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Tailored for investment professionals this site provides information on our products, strategies and services. Please remember capital is at risk and past performance is not a guide to the future. We use cookies to ensure that we give you the best experience on our website. This includes cookies from third parties. Such third party cookies may track your use of our website. By continuing you are confirming that you are happy to receive all cookies on our website. Please refer to our Cookie Policy for further information, including steps to take to disable cookies.

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Notes and musings from a Value investor

In or out of favour?

25 June 2019
Author: Alastair MundyPortfolio Manager

We can often detect a discernible hint of curiosity from clients when we mention that our list of out-of-favour stocks has grown significantly in size. What new fish are swimming in our pool? There is a sense that they are expecting news of some outrageously high-quality stocks available at bargain prices. Sadly, on seeing the constituents of our ‘naïve’ out-of-favour screen, client curiosity quickly changes to something closer to polite disgust.

Their sentiment is understandable, but in a way completely predictable. The reality is that companies can only be truly out-of-favour if investors have very genuine concerns about their futures. If an investor thinks they have discovered a ‘gimme’ it is often because they have not fully embraced and understood the fears of others.

This visceral reaction to names on the list reflects a natural reaction to overweight the recent past when assessing the future – recency bias at work. And the more vivid the recent past, the harder it probably is to conceive of a vastly different future. For example, what’s your immediate reaction when considering the future of Royal Mail, M&S, ITV, BT, Thomas Cook, Kier and Capita? Unless you are the most bloody-minded of contrarians, the answer is unlikely to be particularly positive.

However, things do change. And one way of illustrating this is to look back at when some of the current underperformers (which thankfully we managed to avoid) were flying high.

For example, when Provident Financial’s share price was peaking at the end of 2015, an investment bank described it as a “safe place to hide” with a forward price earnings ratio of 20x. Similarly, Capita was described as a “relatively safe haven in a stormy market” as it peaked in the autumn of 2015 with a forecast price/earnings (P/E) ratio of almost 17x. Kier at its peak in 2015 was also a place to “shelter from the storm” with a prospective P/E of 15.9x. Even Royal Mail climbed to a forward P/E of 11.5x ratio at its peak in 2016 when there was “improved visibility on wages and regulations”.

These examples are not designed to embarrass anyone – we all have our own catalogue of mistakes – but simply to illustrate how facts (earnings) and views (the valuation put on those earnings) can change. In all these cases (and, yes, we are guilty of picking winners that developed into losers, but that is after all what our screen is designed to highlight) investors discovered they were applying high ratings to high earnings numbers. A very dangerous cocktail.

Obviously, our challenge is to ascertain which companies on our watch list are most likely to have futures significantly different from their recent past and provide investors with the beautiful combination of higher earnings priced at a higher valuation. Often – depressingly often – it is correct to extrapolate current trends, but experience tells us that hidden among the rubbish are some real gems doing their very best to look like rubbish.

 

Past performance is not a reliable indicator of future results and all investments carry the risk of capital loss.

No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided. 

Alastair Mundy
Alastair Mundy Portfolio Manager

Important information

This communication is provided for general information only should not be construed as advice.

This is not a buy, sell or hold recommendation for any particular security. 

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Investec Asset Management.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

All rights reserved. Issued by Investec Asset Management, issued June 2019.

The content of this page is intended for investment professionals only and should not be relied upon by anyone else

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