VALUE INVESTING
Lloyds Bashed By Noise

By Stephen Bland (TMFPyad)
January 24, 2003

Welcome to the real world. Anything can happen in the markets, as we're seeing right now. The only minor consolation is that after this lot is over, and I haven't the faintest when that might be, there is unlikely to be another bear market of such proportion for a long time. But there will be another one and before that there will be another bull market with a sector bubble at some point just to sweeten things. So inviolable is human nature.

I wrote a few months ago about the attractions of financial shares, banks and insurance companies. Shortly after, they went up quite a bit and then fell back. The market did the same, but the financials exaggerated these movements. Banks and insurers are often the most rapid performers in sharp general market moves, both up and down. They are thus a good play on a recovery due to the geared effect. Of course timing it exactly is not possible. And if the market continues to fall, as we have seen, then the gearing works against you.

The only aid to timing are the usual value fundamentals. Value is any case a timing device for any share that meets your criteria, not just financials. It takes you in, and it takes you out, successful sufficiently often to make it a very viable strategy that can be followed all the time. In the case of banks we're not looking for pyad shares, but I would stress yield and P/E. In the case of insurers, yield and P/TBV. Note that I've always said that value investors should ignore macro comment and the general market, concentrating on their shares. Thus if a bank or insurer appears attractive on these fundies, it is highly likely that if you are prepared to wait, a decent profit will arise compared with the market because of the geared effect.

The problem is though that at whatever level a share does appear attractive, there is nothing to say it won't go lower. Many of my most successful plays have gone down at first. There is no way of knowing and you can't call the bottom. It is a risk you have to take if you wish to go in at all. Now since banks or insurers are a geared play, it follows that if the market continues to fall after you buy, you are likely to experience large losses on paper. Does that mean you should try and guess the market's direction in an attempt to improve on your bank or insurance plays? No.

I bought Lloyds TSB (LSE: LLOY)(NYSE: LYG) at way above the current price not long ago, not because I talked myself into believing that the market was about to turn, but simply because they looked cheap on value grounds. It didn't hurt that, thinking of them as a geared play, if the market turned up this could only do them a lot of good. However, this was not the primary reason I bought - pure value was. Included in my decision was the judgement that the trading statement they issued in November seemed upbeat in many ways, particularly with regard to their core banking business. Since then Lloyds has fallen a lot. But all the fears about their insurance subsidiaries and so on are much the same as they were back then. Is Lloyds therefore even better value now? No doubt about it unless I have missed something about the fundies having deteriorated.

My view is consequently that Lloyds has fallen only because of the geared market effect. In other words noise. And I am deaf to noise. Obviously I would have preferred to get in at these levels rather than at my actual much higher price. And who is to say that even now there won't be a further large fall? You can't know, you never will, so if you want to be in the share at all you have to make your play at some point. My experience with banks, or any value share, is that as long as you get in at deep value levels you will be rewarded unless there is a really serious crumbling of the fundies, which sounds a bit like some nasty kind of personal hygiene problem. But you need great patience and have to be willing to risk initial falls.

What I find rather useless is the careful analysis, over-analysis in my view, that we have seen on the value board and elsewhere about why Lloyds or banks in general were going to fall much further. Now that they have fallen it may appear that all the analysis was correct. It isn't and anyone taking credit for this is wrong I feel. They were just lucky. Lloyds fell further not because of its own fundamental problems, but simply because the whole market continued to fall. What was already cheap became cheaper but only through sentiment, noise, as I say. Had the market turned up then all that stuff would have been proven to be hot air. Could have gone either way but those trying to justify the fall of Lloyds because they believe they knew the fundies were poor, beyond that which the company has published, are incorrect in my view.