It is not really much of an indicator of value at all, at least not on its own. The way to use it as a value player would be to locate those shares that have high ROCE, whilst being relatively low valued on other fundamental measures like P/E, yield or Price/Tangible Book. So you would be looking for shares making a good return on the capital employed in the business but where this good return is not appreciated by the market. Value players, remember, are looking for the unexpected, not for the normal.

Here are the ten highest ROCEs in the 350:

Company                               ROCE (%)

Capita Group (LSE: CPI)                    471
Cordiant Communications (LSE: CRI)         285
Capital Radio (LSE: CAP)                   221
WPP Group (LSE: WPP)                       196
EMI Group (LSE: EMI)                       172
DFS Furniture (LSE: DFS)                   161
Anite Group (LSE: AIE)                     152
Taylor & Francis (LSE: TFG)                124
Imperial Tobacco (LSE: IMT)                118
Sage Group (LSE: SGE)                      115

Now this list is essentially as expected. It includes a large number of companies whose business arises from media services. The reason that these show high ROCE is that they rely on people rather than investment in tangible assets to generate their sales. And people don't figure in the capital employed shown in a balance sheet. So I would have guessed that there would be ad agencies, software and media type businesses in there.

Note though the surprise entries, particularly Imperial Tobacco (LSE: IMT) for one. You would not assume that tobacco manufacturing, or any manufacturing at all, would be amongst the highest ROCEs.  Similarly DFS Furniture (LSE: DFS), a retailer, some may consider an unlikely candidate for this list. But retailers, profitable ones anyway, are not such strange entrants for a high ROCE list because most rent their properties which consequently do not show in a balance sheet.

Finally a look at what is really a technical analysis ratio, relative strength: the measure of how a share price has moved over a given period compared to the market. One of the things I like to see, but only very much as a secondary value indicator, is negative relative strength over a period, maybe a year or whatever. Relative weakness is a very minor point for me and the lack of it would definitely not put me off an otherwise attractive value play but if it is present then I like it. Every little helps but only if the share is talking my language in any case.

Here are the ten lowest RS shares over the last year in the 350:

Company                          Relative strength (%)

Baltimore Technologies (LSE: BLM)                -95.7
Bookham Technology (LSE: BHM)                    -94.1
Marconi (LSE: MONI)                              -92.4
Psion (LSE: PON)                                 -88.1
Trafficmaster (LSE: TFC)                         -85.9
COLT Telecom (LSE: CTM)                          -82.9
London Bridge Software (LSE: LNB)                -82.9
Energis (LSE: EGS)                               -78.7
Dimension Data (LSE: DDT)                        -76.3
Kingston Comms. (LSE: KCOM)                      -75.8

No prizes for guessing the common link amongst this load of wossname.

All of them, no doubt, one-time growth shares. I reckon that if there was a prize for the most ironic expression in the stock market, then "growth shares" has to win it by miles.

More: The Market's Least Favourite Shares | Using the Price to Sales Ratio