VALUE INVESTING
Trading Places

By Stephen Bland (TMFPyad)
August 9, 2002

There's been a lot of discussion on the value board recently about trading strategies. Some of it went completely off the topic of value shares on to the much more important one of motorcycles. For some reason, a surprisingly large number of value regulars ride, or have ridden, bikes. As we have observed before this was why it was actually right on topic for the value board.

In fact the thread started off topic in the first place by drawing attention to one of our regular readers on another board who had been attempting to trade shares and derivatives over the last year using technical analysis (TA) methods, with no success unfortunately, though to be fair any short term strategy needs a decent time of a few years to prove itself. Value shares or anything can have a bad year. Look at the oft recommended tracker fund, that's had a very bad period for at least two years now.

I have little time for TA. It seems to me that only a tiny number of people manage to use it with serious success, sometimes in conjunction with other approaches, but good luck to them. Whatever floats your boat. Any style that works well for someone obviously has to be good for them, even if nobody else can make it work. Some may disagree but I believe firmly that anybody who does manage to make a long term success of very short term trading exclusively by TA is probably a person who is a natural trader anyway and would have done just as well trading anything, which explains why so few, I believe, succeed.

But the same does not go for value in my view. You don't need to be born that way. I am sure you could pick a largely mechanical portfolio of value shares using typical criteria such as high yield, low price to earnings, low price to book value etc. You could then just sit on them and it would go on to do very well in the long run assuming you had the patience, although I guess you do need to born with the patience. Many studies demonstrate this. Anyone sufficiently interested in the stock market to learn how to do this analysis can do so, there's no particular knack as I believe there to be with TA.

Is value a trading strategy? I'd say a definite yes. The word "trading" carries the implication of holding for only a short time and in this it differs from a straight buy and hold approach like the High Yield Portfolio. The periods for which a trader could hold an investment could be minutes or years. However, it is the intention, ie. buying purely to sell at some point in the not too distant future, which defines a trader in my opinion. But value can have a long time horizon and therefore needs a lot of patience. Sometimes a share can drift along for years, even though it is full of value, with nothing happening. Incidentally this potentially long holding period is one of my reasons for insisting on a decent yield because at least you are compensated for your money being tied up whilst you are waiting and at probably a much better rate than bank deposits too, especially in the low interest environment of recent years.

For beginners to the approach, the aim is to discover a share with some immediate growth prospects that is selling very cheap. The cheap aspect is to offer some degree of downside protection in case things go wrong, as almost inevitably they sometimes will, and the growth prospect is in order to have some reason for the share to rise. Good ones do not come along too often. If it works, you capture the short-term growth, all the time being far more protected than is normal with the rest of the market, exiting when you perceive the prophylactic features to have evaporated beyond the point at which you feel comfortable. And if it doesn't work, you are likely to be prevented from too big a catastrophe by the very value features you sought in the first place.

So yeah, we're traders alright.

Funnily enough though, I do believe that for probably the majority of lump sum investors, a buy, hold and forget approach is likely to prove highly successful in the long run, beating most other styles, which is why I am associated with the High Yield Portfolio idea.