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The cheapest six shares on the market #5

Posted on February 13, 2008 by Richard Beddard
Filed Under Naked PE, Companies, Investing |

Dr Keith Anderson scans the whole market for the cheapest six stocks based on their size, industry and long-term earnings power.

It’s time for Dr Keith Anderson’s quarterly selection of the cheapest six shares on the market.

I’ve explained the maths behind the selection process before*1 but, to summarise, Keith adjusts the price earnings ratio to improve its predictive power.

He adjusts for the company’s size, long-term earning power, and industry. It’s something many investors do, but not scientifically across the entire UK stock market.

Here are February’s selections:

The six cheapest stocks on the market, Feb 2008

These shares have one thing in common. Their prices have fallen dramatically, which is why the ratio of price to long-term earnings is low. To see how dramatically, take a look at these charts: Johnson Service (JSG), Regent Inns (REG), SCS Upholstery (SUY), SMG (SMG), International Greetings (IGR), Autologic (ALG).

Such calamitous falls occur when investors are deeply pessimistic about future profits, probably because the company is in difficulty or going through a lean spell. Typically, such companies recover, though, and that’s why Keith’s so interested in them.

He’s so interested, he wrote his PhD thesis on the Naked PE ratio. He calculated that, by buying the six cheapest stocks in 1975, selling them after a year, and buying the new six cheapest stocks every year until 2004, an investor would have made an average return of 39% a year.

But backtesting is one thing, investing is another. And Keith doesn’t recommend investors trade the six cheapest stocks blindly. As I explained in this article, he waits for signs of recovery before buy shares in companies with low Naked PEs.

Which is just as well because it’s a year since I first published Keith’s six cheapest shares on this blog, and this is how they fared:

Watermark: -51%
MICE: -100%
Invensys: -17%
Vodafone: +21% (including dividend)
Autologic: -42%
Ferraris (now Bionostics): +51%

To say it was a bad year to introduce investors to the Naked PE, is an understatement. A loss of 22.6% is worse than the worst result in Keith’s 29 years of testing six stock portfolios. The previous worst was 20% - one of only two negative years between 1975 and 2004. It tells us:

Apart from Vodafone and Ferraris (now Bionostics) on last year’s list, Wagon has graduated from last quarter’s list. It’s up from 22p to 33p, and currently in seventh position.

Footnotes:

  1. For a more complete explanation see The cheapest six stocks on the market #1
  2. For more information about the Naked PE including Dr Anderson’s research pages, see his Improving the PE site
  3. Previous articles on the Naked PE.

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