UK Value Investor

Price/Book =0.43

I bought Titon Holdings (TON) today. They are a leading UK supplier of Ventilation Systems and Window Hardware.

Notable features were low debt, with current assets (9M) enough to pay of all liabilities (2.7M), leaving 6.3M and a current market cap of 3.1M. So you could buy the whole company, close it down and take the cash in the bank (almost 2M), sell all the stock and collect receivables and make a profit.

The share price has floated around 100p for the last decade, but since the credit crunch and related housing slowdown their share price has collapsed to around 30p. The only reason I can see for this looking at the company reports is that profits halved in the last year and general market sentiment against the housing related sectors.

The plan is to sit back and wait for the cycle to turn and/or management to make the required changes and sell out above 60p. If that hasn't happened in 5 years I'll sell up and move on.

The details were:

Titon Holdings bought at 33p, market cap 3.1M, PB 0.3

My share buying criteria are slowly taking shape, based on extensive back testing as reported in "What has worked in investing" by Tweedy, Browne Company LLC, plus some testing of my own using DigitalLook's Market Stars system and my reading of Ben Graham.

I'm a simple chap so I like simple rules. I start by sorting the FTSE all share plus the FTSE Fledgling indices by price/book. I select those in the bottom 10%. Then I sort those by market cap and select the smallest 10%. Then I exclude those with a dividend yield less than 1%. Finally I sort by price/book again. Basically this gives me small cheap shares that are still paying a dividend. Generally I don't like to buy shares with price/book over 0.5.

I started my toe dipping exercise into value investing this month. The plan is to start out light and only buy once a month or when I sell something. I want to hold up to 20 stocks and also use the sliding cash system I thought about last time where the cash % is twice the average PE of the market.

The general idea is to buy stocks from the FTSE All Share index which fall in the lowest 20% market cap of the bottom 10% price/book. So if there are 500 companies in the index then I pick the 50 with the lowest PB and then the smallest 10 of those by market cap.

Many previous studies have shown that these stocks can outperform the market over the next few years after purchase. The gist is that markets are not 100% efficient and that they over do the gloom on certain stocks or just don't value them fairly.

My sell signal will either be when the company reaches a price/book ratio of 1, or when I've held the stock for 5 years, whichever comes first.

This month I bought:

Pendragon at 8p, market cap 62M, PB 0.15. This is a car dealership network and it's been pretty beat up in this recession.

Ennstone at 16.47p, market cap 81M, PB 0.4. This is a construction and materials company and has not surprisingly lost a lot of value recently.

I want to run some back testing on a couple of value portfolios. They're both based on picking relatively small cap stocks with a low PB, preferably below 0.5.

The first portfolio holds the stock for a year and if the criteria are no longer met (cap too large or PB too high) I sell, otherwise I hold for another year.

The second method buys the same stocks but holds them until the PB reaches 1, regardless of cap. Will this outperform the first method or will I just end up holding a bunch of stocks that are going nowhere, i.e. never reach par? Only back testing and time will tell.

This could be mixed in with the sliding cash holding method of the last post, or I could just be strict with the criteria and if the market is overpriced then there won't be many if any stocks with a PB of 0.5... there certainly weren't many between 1999 and late 2001.

I had an idea today that I might do some back testing with. It's kind of a slant on MPT with a dynamic cash allocation. What if instead of having a fixed cash allocation of say 30% which you re-balance to each year, you instead use the p/e ratio of whatever indices you're invested in (S&P, FTSE100 etc) to determine that allocation?

Assuming a p/e of 14x is fair value, 7x is very cheap, 21x is very expensive and 28x is an insane bubble, what if you used double that number as the cash %? So each year, if say the FTSE100 had a p/e of 14x you'd set your cash allocation at 28%. If the p/e was 7x you'd have the cash allocation at 14% and if the p/e was 28x you'd have the cash allocation at 56%.

This seems reasonable at first glance since at 14x, 28% cash is a reasonable safe amount. At 7x the stock market is historically cheap (with a better than average probability of going up) and yields are high so you load up on it with only 14% cash. At 28x the stock market is historically very expensive (with a better than average probability of going down) with low yields so you don't want much exposure, i.e. 56% cash.

I think I'll do some back testing if possible and see what history says.

The UK and US economies are still heading for recession caused by the credit bust and high food and energy prices. The rest of the world is affected to greater or lesser degrees. So mainstream equities are a bad idea and today they went into bear market territory with 20% drops from the peak last October.

Oil is $146 so oil related stocks are still looking like the place to be. I don't see how that's going to change for the next few years, if not a decade. China and India are still growing, non OPEC supplies are still falling and demand still equals supply. If OPEC starts to decline in the next decade we're in for a hell of a rough time.

This only makes 'climate change' stocks and funds look more attractive since most of the responses are the same for peak oil and climate change. Fuel efficiency, renewable energy, electric cars, lightweight materials, insulation, energy efficiency, etc.

As things stand I might up the climate/renewable % of the fund to 20% from the current 10%.

Just to remind myself, the breakdown is currently:
cash 10%
renewables 10%
oil/gas related 30%
industrial mining 30%
gold miners 20%

I saw a nice chart that illustrated the point of following the long term trends. This ties in with Long Valuation Waves where the p/e of a mature market tends to ride up and down over a time scale of one or two decades. Last time I wrote about this I mentioned the roughly inverse correlation between energy consuming and producing companies. The 1965-1983 period was good to energy producers and inflation bets (gold), the 1983-2000 period was good for energy consumers since energy was cheap.

Another way to view these long cycles is that there is always a decade long bull in something. If you invested $35 in gold in 1970 it was worth $627 in 1980. Put that into the Nikkei until 1990 and it was worth $3,548. Put that into the nasdaq until 2000 and it would be worth $35,105. Finally stick that in oil and it's now worth $159,591.

Those weren't insanely hard trends to spot. Of course, you'd probably be hedged to some extent on a couple of major plays, but in general I still love this strategy. Currently I think the trend for the 2000-2010 period is oil/gold, although emerging markets have been a pretty handy place to be. I think the trend for the 2010-2020 period is likely to be renewable energy and energy efficiency, but again China could be useful. For 2020-2030 the trend may be back to consumption once a new global energy infrastructure is in place.