Valuing Companies and Value Investing

Some miners are binary trades – they will either resolve their issue or it is game over.  I think that some people can do very well out of commodity stocks, intellectual property stocks, technologies, biomedical companies etc. Unfortunately I also recognise that I’m not really one of those people. I’ve been fortunate to do well speculating or trading the upward momentum in HDY and RRR in 2009/2010, and RRL in early 2011, but I can’t see myself ever investing in that kind of project. (PXS also belongs on that list. I behaved like a fool and was lucky not to lose money – like with HDY, after making money on the “momentum up”, there was a fair bit of “momentum down” as the trend ended, if you know what I mean!).

I’m afraid the assets count for nothing once a company starts making profits. What’s the point of owning a company that only makes £1m profit from £100m assets if you can own a company making £2m profit from £50m of assets. Time and again oil speculators overvalue unprofitable companies on the basis of assets until the profits start coming in, and then the stock price drops or stagnates for a few years while return on investment takes over. They usually fall to a market cap of around 10x profits as per AFR. CEO will level out at about 10x next year’s profits. RKH will stagnate or drift down on placings until it makes a profit of about of around one tenth of market caps. Same tends to happen to unprofitable companies in other sectors – remember the talk of AVN and £28 per share because of their assets.

Give me a company that makes door handles, bits for speakers or radiator parts and I’m happy! Rather important day today, within a rather important week.

Value Investing in Terrible Times

In the very longest-run sense, a terrible economy in the present is exactly what you want, something akin to 2008, or 2000/2001. On that time horizon, you can be confident that so long as the world is still turning, you can effectively buy brilliant companies knowing you’re getting a good price. On that timescale, when anyone asks you about the economy you can say “I don’t care”, or if asked about the market say “It will fluctuate”, like the original J.P Morgan used to. You thank the market for giving you discounts, and avoid being flattered when it overvalues your business – but you act as the permanent owner of the company, without any regard for present market value.

On a slightly shorter time horizon where you might want to be in the market during bull cycles and out of them as they turn, you generally get a time period of about six months to a year to take advantage of major market mispricing, and you take the rough with the smooth inbetween. Fairly difficult, but not impossible. In this case, you pay more attention to the economy, but simply buy the dips until you can be sure the party is over.

Go a timescale further down and you’re at the peak of interest in the economy – you want to have consistently good years, a minimum number of bad months. Instead of accepting periods like late 2011, you attempt to avoid them by mitigating risk, “selling in May”, tactically changing your exposure to the market depending on the technical, economic and fundamental indicators. This is probably the most difficult ambition, into the region of hedge funds etc.

A timescale further down than that, and you have no worries about the economy at all, as your positions are open for an average of days rather than weeks or months. You use economic releases to take advantage of momentum in trades, but you look at the charts for guidance rather than fundamentals or the economy – you can make money in good times and bad, so long as you’re on the right side of the trade.

So it goes full circle – investing over decades and you don’t care what today’s economy looks like, the worse the better as you can reinvest or allocate more income to stocks at low prices without a care. Day trading and again there’s no worry about the economy – you just take advantage of what the market is indicating. You can be successful on any time horizon if you’re talented in that field or depending on personality – the forward-looking economy is only materially important if your time horizon is relevant to it. (so guys like Warren Buffett, and at the day trading timescale guys like Dave88 don’t need to worry at all about economic analysis other than for context!).

Note: Dividend reinvestment is absolutely key to growing your pot, have a look at companies who have consistently paid a dividend without a miss over a long period say 5 but preferably 10 years and preferably those who progressively increase it, try to look at dividend cover of at least 2, avoid companies whose dividend yield looks good because their share price has taken a hit because they are in trouble, it is good to have some of these elephants in the portfolio, dividend yield can help mitigate drawdown over longer timeframes.