Looking for value doesn’t make me a contrarian

By Jeroen Bos, portfolio manager, Church House

Added 29th September 2016

I’ve always seen the word ‘contrarian’ as going against popular opinion but when I invest I’m simply looking at some of the other characteristics of a stock that others might ignore.

Looking for value doesn’t make me a contrarian

Unlike the majority of equity investors, we don’t base investment decisions on the current and expected earnings of a company which rely heavily on what the profit and loss account looks like.

The equities we select are bought for their discount to their net asset valuation (as based on their balance sheet valuations) compared to the price at which the company is trading in the equity market.  By focussing on the assets, we are primarily interested in the balance sheet of the company and ignore, to a large extent, the profit and loss account. By concentrating on the balance sheet we are focussing on an area which, to a certain extent, is largely overlooked by most investors. This puts us in a position where there is far less competition to find attractive potential acquisitions.

As long as we buy these assets at a meaningful discount to their true valuations then we should be confident that we have created a certain “margin of safety”.  At first glance, the companies that we buy may not look the most exciting, as generally the earnings will have come down and subsequently the share price chart will often show a disappointing share price development. Often these stocks will carry a very high P/E, and on an earnings basis we seem to be paying a very high price. However, this ignores the fact that we get the assets at very attractive valuations. Clearly, stocks bought on such fundamentals tend to suffer from low returns on capital and the immediate outlook for the company may even be in doubt.

So why invest in stocks on that basis?

These so-called ‘fallen angels,’ backed by real assets, have the advantage that current market expectations of them will be strongly negative. They will be passed over and therefore, under-researched. As a result, any further disappointing results will now be largely ignored. Usually one of two things will now happen, either the incumbent management will make the company’s assets more productive again or the company may become a tempting takeover target.

On the other hand, companies bought for their earnings are strongly reliant on the development of these, as the share price is very dependent on the earnings. When a company is ‘priced to perfection’, any earnings setback could have big implications on the development of the share price. Most research analysts spend a great deal of their analysis on the current earnings and those expected in the immediate future which can contribute to one-directional trading in these earnings driven stocks.

We’re looking for those ‘fallen angels’ where the share price performance has been disappointing and the company has really fallen out of favour. The deciding factors for us are always the discount to the net asset value, that these companies have been profitable in the past, and that there is a catalyst for future growth.

That doesn’t make me a contrarian. I’m looking for growth stocks just not in the same place as many other equity managers.

A good example of such a company currently held in the portfolio is BP Marsh & Partners, a rather unique company quoted on The London Stock Exchange. The Company takes stakes in predominantly insurance based businesses and, by providing capital, aims to accelerate their growth. Then, from time to time they may divest these in order to free up capital to start the process again in smaller start-ups. It has no real competitors in this market and the business model has now been rolled out in other international markets. The Company should really be seen as a venture capital provider, and the earnings are partly event driven which gives it an attractive counter-cyclical characteristic.

We bought the shares at 143p in August 2015 (when the net asset value was 214p) and they are currently trading at 190p (As of 4th August 2016). The share price appreciated materially on the release of a statement in July concerning a strategic review for Besso Insurance Group Ltd, which represents 27% of BP Marsh's NAV, and which could potentially lead to a sale.   

We like companies where earnings are strongly event-driven and the fund’s portfolio reflects that. Catalyst Media Group, for example, is another holding which announced in July that it had received a cash dividend equal to 20% of its market capitalisation; or PV Crystalox Solar, which is currently engaged in an international arbitration, which, if successful, would receive a settlement representing a multiple of its current market capitalisation. 

These deep value investment opportunities, outside the main stream, tend to give lower correlated returns and are frequently overlooked; they are deemed to be unattractive at the time of investment as the outlook is seen as negative, but that, for me, is exactly what has created the opportunity.

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