An open love letter to Ken Fisher
Posted on May 8, 2008 by Richard Beddard
Filed Under Markets | Leave a Comment
Still, I couldn’t let his latest column pass without pointing to it, because it’s so unashamedly belligerent:
I get lots of mail from readers - US, UK, even Germany. No love letters - now, mostly hate mail. Folk are personally offended by my bullish view. Great! The more hate mail, the better - it tells me my bet against the masses is right. If everyone were telling me I’m a genius, then I’d worry.
And I can just imagine the hate mail. Particularly this bit, which must surely have come from the UK:
You git! This is a credit crunch
He says we’re not experiencing a credit crunch, which I suppose, depends how you define credit crunch, or to which markets you apply the term.
But there’s no arguing, he’s right when he says:
Here we are… world shares down just 2% for the year. Same with British shares!… World shares are up 14% since mid-March and British shares 15.5%!
And very few people other than Ken would have predicted that six months ago.
From our conversations I know he doesn’t sees himself as a contrarian. Not by design anyway, he doesn’t deliberately take the opposite view. He’s just not swayed by the majority view, and that’s what really winds people up.
He’s arrogant, he’s dismissive, he’s pompous, he’s full of himself, he thinks he’s better than everyone else.
He reminds me that things may not always be how they seem, which is very important, because the last thing I want is to make investment decisions based on the prevailing mood in the market.
So there you go - a little bit of love for Ken.
That ought to get his hackles up.
The six cheapest stocks in May
Posted on May 8, 2008 by Richard Beddard
Filed Under Naked PE, Companies, Investing | 2 Comments
First, here’s the May list, straight from Dr Keith Anderson’s database:
Just in case you haven’t been following the series so far, here’s a recap:
- The Naked PE is a company’s price divided by the average of its past eight years of profits, and
- It’s also adjusted for a company’s size, and sector.
By back testing concentrated portfolios of shares Dr Anderson, a lecturer at Durham University, calculated that between 1975 and 2003 a portfolio of six shares, rebalanced every year, would have returned 39% a year, suffering only two down years. Since then, the Naked PE may have performed less well - last year two Naked PE stocks went bust - and Dr Anderson is in the middle of updating his testing through to 2008. I hope to bring you the results with the August list.
There’s a lot to like about the Naked PE, apart from its name.
As any investor knows prices tend to follow earnings because we base the value of a company on our expectations of its future profits which, at the risk of oversimplifying, the company will return to the shareholder as dividends or reinvest in growing his company.
The problem is, in the short-term earnings can be an unreliable guide to future profits. Quite often, a company’s price will fall dramatically if its earnings do, or even before, but that drop in earnings is temporary. A temporary drop (or spike for that matter) in profits can’t possibly be a benchmark for the company’s future earning power.
Using the average of at least five years earnings is a more reliable, if conservative measure*1. Allowing for a company’s size and sector is something most investors do, at least intuitively.
Obviously, any company with a low price relative to its earnings is disliked by most investors. The six companies with the lowest PE ratios are most despised of all. That means our list of the six cheapest stocks contains companies investors wouldn’t normally consider. If like me, you think you can beat the market by doing something different, it seems a good place to start.
I’ve been looking at one of our last picks, Johnson Service (JSG), published in February, which tops a similar list that I keep. It shows the dilemmas an investor can face, when appraising very cheap stocks. According to my list, Johnson Service’s long-term PE ratio is just 1*2.
The company does drycleaning, rents and launders work wear (i.e. uniforms), and manages properties.
Last year amortisation and impairments turned an £18.5m pre-tax profit into a £52.4m loss. The company seems to be writing off everything including the washing room sink. It sold off its most profitable business (corporate wear) to prop up the remaining three and arranged new loans with bankers that it says will see it through to 2010, but I think this statement in April’s results:
The terms of the banking facilities incentivise the raising of equity and the Board will be considering this in consultation with Shareholders.
Means that existing shareholders may find their holdings diluted by a rights issue. Having already lost a valuable division it would be foolhardy to assume profits will return to former levels any time soon.
With both sides of the earnings per share equation so uncertain, to understand the value in Johnson Service, and the risks, you’d need to be a restructuring expert, and that’s where the story gets interesting. The interim chief executive, John Talbot, is an experienced restructuring expert.
