The closure of Neil Woodford’s Equity Income Fund has prompted a devastating backlash from his dedicated investors. Quite rightly too as these funds were deemed relatively safe investments and marketed to would-be investors as a sensible place to save.
Although I fully understand why some will turn their backs on the stock market forever, for those who would like to take control of their own finances and try to regain some of their Woodford losses, a sound investment strategy is needed.
Warren Buffett and his mentor Benjamin Graham, each suffered losses along their investing paths, but they moved on, sticking to a tried and tested formula. Value investing is their mantra and each investment meets strict criteria.
Buffett-Graham value investing criteria
- A quality rating from a rating agency such as Moody’s.
- Current ratio over 1.5
- Positive earnings per share
- price-to-earnings ratio (P/E) of 9 or less
- Price-to-book-value less than 1.2
- Dividends
We live in strange times and the stock market is in its 10th year of a bull run, so finding a company with a P/E of less than 10 is nigh on impossible unless it’s got problems. Therefore, I think these principles should be slightly tailored to suit the times.
What is a value investment?
I think the ideal investment has:
- Dividends
- ‘Low’ P/E
- Growth prospects
- Established company
A dividend usually indicates the company is doing well enough to return some profits to shareholders.
A high P/E indicates the company may be oversold, but it’s important to compare the P/E with other companies in its sector to better gauge value.
It’s important that a company has a consistent customer base to sell to, so growth options should be considered.
Make up and move on
An example of a possible value investment that springs to mind is AIM-listed cosmetics company Warpaint London (LSE:W7L). It has a market cap of £58m and a dividend yield of 5.75%. It manufactures its products in China and sells cosmetics under several brands, including W7 and Technic. Its P/E is 16, it has low debt and its current ratio is 4.8. So far, so good, but there’s always a downside. Earnings per share are negative and since declaring a profit warning last year, its share price has fallen from £2.25 in October 2018 to 75p today.
In its recent interim report to June 30, sales rose 2.9% but adjusted operating profit fell 53%. UK revenues were down 11% but the company enjoyed strong growth in the US and Europe so has lots of growth potential.
Is it a bargain? Maybe, but like the rest of the retail sector, it’s up against a challenging climate and operating in such a competitive environment means it has a lot of selling to do to boost the share price. Its owners are major shareholders, but the company is still relatively new.
When looking for a value investment it’s important to consider several factors and not get carried away on the potential for massive gains, by overlooking red flags.
FTSE 100 companies usually offer dividends but have slimmer growth prospects, therefore, finding established companies with growth prospects can be trickier. Not that it can’t be done; Tesco is an established FTSE 100 company that still has the potential for future growth.
The key to successful investing is to stick to your plan and monitor it, don’t stray from the path and profits should follow.
