VALUE INVESTING
Bad Sectors and Good Shares

By Stephen Bland (TMFPyad)
August 24, 2001

Regular readers of my stuff, if there are any, will be aware that I pay little attention to the nature of the businesses in which I invest as value shares. I have certain prejudices, for example against small specialist retailers like clothing chains, most of which prove ultimately to be trash stocks, but even these may occasionally have a little play time window in their cycles when they "go value" and it might be possible to score. But generally I am more of a pure numbers investor as far as my larger holdings are concerned and try not to be diverted too much by macroeconomic considerations of what the company does, or even worse, the general business climate for the industry.

That does not mean that I will always ignore these considerations completely, but the weighting I will accord them will usually be low to zero. Far more important to me are the usual fundamentals including earnings forecasts, directors' statements to gauge the mood, and so on. I believe that any deep value share displaying good directorspeak supported by rising earnings per share forecasts may well be a worthwhile short-term investment, whatever it actually does for a living. That does not mean that it can't fail -- you cannot avoid that risk -- just that it is likely to do well. Successful share investing requires betting on likelihoods; there cannot be any certainties.

It seems to me, though, that possibly too many investors that have an interest in value shares are diverted excessively by these "macro" considerations. They give too much weight to worrying about the general outlook for business or the specific industry and thus miss out on some decent plays. Great value shares are pretty rare in any event, especially those that are as deep as the kind in which I am prepared to invest. I would be very reluctant to ignore one if on the fundamentals, including forecasts, things looked attractive, but someone thought that the outlook for the widget industry was not too hot right now. This in fact could be the very reason that the share is possibly unfairly depressed, precisely because the prevailing mood is bearish for the sector yet the individual share looks good.

Because value investors are against the market, in fact it often happens that good plays are located in sectors that have been falling because of such negative sentiment. I have found myself buying shares in companies where the larger-scale sentiment is against them, to the extent that I take any notice at all of such matters. If you have a share with all the required value characteristics, with strongly rising earnings forecasts and similar happy talk from the directors, yet other general evidence suggests that the near future for the industry is flat or declining, then your personal belief system will be tested as you go against this. You need to be able to do so as a value player, because in such situations lies great opportunity. Is it possible that you, the lone investor, are right, and an army of experts are wrong? Yes.

A good example of this was housebuilders a few years ago, before the current boom got going. At the time the general talk in the financial press was bearish but there were some very attractive value shares in there. Clearly, to me anyway, something was wrong with the talk because this bearish outlook was not reflected in the forecasts of these companies. Now housebuilding is a highly cyclical boom to bust industry and following a depression, investors take time to wake up to the fact that it might be over and the good times have returned. As it turns for the better, many of the shares start looking highly attractive from a value point of view because their price has not yet recognised the truth.

Note that I was not looking for shares in this sector -- I don't play the game this way -- but they just kept appearing in my trawls across the market. But the dichotomy between the press bearish view and the highly positive fundamentals intrigued me. I decided that the pundits had it wrong. I ignored the macro comment and just made up my own mind based on what I was reading in company reports and so on. And it paid off. But if I had listened to those predicting a dull short-term outlook for the industry I would have missed out on a couple of good plays.

Interestingly, any search now on low P/E will throw up a load of housebuilders. I showed this a few weeks ago in one of my articles on ratio trawling in the FTSE 350. The difference is that the press outlook is now hot. There have been many articles around on how cheap many of these shares appear. For those value investors that devote much attention to macroeconomic factors this must look attractive. After all if the share is attractive, plus the industry is attractive too, then that is the best of all worlds, is it not? Your call.