He, along with most of his board bought shares recently, lots of them. Mr Talbot bought the most, 635,000 shares at 21.16p - an investment of £134,366. It’s difficult to imagine him laying out that much if, having reviewed Johnsons’ businesses, he didn’t think the shares were cheap at the price.
By yesterday the shares had risen to 36.5p. Other investors have probably followed Mr Talbot’s lead. Is that cheap? Dunno. But I think Johnson’s worth studying because if it does recover, I’m sure there will be opportunities to buy along the way.
Dr Anderson, who thinks the returns from the Naked PE can be improved by waiting until the downward price momentum typical of low Naked PE shares seems to have abated, cautions:
Over the ten years before the latest results, EPS according to Datastream averaged 29.1p. So it is easy to see where John Talbot’s confidence comes from. Though looking at how quickly the 200-day moving average is still descending, the latest rise could well turn out to be a dead cat bounce.
Footnotes:
- Also demonstrated by James Montier. See chapter 27 of Behavioural Investing.
It’s fallen out of Dr Anderson’s list because he requires 8 years of unbroken positive earnings and in April Johnson Service announced a loss. - I’ve also blogged and iBalled Johnston Press.
Last word on banking
Posted on May 2, 2008 by Richard Beddard
Filed Under Companies, Ramblings | Leave a Comment
This paragraph stands out:
Whatever his problems, a banker is virtually obliged to maintain that his bank is totally sound until he has to close the doors. Any admission of difficulties will worry depositors and make them more likely to withdraw their money. So statements from bankers that everything in the garden is rosy must be treated with a large dose of salt. It may be true, but the banker would be equally obliged to say this if it wasn’t.
For now, at least, the market seems to be taking RBS’ assurances at face value. But with Michael Brett’s advice ringing in my years, its worth remembering the capital ratio is a solvency ratio and if the bank feels it needs to be more cautious in future to protect its depositors, it can’t be good news for profits. Maybe things aren’t any worse than Mr Goodwin says, but they’re unlikely to be better.
I wonder if the same could be said about central bankers.
Bus company reverses into bus company
Posted on May 1, 2008 by Richard Beddard
Filed Under Companies | Leave a Comment
I’m arranging interviews with Roy Stanley and Andrew Brian, Darwen’s (DHP) chairman and chief executive about their exciting new bus manufacturing company (yes, really - see below) - the deadline for the iBall script is tomorrow - when their PR adviser gives me a call saying, “Have you seen the news today?”
The shares are suspended while Darwen ‘considers‘ a reverse takeover, apparently of Optare, a bus manufacturer owned by Jamesstan - an investment vehicle run by the same Roy Stanley.
So what does this mean?
I asked Peter Temple, who’s written about Darwen on the Interactive Investor mothership recently, if it’s the classic reverse takeover where unlisted Optare would buy Darwen and get a controlling stake in the combined company and a listing on the stockmarket.
He said:
Not quite. That’s what it would mean if Darwen were simply a cash shell. In this case it’s not quite as simple as that. Both companies have ongoing businesses. Optare is probably larger than Darwen either in terms of turnover or assets - at least it is in terms of historic numbers though possibly not prospectively. The LSE would deem it a reverse takeover (a listed company taking over a larger - usually unlisted - one for shares) in circumstances like this. It’s purely a relative size thing based on historic numbers.
Change of control, though usually associated with reverse takeovers, is a separate issue. Normally shares are issued to the vendor that leave them controlling the merged entity. Since Roy Stanley owns Optare he is going to end up with a much bigger stake in Darwen, but he’s the prime mover in both companies anyway so there isn’t really any effective change of control.
As well as being chairman of Darwen, Mr Stanley is chairman of Tanfield (TAN). Tanfield has been a stockmarket superstar ever since it took took over Smith Electric Vehicles in 2004, though it’s fallen back a bit lately.
Mr Stanley fashioned Darwen last year out of a struggling coach builder and a design company, and intends it to become a leading bus manufacturer and a developer of hybrid low-emission diesel-electric buses and coaches. The recurring clean energy, and turnaround themes are not lost on investors.
Hopefully I’ll get my interviews next week, and we’ll see if Darwen/Optare has taken another step in that direction.
Rewriting the Financial Stability Report (or the credit boom in a nutshell…)
Posted on May 1, 2008 by Richard Beddard
Filed Under Investing | Leave a Comment
A prolonged period of overextension…
For a number of years, low interest rates and benign global economic conditions encouraged higher risk-taking by investors and increased borrowing in parts of the household and corporate sectors. Strong demand for financial services and mark-to-market gains from rising asset prices boosted profitability at financial institutions and stimulated further expansion of activity, including innovation in markets such as structured credit. Financial markets provided a plentiful source of funding for growing balance sheets.
