VALUE INVESTING
Here's One I Picked Earlier

By Stephen Bland (TMFPyad)
November 26, 2004

Shell (LSE: SHEL) was one of my earliest selections for our Value Investor newsletter high yield portfolio (HYP), back in February of this year in our second edition. As I write, at 439p it is that portfolio's leading performer with a gain of about 21% on its selection price of 363p. In addition, it has declared dividends totalling 15.9p. Thus the total return to date is about 25% in the nine months since I selected this share.

I'm not claiming this is typical for the HYP. Shell is the best performer but the second best is May's choice, Legal & General (LSE: LGEN) with a total return of around 20% of which capital growth accounts for about 18%. Other shares show smaller returns with Sainsbury (LSE: SBRY) showing a marginal loss at present.

Because Shell was only my second choice I still had a pretty free hand in the sector selection. The first share I picked for the portfolio was mortgage bank Alliance & Leicester (LSE: AL.) in January's edition, so that meant for February I could still consider most of the market except for banks. I was not looking deliberately for an oil company, though at some stage it was almost certain that I would wish to include one since I quite like the sector. There aren't that many big oil companies around however.

I knew that Shell was going through a temporary bad patch because of the problems about overstated reserves. Moreover, it usually yields a margin over its principal rival BP (LSE: BP.) so Shell was always very likely to be my HYP choice amongst oils whenever I selected it. The question was therefore whether I should purchase it at that point since I needed to make a selection for February anyway or leave it and go for a different sector.

Shell's yield at the time of about 4.4% was not that great by HYP standards. Although it was well in excess of the market it is actually one of the lower yields in the portfolio. I have found in the past that Shell has been a good buy when yielding over 4% and sold at a much lower yield. That is a trading approach and not a HYP style at all but despite that, because I'm very probably going to include Shell at some stage, this was as a good a time as any to pick it. BP was never likely to be the oil choice because it usually stands on a lower yield. So Shell was only a matter of time really.

Oil is one of the few sectors where I'm pretty sure which share I want and it's Shell because it's nearly always Shell from a yield standpoint. In contrast, banks, for example, contain a much wider range of shares from which to choose. I have Alliance & Leicester and Lloyds TSB (LSE: LLOY) as my selections because these appeared to me to be the most attractive yield picks from the sector at the time but at another time I might choose differently.

The market is definitely overbanked and underoiled in terms of the number of suitable HYP shares available in the sectors.

What I am suggesting is that those building up an HYP by instalments should not go for a particular sector each time they choose but head instead look for suitable shares across the market. Clearly as you gradually satisfy the sectors in your portfolio, you will have a reducing number of unchosen remaining sectors from which to find your next shares. What you do is to scan the remaining market of those sectors you haven't yet included.

This is the approach I have adopted in the newsletter's HYP. I don't think to myself each time that I need a specific sector representative. I scan across the gamut of suitable high yield shares, rejecting those whose sectors the portfolio possesses already. Eventually I will hit on one that is in a new sector.

This process leads you to the finding the cheapest shares that fit the strategy at that moment. Against that, homing in on a particular sector for each selection might cause you to miss a share in a different sector that may be more attractive at that time. This was the process that brought in Shell back in the February edition of the newsletter.

Which share will Stephen pick for the portfolio in December? You can find out if you sign up for a 30-day free trial, plus you'll also get access to previous editions.

Stephen owns shares in Alliance & Leicester and Lloyds TSB.