Consulting » Getting down to value.

Getting down to value.

The FTSE-100 has fallen by almost a fifth over the past year as confidence has drained away and investors return to old-fashioned measures, such as investing according to value.

TMT stocks are rallying slightly as we go to press. But this does not mean that sustained market recovery is around the corner. The FTSE-100 fell to 5551.6 on 19 March from a high of 6930.2 at the beginning of 2000. This drop of 19.89% is just short of the 20% fall that signals a bear market.

Bear markets are historically accompanied by social and political unrest. In 1973 political unrest in the Middle East, a banking collapse and miners’ strikes made prolonged downturn inevitable.

In marked contrast, UK unemployment is currently low, banks have cut interest rates and all is quiet on the eastern front. So why, then, are the markets at risk of emulating the fall of the early 70s, when equity prices went down, and down, and down – a 63% decline that wiped out 16 years of gains in a few months?

The slump of 2001 has less to do with politics, social upheaval and rising oil prices than with misplaced confidence in TMT stocks. During 2000, investors were happy to back concepts: page impressions and unproven technologies. Public relations was driving investment rather that old economy values.

Henry Bloget, Merrill Lynch’s internet analyst summed up the unorthodox approach to investment in January 2000. “Valuation is often not a helpful tool in determining when to sell hypergrowth stocks,” he said. The inference was that revolutionary technologies required revolutionary valuations. Inevitably, inflated prices clouded common sense.

So what in this current bearish period of “back to basics” constitutes a value investment? As Colin McLean, managing director of Scottish Value Management, says: “The value investment approach recognises that the fundamental value of a share is dependent on its long-term earning power.” Value investing involves researching the underlying value of a business through its balance sheet and trading accounts.

Nevertheless, a lot of investors are still making the same mistakes. “When a company’s value drops 90% it is still not necessarily cheap enough to invest in,” says McLean. “A further 5% fall will in fact constitute a 50% fall. We have seen investors get burnt in this way recently. Investors have still not begun to recognise real value.”

Even old economy stocks can be risky. “Value investors tend to focus on cyclicals, such as Corus, ICI, and Pilkington. These companies are fake-defensives – they carry false value. A year ago Corus was three times its current price. These companies are not worth investing in at this low point in the cycle,” says McLean.

He believes that in this time of global economic slowdown all companies will have difficulty encouraging investment.

“There are a lack of safe havens for investment,” he says. “Even though stocks like Pilkington look quite low rated, value investors need to have a bit of growth orientation and look beyond the numbers. Going for something with a low multiple right now could be dangerous.”

When the bear comes out of hibernation all investments have a habit of biting back. The warning signs are there: Do Not Feed The Animals.

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