VALUE INVESTING
When Value Is Unattractive

By Stephen Bland (TMFPyad)
January 17, 2003

A quick trawl through the database I use, applying a low Price/Tangible Book filter, shows the largest cap share on the list by miles to be Cable & Wireless (LSE: CW.)(NYSE: CWP) with a ratio of only 0.24 at a price of 62p. In addition the company had net cash at the last accounts and a yield of about 8.5% though it has made large losses recently. But is this one time blue chip attractive as a value play?

It has certain charms I guess but not sufficient for me to become intimate with it.

I seek a variety of safety features, one of which is profits, so that generally I don't like buying lossmakers unless there appear to be strong grounds in the forecasts for a recovery into profit for the next year. Not the case with C&W where another loss is forecast for the year to 31/03/03 and even for 04 for what it's worth. Analysts though do consider it will continue to pay a dividend of around 5.3p despite the losses and it has already paid an interim of 1.6p, oddly perhaps in the circumstances, up from 1.5p last year.

Personally I usually need exceptionally strong safety nets, hence the four basic pyad filters, because I prefer to invest in a very few number of shares at a time and frequently just one. At the moment though I'm holding a broad diversified portfolio of two shares in a seriously large bet on the financial sector, neither of which are pyad shares but banks will almost never be so. Despite that I like them at certain times. Mad, but then I never claimed to be playing with a full deck. More than once has it been suggested to me that whatever I'm taking I should double the dose.

By the way, nobody should follow this style because it invites excessive risk. It makes far more sense to spread your investment across a number of value shares. David Dreman in his book "Contrarian Investing Strategies" advocates very large portfolios of twenty or more in the US, but I don't think value investors really need anywhere near that amount even if you could as many in the UK market. A value portfolio of five to ten shares is probably sufficient to diversify away a lot of the risk and in that case I doubt they would all be full pyad shares.

But back to the theme of when one should not invest in ostensibly attractive value shares. C&W puts me off because of the lack of profit and I'm not too turned on by the partially techie nature of the business either. On other occasions it could be the type of industry. For example I dislike retailers, particularly specialist operations in areas exposed to the whims of fashion like one type of food such as pizzas, clothing, perhaps sports goods or computer games and so on. You can make money on them at certain times, principally in the early stages of rapid expansion provided you know when to get out, or after a setback in the hope of recovery but it's not my style, that's more of a growth play because they don't have the assets, they will nearly always rent their property so one major leg of the safety net and possibly the most important one of all for a deep value investor, is not there.

Very rare to see P/TBV under 1 for a retailer and even if it is, you need to consider the type of assets involved. Forget stock, it needs to be largely property and/or cash to make it attractive. My recent losing play on Allders was just such a case because it was covered heavily by property assets and eventually received a bid, very likely due to that property, though I sold before that due to deteriorating profits.

There are some other shares I might not buy. Property companies traditionally trade below book in any event so that alone does not make them attractive. Plus they nearly all have debt, often excessive, so a lot of them go broke in property slumps. A good property value play would therefore be defined by me as one where the discount to book was much greater than that prevailing in the sector at the time and the debt well below the norm. Ideally it should have net cash if you could find it of course but that hardly exists, together with the other usual features like a decent yield. Property shares are valued on assets rather than profits so P/E might not be that important here. Whatever I think of the merits of various ways of valuing shares, I prefer to use such measures as everyone else is using.

Mining and oil is an interesting sector but be ultra careful. Even if you find a value play here, note that the overwhelming influence on such shares is the market price of their mineral. This is absolutely critical. You will normally need to catch such a share in an uptrend for its mineral price in order to make money. Get this wrong and you are very likely to see the price fall away from you even though it may have been a deep value share to start with. Get it right and you can score seriously. This adds an interesting extra dimension of risk to such plays though I admit to liking them at certain times. They are usually no more than a highly geared play on the price of oil or gold or copper or whatever so it is not enough to go in on deep value alone, you have to believe that the mineral price will do well.

These are just a few of my thoughts on possibly unattractive value shares. People holding larger portfolios can afford to weaken their criteria somewhat or buy very small caps which I usually don't like. Not everyone shares my prejudices for and against certain types of share either, nor should they because people should work out their own versions of value.