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The six cheapest shares in the market
Posted on August 14, 2007 by Richard Beddard
Filed Under Companies, Investing, Naked PE |
Dr Keith Anderson reveals the six cheapest shares in the market according to the Naked PER, a measure that promises superior returns.
This is the third of our quarterly updates on the cheapest six shares on the market, measured using the Naked Price Earnings ratio, and calculated by Dr Keith Anderson. The gist of Dr Anderson’s research is that the Naked PE, which takes into account a company’s size, industry, and past profitability, is a better predictor of returns than the venerable Price Earnings Ratio*1 and 2.
Here are his latest selections:
Avis Europe, Wagon and SMG are all new entries in the table, although SMG has featured in it before. Of the three, Dr Anderson, reckons Avis Europe is the most interesting. He says:
“Avis are down considerably recently at 48p, but are no lower than they were during 2005. They seem to me to be worth considering further, since in 2000 and 2001 they earned around 12p per share. The one really counter-intuitive result from my PhD work was that calculating the PE by dividing the price today by the one-year earnings from seven or eight years ago gives a better predictor of returns than the traditional PE.”
Why should that be? Dr Anderson’s hunch is it has to do with the fact, demonstrated in research*3, that investors tend to overreact to bad news, for example temporarily depressed earnings, hence the need to use a longer run out of data to calculate the PE ratio. The proviso is, of course, that earnings recover.
That was not the case with two of last May’s six cheapest stocks. Following their appearance in the table, MICE and Interlink foods promptly went into administration. Assuming 100% loss for those two companies, the portfolio of six stocks with the lowest Naked PEs in May has returned -41% since. For two of the six to go bust, is unprecedented, says Dr Anderson:
“It’s very rare for companies with such a long history of positive earnings to go bust. The only one that occurs to me from my testing, off-hand, was Polly Peck, when they were telling lies about the earnings. There’s not much you can do about that.”
He tested the returns from a portfolio of six stocks with the lowest Naked PE ratios, rebalanced every year over 29 years to arrive at an average return of 39%. The portfolio only fell in value in two of those years, and the biggest annual loss was 20%. We’ll check back in May 2008 to see if the May 2007 portfolio sets a new and unwelcome benchmark.
SMG and Wagon’s shares have fallen sharply and, as he did with Mice and Interlink Foods, Dr Anderson urges caution. When using the Naked PE to inform his personal trading strategy*4, he prefers to wait until he has confidence the share price has settled down, and that can take years*2.
Footnotes:
Dr Anderson updates his table of the cheapest six stocks on the market every three months, and we publish them. Previously:
- The cheapest six stocks on the market (February 2006). An explanation of the Naked Price Earnings Ratio used to select the stocks, with links to Dr Anderson’s research.
- Chasing 39% profit a year (May 2006). Back testing the performance of the Naked PE ratio yields impressive average returns, but Dr Anderson uses it selectively.
- Debondt and Thaler, 1985.
- Dr Anderson owns shares in Autologic and Vodafone.
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[...] is empirically bogus. Are the academics finally catching up with reality? Right after I wrote Monday’s blog, which didn’t take a swipe at behavioural investing but at the conclusion often drawn from [...]
[...] 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 [...]