VALUE INVESTING
The Market's Cheapest Mid-Caps

By Stephen Bland (TMFPyad)
May 28, 2004

Having had one of my regular trawls for value in the FTSE 100 a couple of weeks ago, it's time to have a similar look at the FTSE 250. This index is made up of the next 250 largest companies immediately below the 100-share index.

The information I used for tangible book values is based on the last annual accounts with no allowance for interims or news since. Price to earnings (P/E) ratios and dividend yields are based on consensus analysts' forecasts. Consequently, and because databases can contain errors, readers must look further into any shares in which they may be interested. This is just a starting point.

As usual, I am seeking appearances in all three lists, but there are none and only one company, utility Northumbrian Water, makes it into two (yield and price to tangible book (P/TBV)).

The most remarkable thing about these three value tables is revealed in the P/Es, where every single entry in the top five is a housebuilder. No housebuilders are listed in the FTSE 100 but the 250 index has quite a few. In fact, the low P/E table for the 250 extending much further than just the top five contains a large proportion of shares in this industry, telling us that the whole sector is being given a very low rating by the market at present. This is quite common during boom times for cyclical shares like housebuilders. In a housing slump, P/Es will rise to very high figures or disappear entirely as profits collapse into small figures or turn into loss. The market therefore appears to be looking ahead to this happening by awarding very low earnings multiples.

I can't help thinking that now maybe it's a little late in the day for housebuilders as short-term plays, though this is not yet reflected in the record profits that many of them continue to display. In any event, they are trading above book now. I would go for them as deep value plays when they are below net asset value, which will be during or towards the end of a slump when you get the benefit of the downside protection. Now, the latter really isn't there and any signs of profits cracking may cream these shares despite the low P/Es.

Generally, companies presenting high cyclicality tend to be regarded as lower quality than those with more maintainable profits. But that's an institutional view. The individual value investor can often find attractive short-term plays amongst such shares. Sooner or later the housebuilding boom will fail, it always does and this time it definitely ain't different. However, as I've said often, booms and slumps frequently go on much longer than anticipated and when you start hearing the first "it will all end in tears" clichés, it is near certain that there is still some way to go yet. In fact, such early warnings can be a good contrarian indicator for a short-term player. You would have done pretty well for example in the tech bubble a while back if you bought all the rubbish shares with no earnings etc. when you were first told that "it can't go on", provided of course you had the sense to get out a little later and much higher whilst it was still going on.

The P/TBV table has a couple of property-based companies as expected because these usually trade below book. Millennium is in the hotels business while London Merchant is a traditional property company with a non-traditional sideline consisting of a substantial portfolio of venture capital shares. London Merchant is quite an interesting company in fact, with its value characteristics prompting me to write about it in issue three of my Value Investor newsletter. The very low P/TBV of Northumbrian is perhaps a little surprising, while Corus and Eurotunnel are companies with well-publicised problems leading to their low ratings.

Where next? Every month Stephen Bland trawls the market for shares that offer the lowest possible downside risk while at the same time possessing strong upside growth potential. They're revealed only to subscribers of the Motley Fool's Value Investor newsletter (with free 30-day trial!). Click to learn more.