Don’t fall into a value hole
There is still plenty of time
THE VALUE HOLE, a thing that’s more dangerous than any of the black holes in the universe, attracts investors during a bear market. Then it eats holes in your portfolio and the temptation is usually so great that most investors – even those with a few years of experience – then pour more money into the hole.
The main features of the value hole are the extremely attractive earnings multiples at which the shares trade. Those attractive PEs are often supported by excellent dividend yields – and then the widows and orphans also fall into the value hole.
Well-known Professor Jeremy Siegel again recently praised the attractiveness of ordinary shares on nearly all share markets worldwide. In the table based on his research, Siegel shows shares worldwide are currently trading at very attractive PEs. He uses the projected profit for 2008 for his calculations. There’s no doubt the PEs really are attractive. Investors who like the more understandable percentages should calculate back from the ratios to a percentage.
Take the S&P 500 as an example. It represents the 500 top shares in the US. The forward PE for 2008 is 11,7. Converted to a percentage, that’s a profit return of 8,5%/ year. That should also be the minimum combined return an investor receives in dividend income and capital growth from an investment in the index per year.
That’s streets better than the best interest return of about 2,5% to 3% an investor can now earn from so-called safe US Treasury bonds. And the capital value of bonds can never increase much, while share prices can sometimes double.
That’s the first value hole. The US Treasury guarantees the interest on Treasury bonds; the profit and dividends of even the best companies can suddenly dry up. There have been quite a few unexpected examples this year.
Value hole number two is the argument by Siegel and many others that PEs are currently far more attractive than the average of the past 10, 50 or even 100 years. What they forget is that the world economy is currently in a far worse state than in the past 10, 50 or even 100 years. Yes, the current mess is starting to look much worse than the long recession of 1929. That’s when share prices on Wall Street lost 90% of their value.
But Lehman, General Motors, Ford and AIG survived 1929. It doesn’t look as if they’re going to survive the current crisis. In fact, some are already out.
The historical PEs of SA’s main and tradeable indices are currently as shown in the table.
Just like the table with Siegel’s worldwide PEs, the table of conditions in SA shows our shares are now also dirt cheap. It’s very difficult not to notice the very attractive financial shares. They’re currently trading at only seven years’ profit, and the average over the past 20 years is certainly closer to 13 times, which means the shares are at least 50% undervalued.
The 6,9% dividend yield on financial shares translates into a taxable interest rate of 11,5% for individuals with a marginal tax rate of 40%.
Everything indicates so much value that, just like Siegel, I sometimes throw my hands in the air and wonder why other investors don’t see it. Sometimes the temptation becomes too great and I can’t help buying a few of the ridiculous value shares, such as Altron, Omnia and Steinhoff, to mention just a few. A few days later they’re red marks on my portfolio.
Watch out for value holes: they’re there for good reason. SA’s financial shares are currently trading at extremely attractive historical and even forward PEs: not because the shares are so good but because the market – the silent, invisible market – is already whispering very loudly, or is perhaps roaring, that financial companies won’t maintain their profits in future. Even dividends might be cut, as is in fact the current case with Investec. Then the value investor falls into a value hole.
A few words of consolation for investors: avoid the attractive value offered by shares. Those are mostly dark value holes. The world economy is in a recession: in fact, it’s edging closer and closer to a recession, almost like the tragedy of 1929 to 1933. There’s plenty of time to make value investments later.
If it’s really good value – and it seems as if good shares are starting to trade at PEs of five or even less – there’s still plenty of time.