VALUE INVESTING
One More Opportunity For Value

By Stephen Bland (TMFPyad)
February 27, 2004

Sometimes I find it a bit difficult to come up with a suitable theme for my Friday column. I mean I could write about a million things in general but because this is a value investing column, that sort of restricts my range somewhat. In any event, I'm sure that no Fool reader is interested in hearing the fine details of my recent exploits with a couple of minor celebs who almost appeared in a recent reality TV show but just missed it on account of not being quite major enough to be on a par with the other characters there.

Here's a topic. Pension fund deficits. These are much in the news. As a result of the bear market, a large number of companies have been reporting deficits under the rules of Financial Reporting Standard 17. But how much should value players take this into account?

Not that long ago, nobody took much notice of pension funds at all. However the twin advent of FRS17 and the bear market put them under the spotlight. The problem arises with final salary scheme type funds, known as defined benefit, where the members are guaranteed a pension based on their final salaries whatever the actual performance of the investments in the fund.

It is easy to see that this is quite risky because there is no link between the pension liabilities of the fund and the value of its investments. Inadequate investment performance over time will mean that the fund simply cannot afford to pay the guaranteed pensions without further employer contributions, hence the deficit and the potential negative impact upon the company. Many employers have now closed these schemes to new entrants because of these risks but the existing ones have to continue.

In my view, this whole thing is very much a phenomenon of the bear market. If the market rises to its earlier much higher levels most of these deficits where the funds are invested primarily in equities will be eliminated, because it is unlikely that the liabilities will rise at the same rate.

My view as a value investor is that pension fund deficits are not that critically important in assessing a share, principally because the whole thing is so very much a function of the bear market and not likely to be a permanent impairment of the company's own net asset situation. Value investors are short-term players. I hold only until the value is outed which might be anything from a few days to maybe a couple of years. Consequently, I have no interest in the longer term future of the business. In fact, I have little interest in the business at all.

So if a I find a decent value share with rising eps and all the usual characteristics, does it matter if a pension fund deficit is present? Probably not. Nothing is certain but all I am looking for is the market to re-rate the share north to a decent extent. It could well be argued that the market is less likely to do so if such a deficit exists but I believe in general that with a good value play, sufficient upside potential should exist despite doubts over the deficit for the risk to be taken. I don't think that the reduced likelihood of the market to re-rate is sufficient to justify avoiding the play altogether.

Value is as much about perception as anything else. When I buy a value share, I am perceiving it as one thing, the market another. If it rises well, then the reverse happens and I will similarly see the share in a different way to the market and sell. But note the key point. It is quite likely that nothing at all has happened to the company during this time, particularly in the short term when there has been no news or results. So what's changed apart from the share price? Nothing, just the relative perception by me and the market.

In practice, you could even see some pension deficits as a good thing for a value player. If you believe that their negative importance is over rated by the market, one of those temporary flavour of the times things, then this could lead to greater depression in the share price than you think is warranted. You can't quantify it but it may just be contributing to holding down an otherwise decent share for a time. A sort of crisis play situation that is no real crisis at all.

Finally, an admin note. We published recently the second edition of my Value Investor newsletter, following which one of the shares mentioned, William Sinclair Holdings (LSE: SNCL) has just issued interim figures. I expect I will be commenting on this in our mid-month e-mail to subscribers, which will be sent out on Friday 5 March.

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