Investing in the uninvestable
Posted on March 26, 2007 by Richard Beddard
Filed Under Investing |
British Energy ought to have been a blip on most value-oriented investors’ radars recently. It certainly ghosted across mine in February when its price hovered above 400p, its historical price to earnings ratio (PER) was below 5 and the company promised a big dividend payout. But the more I looked at British Energy, the less confident I became. As Britain’s only nuclear energy generator, it’s earnings are irrevocably tied to electricity prices. Then there’s the matter of the cash sweep…
Not having any insight into future electricity prices or British Energy’s funding, I didn’t go any further. It turns out I might have been looking at the company the wrong way. It’s one of the perks of being an editor that, when it’s in the wider readerships’ interest, you can ask another writer to follow up a story. So, when Edmond Jackson suggested British Energy as a candidate for his ‘Stock to Watch’ slot on our mother-ship, Interactive Investor, I took the opportunity to find out what might make British Energy investable.
We published Trading British Energy’s fortunes, this morning. I won’t repeat the four points Edmond makes, just one of them:
When a share is fundamentally hard to value, trends are more likely to influence its price. No one can be sure of electricity prices in the future. However, it does feel comfortable to be in the company of other investors thinking alike - whether it means buying or selling. An aspect of self-reinforcing bias can set in, where the trend feeds on itself, besides new information.
I took heart from that, and not just because I’m in good company in finding British Energy difficult to value. He also confirmed something that should be obvious to all investors. Certain companies suit certain types of analysis. British Energy and other companies that defy fundamental analysis, it seems, are for momentum investors. Not being one, I just deemed it uninvestable.
You can never learn too much from other people’s styles of investing. That’s why I answered Geoff Gannon’s questions. Geoff is publishing a series of ‘twenty questions’ with investment bloggers, most of them about our investing styles. If you read the interview you’ll see that I sift through over 4,000 shares for growth, income and recovery opportunities. It frustrates me that so many of the shares I come across are outwardly attractive but don’t, on more careful consideration, fit the growth, income or recovery templates I am comfortable with.
As an adventurous investor I want to spot the best opportunities in the market, not just the best opportunities in one category. It may be a while before I embrace momentum investing but I’m always seeking to broaden my approach. It seems precariously one-dimensional to wear your investing allegiance unthinkingly, like a footballing one, especially as investing styles go in and out of fashion (see: The fundamental flaw in value investing, and The periodic table of investment returns). This is recognised among sophisticated investors, even when they do stick to one style.
On Seeking Alpha Geoff Gannon, my interviewer, says:
It’s no secret that “value stocks” have outperformed in recent years. These are the conspicuously cheap stocks – the ones that knock you on the head and say “Look at my price-to-book ratio, look at my price-to-earnings ratio! Does it really matter what kind of business I am? I’m so cheap the only thing you need to know is that I can pay my bills on time.”
And sometimes that’s true. Sometimes, there’s a veritable feast of such conspicuously cheap stocks scattered across a variety of industries. By selecting a diverse group of stocks that share only their conspicuous cheapness and nothing else, an unimaginative investor can rack up solid returns during such times.
Today isn’t one of those times.
Later…
There’s a danger that otherwise intelligent investors will relax their standards or allow themselves to be blissfully ignorant of “price creep” – where a business that once would have been a bargain at six times earnings now begins to look attractive at 10 or 11 times earnings, even if it isn’t the kind of business you really want to be in. The desire to cast a wider net when confronted with a scarcity of the fish you know is natural; it’s also dangerous.
Like Geoff, I think it is dangerous to embrace mediocrity; companies that aren’t quite cheap or good enough when you apply your value criteria. But although I’m not casting a wider net by relaxing the rules that determine what fits my definition of a value stock, I’m also casting different nets. Although they’re a staple food, value shares are not the only fish in the sea.
Footnotes:
- There’s one comment on 20 Questions for Richard Beddard, but it’s the one I’d have hoped for: I think this is my favorite 20 Questions post. I found Richard’s answers very interesting because he didn’t fit a particular mold. I didn’t write it myself, honestly!
- Strictly it’s not a blog, but Old Media comes up with the goods sometimes. The Financial Times runs a series called ‘My Portfolio‘ in which celebrated investors describe their trades. It includes our own Peter Temple. I enjoy it and, unlike most of FT.com, it’s still free!
- Edmond sent me a clip from the Telegraph this morning. British Energy has been talking to other energy companies about building a new generation of nuclear power stations. Excerpt: “The key value of British Energy is its sites. It makes sense for the company to want as much competition for those sites as possible. Non-nuclear partners like Scottish & Southern would allow it to keep a bigger slice as they would need its nuclear expertise,” said one executive.
- Update! Just in from CXO Advisory Blog. Research shows that old-fashioned value investing still works, but it’s getting harder: Benjamin Graham-style value investing still works but is more difficult to execute than in the past because severe undervaluation has become rarer.
Comments
Leave a Reply