A concise summary, but I’m not sure about the order of the words. It subordinates the actions of the participants in the credit boom to the broad economic trends. I think reordering the words makes the participants more culpable:
A prolonged period of overextension….
For a number of years investors took higher risks and householders and companies borrowed more money without considering whether those risks would be manageable, and those debts affordable, should the benign economic conditions of previous years come to an end. The banks that created the money borrowed by investors, householders and companies made big profits innovating structured debt products and revaluing their own assets at higher ‘mark to market’ prices.
And I question the use of some of the words, and the necessity of some of the jargon. “Innovation“, has a positive connotation that is inappropriate now the banks are writing down the value of billions of dollars of structured credit.
So here’s another attempt:
A prolonged period of overextension…
For years investors took high risks and households borrowed excessively without considering what would happen if the economy slowed down. Meanwhile shortsighted banks created the money and boosted their own profits by repackaging risky debt as safe debt and valuing it at inflated market prices. This only worked, however, until borrowers started defaulting on the debt.
Of course, its not comprehensive and we know the story well, but, all I’m saying is, as the Bank wants to help the public and financial firms prepare and manage for financial crises, it could speak with a clearer voice. Then perhaps it would be more difficult for bankers and borrowers to say, “We didn’t see it coming.”
Fake boob scandal rocks iBall
Posted on April 28, 2008 by Richard Beddard
Filed Under Ramblings | Leave a Comment
As regular readers know, when I’m not writing this blog, or editing the Interactive Investor mothership, or writing my Moneywise columns (or eating Swedish Meatball Wraps at Pret-a-Manger), I’m writing scripts for iBall.
It’s a lot of fun, though sadly with success comes money and ambition and the iBall team has moved out of our basement to film the shows in a swanky studio somewhere*1. For much of the day I’m alone at a bank of desks waiting to hear about their triumphs collaring unsuspecting members of the public on the streets of London.
They don’t even ask me to make props at lunchtime any more (I made the witches hat in this episode - they’ll never take that away from me).
Anyway, as Steve, our commandant-in-chief and very occasional blogger reminded me last week (when he oh so delicately suggested I share news of iBall’s 100th episode with readers), six months ago iBall was just a concept. Now it’s a badly executed concept.
No, seriously, it’s a premium piece of internet TV. We’ve learnt a lot, and it’s not just the props that are better. Compare today’s episode on British Airways, with one of the very early ones. Or take a look at the Kingfisher episode - it has a cult following, although maybe not for the right reasons.
Here’s Rupert, iBall’s fixer:
My first recollection of Rupert is walking into the office a month or so ago to find somebody new in Mike (Unilever Man) Langdon’s seat. Rupert was on the ‘phone when I first heard him speak, trying to ’source’ a pair of ‘fake boobs‘.
I think he only managed to get one boob, but they’ve made good use of it.
Anyway, Rupert’s with with my main source of companionship in this photo. It’s an oil drum he bought, but can’t get rid of.
Footnotes:
- I’ve never been there
- Steve doesn’t just make the news, he is the news. Watch him congratulate everyone except the script writers in i2i. Strike anyone?
On bankers winning beauty contests
Posted on April 28, 2008 by Richard Beddard
Filed Under Investing | 10 Comments
Your article reminds me of James Montier’s idea that investment performance is not based on what is true and not based on what you believe to be true but is based on what the majority of other people believe to be true…
James Montier*1 nicked the idea from John Maynard Keynes.
Keynes compared professional investing in the stockmarket to a newspaper beauty contest (I suppose it would be on Facebook these days) in which the contestants pick the six prettiest faces. The winner is the person who makes the closest selection compared to the average for all contestants.
So the challenge isn’t to pick the faces you think are prettiest, or even the faces you think average opinion says are prettiest, but the faces you anticipate average opinion expects the average opinion to choose or some iteration beyond that!
In other words, professional investors are more interested in gaming the market than buying shares in sound companies with good prospects.
The point they both make, though, is this game of speculation is risky. It means buying popular but expensive stocks and selling before they become unpopular - or ‘the greater fool theory’ (there will always be someone prepared to pay more “for the bad, or depreciating, half crown” as Keynes said).
