Good companies going cheap
Posted on September 12, 2007 by Richard Beddard
Filed Under Companies |
Although I detest screening, because it’s a way to accidentally screen out perfectly good stocks, I’m reverting to a screen of sorts to help me find companies to invest in. Recently I’ve been cycling through the whole market (described in this interview), but I just don’t have the time any more. Fortunately there is a half-way house, and the process I’ve resurrected is a ranking system. I take:
- the price earnings ratio as valuation measure (is the share cheap?)
- the return on capital employed as a measure of how profitable it is (is it a good company?), and…
- the interest cover as a measure of how indebted it is.
I export this information from a popular stockpicking program and rank each company. Stocks with low PEs, high ROCEs and high interest cover get the best rankings. It sounds complex but actually it’s a rough and ready technique and takes about 15 minutes.
Highly ranked companies, I believe, are more likely to be good companies at cheap prices (i.e. value shares) than a random selection of stocks. All the companies I might be interested in are there, none are screened out. They’re just presented in a priority order.
I scan the list, paying progressively less attention to those further down. Sharing the list would be futile because it’s full of rubbish. It’s just the first stage in my stock selection process. The number one stock is not automatically a ‘buy’, like it would be in a mechanical stock picking system.
The next stage is to note down companies that catch my eye. I’ll share some of those, but it’s very important to understand that I’ve not yet checked the numbers, or looked in detail at the company’s financial statements. This is like a page torn out of my notebook. It’s not of any use to an investor seeking to be told what shares to invest in, though it might be a source of ideas, inspiration, agreement or disagreement for other investors who do their own research.
Something small: According to my rough-and-ready screen, office2office is a profitable company going cheap. Although it’s restructuring, on 4 September it reported headline profits and revenues up slightly on the first half of last year and it seems to have reassured investors following a summer sell-off. Apparently office2office is on a PE ratio of 9 and a dividend yield of 5%. The chairman and chief executive bought £21,000 of stocks between them on results day, and despite the cheesy name, I think its worth digging out the annual report to see if it really is, as they seem to believe, a good company going cheap.
Actually, a cheesy name and boring business (office supplies) are both positive signs in the topsy-turvy world of value investing. Legendary fund manager Peter Lynch thinks these are factors that turn other investors off, thereby driving prices down until they can no longer ignore the fundamentals (i.e profits). Sadly ridiculous names didn’t stop companies taking off in the dot.com boom, though.
Moathunter spotted the good fundamentals, but he thinks they only reflect the past. It’s a risk to bear in mind when reading the company’s reports.
Something big: Astra Zeneca’s looking so cheap it might tempt me out of my smaller company mindset. Statistical work shows that smaller companies perform better, but that doesn’t mean that goliaths never do well and Astra Zeneca is conspicuously higher in my list than any other mega cap. I confess, you could fit what I know about big pharma in a syringe, but maybe it’s time to learn.
A cursory glance at the data (mine goes back to 1994) shows a PE of 12 (its lowest in that period) and a dividend yield of about 3.5% (the highest). It appears to have more cash than debt and earns a consistently high return on capital. That sounds like a good company going cheap. Presumably competition from low cost out of patent drug manufacturers is weighing on investor’s minds, and they’re wondering when the next exclusive fully patented blockbuster drugs are coming. It’s hard to see demand for drugs in general going into decline, though, so the lower the price goes, the more attractive it gets. That’s the theory, anyway.
One that got away. Manganese Bronze, manufacturer of the London black taxi, was once high on my list of potentially good companies going cheap. Today it’s ranked 864, and, according to the data, its PE ratio is 161 (I’d have about 10 in mind). Maybe innate scepticism of China hype deterred me, but Manganese shares have risen from a low of 50p in 2002 to £8.15 yesterday.
Manganese is planning to build and export cheap taxis from China. Speculators must be anticipating the colonisation of the world’s taxi ranks, but at its current price, I can think of at least 863 reasons it might be better to look elsewhere now. A member in the Interactive Investor discussion would rather buy BMW. It’s not on my list, but he sounds persuasive.
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[...] of it’s low price earnings ratio, Fonebak is high in my list of good companies going cheap. But I’m not sure it really is a good company. Its a very different company to the one that [...]
I am looking for a several china stocks that are below the $10 mark. I dont care about how volitile. I would appreciate any investor advice and the reasons behind your thoughts.
Jason Merkel