Don’t fall into a value hole

There is still plenty of time

Finweek English Edition - - Moneymatters - North Amer­ica Europe Asia

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.

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