The cheapest six stocks on the market
Posted on May 27, 2009 by Richard Beddard
Filed Under Companies, Naked PE |
In practice:
160% in six months ain’t bad
For the first time since February 2007, I’m starting our quarterly exercise in bottom fishing, ‘the cheapest six stocks on the market’, with good, even spectacular, news.
Each quarter Dr Keith Anderson, of the University of York, calculates the cheapest six stocks on the market using the Naked PE ratio he invented, (this month’s list is at the end of this post).
Last February’s portfolio is up! So is the previous November’s. In fact they’re not just up, most of the companies have doubled, or tripled in value. At least.
If you’d plunged £6,000 into the six cheapest stocks in November, which is not to be recommended for reasons that will become apparent, you’d have nearly £16,000 now.
Taylor Wimpey has more than quadrupled from a purchase price of 7p in November to around 33p and the worst performer in the November portfolio, Johnson Service, is up nearly 50%.
There’s only one loser in February’s portfolio, STV, down 23% a small loss when you consider Johnson Service and Johnston Press have nearly tripled in price.
These were the media companies and house builders with cyclical businesses and big debts hit hardest by the credit crisis and recession. Investors questioned their survival but now, judging by the improvement in the market this spring, they think the recession will be more benign than the depression we feared then.
Since the once dire prospects of these companies have improved most, they’ve rallied furthest.
But, despite the successes of the last six months, the bear market of 2007 and 2008 has been catastrophic for the Naked PE, which up until then had an extraordinary record predicting higher share prices. Of the 21 companies that appear in Keith’s portfolios, four have delisted, or are in the process of delisting, leaving investors with nothing.
If an investor had invested £1,000 in each Naked PE share, each time Keith included it in a portfolio, the table above shows how she’d have done, assuming no sales and £15 in charges and tax for each trade.
It’s a hypothetical exercise, Keith doesn’t use the Naked PE this way, and doesn’t recommend we do either, but the table does, I think, illustrate events so far.
As well as the four failures, four other companies have made losses of 70 to 85% on the average price our hypothetical investor would have paid. Many would regard those as failures too. Certainly they’re unlikely to recover those losses completely for a long time.
Seven of the 21 companies are in profit.
The recent bear market has exposed a flaw in the Naked PE. When share prices are pushed to extremes, it’s too quick to indicate a company is cheap. The old adage, that a share can always get cheaper, holds true. A company can also go bust. Keith says:
The naked PE tells you when a share is cheap, not necessarily when to buy it… [That’s] why I always use the log charts option on Interactive Investor. It gives a much better idea that even if a share has lost 90% already, it can still lose a lot more.
To protect the picks in his own portfolio from that fate Keith monitors the old lists, looking for evidence the company is surviving (if it’s still listed after two years, it’s a good sign) and the price is recovering (it’s moved up through its 50 week moving average). He caught Taylor Wimpey, DSG and Journey earlier in the year but missed out on Barratt at 110p. He says:
I should have bought when they went up through the MA [moving average) at about 110p… That’s what comes of not trawling through the charts in my watch list regularly enough.
I’m toying with a different approach. Joseph Piotroski demonstrated that of all distressed companies, those with the strongest finances are most likely to turn around. I think we could improve returns by marrying strong companies with a high F_Score, his measure of financial strength, to low Naked PE’s. Piotroski concluded that companies are likely to be stronger coming out of a slump, than going into one, so the F_Score could be an aid in timing when to buy one of the cheapest stocks on the market.
The F_Scores in the table are from Sharelockholmes.com, and indicate that STV, Vodafone and Johnston Press merit attention.
Here’s this month’s table (as of 10 May). As usual, Keith is most sceptical about the new entries. Dawson, which distributes newspapers, has lost two contracts recently and Pubs ‘N’ Bars is tiny. The market values the whole company at under £2m.
In the case of the Naked PE, it’s the old lists that are most interesting.
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The bid’s off at Carluccio’s (CARL), an expanding restaurant chain with solid looking finances. On a six-year PE of 18, I think it’s still a bit pricey for safety-first investors, though.
In theory:
Growth v Value, it really isn’t a fair fight.
Over the past forty years, firms with low asset growth have returned 20% more than firms with high asset growth reports Empirical Finance Research Blog. A new Paper by Michael Cooper, Huseying Gulen and Michael Schill of various American universities concludes that low-growth companies aren’t as risky as investors think (and, presumably, rapidly growing companies are riskier).
Meanwhile, there’s some good news about short-sellers for a change. Even those who don’t short can profit, just by investing in shares the shorters are avoiding. CXO Advisory’s blog reports on a study by Ekkehart Boehmer, Zsuzsa Huszar and Bradford Jordan, also of various American business schools.
Star Trek script writer, and lecturer in randomness, Leonard Mlodinow says it’s possible to decrease the odds of bad outcomes, but that doesn’t mean they won’t occur. He’s talking about cancer, but he could be talking about investing.
Pension Insurance Corporation may have the money to buy out company pension funds, but judging by its pursuit of rival, Paternoster, many others are running short of capital.
James Kwak of The Baseline Scenario, says that when an industry innovates, a few innovators profit and lots of customers benefit through competition. By contrast the financial industry innovated but refused to compete on costs and price.
How Google ended up in the auction business (Wired).
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Richard,
Your combination of the Naked PE and Piotroski’s F-Score looks like a great idea. It would be very interesting to see a “backtest” of the two of them used in combination, similar to the table you did in this post showing the results of using the Naked PE alone. It would be quite interesting if adding the F-Score turns out to have materially improved the results. Any chance you’ll do this in a new post?
Hi Jim, I’m glad you think so
I have actually been talking to Keith Anderson, who computes the Naked PE about this subject, and I think he’d like to do it sometime (but he’s very busy).
I sometimes publish lists of low long-term PE/high f_score shares using data from Sharelockholmes.com. I believe the site has a backtesting facility, though I’ve never used it.
So it ought to be relatively easy to test a very similar strategy (the long-term pe is an important component of the Naked PE). I’ll have a play sometime (you can too - it’s not expensive).