While that’s the way the game is played, Mr Montier says its very hard to win. So when you say “investment performance”, I hope you don’t mean “good long-term investment performance”, because I’m sure Mr Montier, and Mr Keynes, wouldn’t agree.
I was thinking of the recent out-performance by banks and trying to work out why it is happening.
I confess, I didn’t realise banks were beating the market.
Banks may be a good investment simply because people believe that they will not be allowed to fail by the governments.
In addition they are able to access a lot of extra liquidity in exchange for their safest assets. It is highly unlikely they will reduce the cost of mortgages using this liquidity (which is a good money spinner for them) and much more likely that they will use it to invest in the stock market in better performing assets.
The US job data is still quite strong and corporate earnings is still strong enough to support the jobs. This may reflect a similar situation in the UK. Jobs mean that people can continue to repay their mortgages.
Even if the Banks have to cut their dividends in half later in the year, they will still yield a reasonable amount.
If the number of write-downs turns out to be too high (because people can keep paying their mortgage) then the banks will be able to undo those write-downs later in the year.
All in all, it seems a fairly safe investment.
That may be what investors think. Or what they think, other investors think…
But there’s plenty of punditry around to the contrary. You know; the American economy is already in a recession that will precipitate a global slowdown, prices are rising, it will take years not months for bad debt to work its way out of economies, and there will be more write-downs to come. Governments will intervene to save banks, but:
- Events at Northern Rock and Bear Stearns show they’re not interested in bailing-out investors, and…
- Would they be able to prevent a number of banks going down simultaneously?
It’s fun to debate, but I don’t think such speculation helps - most of it should be written off quicker than a brace of sub-prime mortgages.
The alternative is not to look at banks as participants in a beauty contest, but dispassionately as business for sale at a price (if you’ve been following this discussion, you know I don’t think they’re cheap enough).
Finally, if you do not invest in equities now then you are going to be absolutely hammered by the massive global inflation which is going to hit us over the next few years with all these extra dollars and pounds in the system.
We’re back in the speculation game again there, but I agree, as long as capitalism isn’t doomed, equities are a good long-term investment (and if capitalism is about to end, there are probably other things that require our attention more urgently than our share portfolios).
The question is, which equities? The ones that are winning the popularity contest now? Or the ones that aren’t even in it? It’s one of the great divides in investing; do you follow the herd or seek comfort in obscurity?
This is the story so now you have to try and pick it apart to see where it all goes wrong
Well, I tried! What do you think Robin (or anybody else)?
Footnotes:
- See Chapter 13. ‘Who’s a Pretty Boy Then? Or Beauty Contests, Rationality and Greater Fools’, in Behavioural Investing by James Montier (reviewed here, on sale here).
When a bargain’s not a bargain
Posted on April 28, 2008 by Richard Beddard
Filed Under Investing | 2 Comments
…we really don’t know which financial companies will survive the deleveraging, by the time share dilution is done they won’t resemble anything like they were before, and their level of historical profits weren’t based on any thing sustainable. My gut feeling is that about half the profits will never come back, or at least won’t come back while the Great Deleveraging lives in memories*1.
She’s right, we don’t know. More banks could go under. On the positive side, I don’t even know if there is going to be a ‘Great Deleveraging’, if that means levels of debt are so unsustainable, banks will have much less opportunity to profit from it for many years to come.
I think there are three rational strategies for value investors, sensing opportunity because bank shares have fallen so far in price:
- Don’t. They’re not cheap enough, and they’re too hot. That’s my current view.
- Establish which banks will survive. I’m tempted to try, though it’s tricky, and…
- …Wait to see if prices drop so low the shares are unequivocally cheap.
In fact, they all go together. You want a bank that can survive an awful storm in the credit markets trading at a ridiculously low multiple of its average earnings over the last decade or so.
That way it really doesn’t matter if only half the profits come back. The shares would still be an utter bargain.
Footnotes:
- Deborah also comments here.
Value investor not conservative enough
Posted on April 26, 2008 by Richard Beddard
Filed Under Investing | 3 Comments
The companies at the top of the list are selling for a low price relative to what their histories suggest they should be earning in the future. Now, typically, they’re not earning what their histories suggest, which is why they are at the top of the list. Something has gone wrong, and the stock price has gotten killed. So now you have basically three questions to answer: Is the business any good? Are the problems temporary or permanent? Is it rational to expect that the earnings will return back to that historic trend? We spend all our time trying to answer those three questions. That is the hard part. It’s easy to do the screen, to come up with a list of companies.
