VALUE INVESTING
Value Vs High Yield

By Stephen Bland (TMFPyad)
September 30, 2005

The question of which of these two share investing styles with which I am associated are preferable has often been raised by readers on our boards, principally newcomers. To consider this, you need to analyse the differences between the two styles though they both are rooted in value. As I see it there is only one major difference between the two.

Value shares are bought with the intention to trade. As soon as the share is purchased the investor is looking for an exit, indicated by evaporating value. The only reason a value share is bought is to sell it and realise a capital profit.

Against this, high yield portfolio (HYP) shares are not bought with the intention of selling. Quite the reverse. They are bought to hold for income and continue to be held until such time as it might very occasionally suit the investor to sell, perhaps never. Selling is not the reason for buying, unlike value trading where selling is the only reason for buying.

Thus this difference of intention marks in my view the most substantial variation between the two strategies.

There are several other differences too. Specifically, HYPs are portfolios of high yield shares chosen by the requirement to demonstrate sector diversification. Thus they're not just any old group of high yielders, the shares are selected to avoid excessive concentration in any particular industry. The reason for this is simply to reduce the risks involved. So the choice of shares in an HYP is affected by the need for them to be diversified, picking one type of business will often have the consequence of exclude another from the same sector.

A value portfolio on the other hand can contain any shares, there is usually little regard paid to the nature of the business at all. It's a game of fundamentals and if the numbers appeal, that's usually adequate whatever the company does for a living. Thus a value portfolio is a group of independent loners, there is no connection between them. Having one particular value share does not exclude another.

Other differences include the selection procedure. HYP shares home in on yield as the principal reason for buying. Value investors will typically look at a range of features such as Price/Earnings, Price/Sales, Yield, P/TBV, debt, immediate prospects and so on. Also they players will consider small caps whereas HYPers will usually concentrate almost exclusively on the very largest shares. Additionally many value players may hold very small portfolios, something no HYPer is likely to do.

From all this I believe that the HYP style is far less risky than value. It is in thus my view suitable for the most risk averse investors around, amongst those who are prepared to take the step of moving away from cash into risk investment at all. For example, people who might otherwise invest in funds or insurance company schemes should consider seriously an HYP. From a capital growth viewpoint my view is that it will beat most such institutional investments long term. For income investors too I see it as highly attractive compared with other risk sources of income.

Value investing is quite risky. You may do very well though you will take some hits too. And although it is a trading strategy, it can take years for the right selling time to come along. Thus it requires great patience, not a trait found that commonly amongst those of a trading inclination. HYPs too require enormous patience but that goes with the territory from the start, the whole idea being merely to sit on the shares and receive the income. Thus it attracts the patient and repels the impatient. But many newcomers I think underestimate the degree of patience required to trade value shares successfully. Consequently, in many cases it may attract the impatient, quite the wrong type.

So the answer as to which is best depends entirely upon the personality of the investor. Examine yourself, be honest, and don't choose an approach which you know you won't be able to handle, one out of which you'll easily be panicked as soon as it doesn't do what you want. And it often won't.

Some people can handle both approaches successfully, I know many of my readers do this. But they will likely be fairly experienced and disciplined investors who are very familiar with their own financial personalities.

For the great majority of people who wish to invest in shares, the HYP approach used as a growth vehicle by reinvesting dividends is likely to be far more fitted to them as long as they can resist dabbling unnecessarily. Value is a style that is more suited to a minority of individualists because only a limited number of people I believe can handle it. A growth HYP though can be seen as simply a long-term equity based savings scheme, an alternative to the wide range of other types of saving scheme out there designed to appeal to large numbers of ordinary investors