His style is very similar to one I favour, I’ve plucked this explanation from a comment I left on Graeme’s Moneyterms blog:
I would say my own method is 80% mechanical. I search for stocks that have low long term PEs, high interest cover and cashflow roughly equaling or exceeding earnings over the long term. Then I rank them and look among the low pe shares for companies that are in businesses that are still relevant. Judgement only comes into the last bit.
Mr Pzena’s down 38%, in twelve months - undone by a premature foray into financials. I’m not sure how many years of a company’s historic earnings Pzena uses, but in the UK I reckon banks are not cheap enough - relative to their nine year earnings histories.
On this occasion, I don’t think he was conservative enough.
Four reasons banks aren’t cheap enough
Posted on April 24, 2008 by Richard Beddard
Filed Under Companies, Markets, Investing | 25 Comments
Weighing in on bank valuations again, here are four fundamental reasons why I ‘m not buying banks: Price, profits, cashflow, and deposits.
The long-term price earnings ratio is my preferred measure of value. I take the average of up to nine years of earnings and divide it into the current share price. Using the average of a large number of years ensures a very good, or very poor, year last year does not misguide us.
This is how the banks rank out of 1192 shares with more than five years of earnings (Long Term PE is in brackets):
Rank
155 (6) Bradford & Bingley (BB-)
201 (7) Alliance and Leicester (AL-)
221 (8) HBOS (HBOS)
256 (8) Royal Bank of Scotland (RBS)
294 (9) Allied Irish Banks (ALBK)
297 (10) Bank of Ireland (BKIR)
309 (10) Lloyds TSB (LLOY)
339 (11) Irish Life & Permanent (IPM)
345 (11) Barclays (BARC)
494 (15) HSBC (HSBA) (iBall)
566 (17) Anglo Irish Bank (ANGL)
784 (27) Standard Chartered (STAN)
For comparison, here are some companies*1 that are cheaper, by this measure.
73 (3) SCS Upholstery (SUY) (blog) (iBall)
113 (5) Johnston Press (JPR) (blog) (iBall)
148 (6) DSG International (DSGI)
The other reason I’m not keen on banks, is their accounting. Normally when I use a company’s earnings as a measure of value I like to check that, long-term, its cashflows - the actual money the company makes as opposed to its accounting profit - roughly equals or exceeds its profits.
But banks don’t report cashflow. And as we are discovering their accounting - off, and on balance sheet - is complex and not widely understood. Even by the banks themselves sometimes.
There might be a time when I’d consider banks, but they’d have to be dirt-cheap.
Soc Gen analyst and behavioural investing guru James Montier says:
A bargain basement way of valuing banks is to look at the ratio of market cap to deposits. In previous banking crises this has bottomed out around 3-4%. Outside of Japan, there are no banks priced in this range.
The quotes and table below are from a report he published on 10 April 2008.
Bringing us back from the blizzard of numbers, and into the real world of rights issues and bailouts, he says:
…it is worth noting that in Japan in the wake of the bubble bursting, the banks had to keep returning to the market time and time again to recapitalise, as wave after wave of corporate insolvency washed through the system, driven by ongoing deflation. Even if the US manages to avoid following the Japanese template, the current round of recapitalisations is unlikely to be the last. Investors may need deep pockets indeed!
Mind you, languishing at the top of my list, and the bottom of James’, is Bradford & Bingley*2. Of all the banks, it could be the one to watch, although it hasn’t ruled out a rights issue and trouble in the housing market could mean big trouble for the mortgage lender.
Other views:
Looking back at previous non-systemic tension in the banking sector they conclude that market indicators (share price slump, steeper yield curves and wider credit spreads) would suggest a buy, but real world measures (i.e defaults) suggest it is still to early. If you must go back in stick with the US concludes Citi, where recapitalisations have run further and the central bank has moved more aggressively.
Whitney Tilson, US Value Investor, on Bloomberg:
The fundamentals… indicate we’re in the third inning of a nine inning game here, and investors are pricing stocks as if we are in the ninth inning.
Video:
[Via Todd Sullivan’s Value Plays]
Footnotes:
- I own shares in SCS Upholstery
- Edmond Jackson made Bradford & Bingley a stock to watch last October.
