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VALUE INVESTING
02, Oh Dear, Down 6%

By Stephen Bland (TMFPyad)
January 3, 2003

A few years ago at parties, you had only to mention (carefully stage managed of course as though it were of little import during those dreary initial conversational exchanges about what you do for a living when you try to create an impression) that you write about the stock market for the most attractive ladies there present to fall about you with a passion bordering on instant infatuation. On New Year's Eve, I discovered the exact reverse now pertains.

In contrast to those good old days, telling anyone these days that you write about the market has about the same aphrodisiacal powers as telling them that you do nasty experiments on cute, fluffy little animals for a shampoo manufacturer in order to earn your keep and what's more -- you damn well enjoy it.

And so on New Year's Eve, I ended up ladyless and I reckon I'd have stood more chance in a convent. Not through want of trying, though. One particularly attractive red-haired lady appeared to start getting interested despite my frank admission that I wrote about the markets. When I mentioned the phrase "P/E ratio", in the old days the knockout chat-up line, she turned to a bloke standing near her who had been listening in, trying no doubt to pick up some tips on how to enthral women, and asked him if he knew what that meant. He did and appeared to know the lady, too.

"You know this guy?" I asked her. "We've been married for thirty years." With lightening speed I came up with the perfect riposte: "I didn't ask you that, I asked if you knew him."

Ha ha. Only I came up with it several hours later when being given a lift home at six in the morning.

Such has been the effect of the third year of market falls on the public image of share investing. The turn-off is well deserved as far as the last few years are concerned because the great majority of small investors have lost serious money. This applies to those holding shares directly, to those in trackers and most other funds, and to those holding less directly, via pension plans and endowments. The market fell by some 25% in 2002.

But the view doesn't apply to a lot of value players who don't buy markets. Here's my year.

At the end of 2001, I was holding PYAD share Allders (LSE: ADS) in which I'd invested a sizeable chunk of my money but still only a minority of it. Dunno why, but I hadn't bet the farm on this one and had the majority of my funds in cash. Allders turned out to be one of my mistakes. Around the end of September 2002, I sold it for a total loss after dividends of some 32% following a profit warning by the company that changed the fundamentals. Not long after, there was a bid of 160p per share, which by chance was only just above my buying price.

But I'd spotted what I saw as irresistible opportunities developing in the financial sector. If the market was to recover overall, I knew from past experience that financials are amongst the fastest moving and highly geared in such a situation; often first into and out of bear markets, magnifying the overall falls and rises. I had no idea if a recovery was on the cards at that time, and I don't really follow markets anyway, only shares. But the fundamentals of financials were highly attractive, taking the usual value player's short-term view of up to a couple of years or so. Sooner or later, the market will move up and then financials will be good shares to hold.

Banks Abbey National (LSE:ANL) and Lloyds TSB (LSE: LLOY) were my selections, the two cheapest in the sector on price to earnings (P/E) and dividend yield grounds. Fortuitously, Abbey National subsequently became the subject of a weak bid, which was rejected by them and thus very likely to fail. This time I went in with the lot, half the farm each into the two banks, including the Allders proceeds. Note that neither are PYAD shares, but I've always liked financials at the right moments and they smelt real good at that point.

Within a very short time, which I couldn't have known in advance, both rose strongly. I mean that I was pretty sure they would come good but I didn't know it would happen that fast. Abbey National was propelled by the bid and Lloyds TSB put in a good performance, too. I sold out of Lloyds TSB at a decent profit and switched into Royal & Sun Alliance (LSE: RSA). The latter had been very cheap for some time because of market fears over its very survival due to a series of well-publicised claims and the bear market, which hit its equity portfolio.

RSA had published a review indicating that it intended to turn the business around with a number of major moves, involving selling off unprofitable areas of the business. This would both raise the cash needed to satisfy their regulatory requirements and improve profits in time. Turnarounds are often a feature of value investing and this one appealed to me. My buying price is around 108p. Subsequently, the shares took off, rising to about 150p in a short time but I hung on, thinking that in the slightly longer term, larger profits than this might well occur. I still hold and as I write, they have come back from that peak quite a bit.

In November, I sold my Abbey National but at only a small profit. Lloyds TSB had also fallen and looked more attractive to me, so I reinvested the Abbey National proceeds with a switch into Lloyds TSB. My buy price was around 538p so currently I'm showing a substantial loss on paper. I thought Lloyds TSB was attractive at 538p and consequently much more so at their present 456p level. I see no reason in the fundamentals for the subsequent falls that have occurred; so as far as I can see it is just noise. Their trading update published a few weeks ago appeared attractive to me. In fact, it was what persuaded me to go back into them. The market disagrees -- so far -- but plenty of winning shares I have owned have fallen at first. That happens and all value investors have to be able to live with it.

I would buy more Lloyds TSB if I hadn't invested the rest of my funds in RSA or if I saw the latter as having lost some of its attractions.

So my actual realised performance for 2002 shows a loss on Allders, a decent profit on the first Lloyds TSB trade and a small profit on the Abbey National trade. The two latter deals more than covered the Allders loss so at that point I was in profit for the year. However, after re-entering Lloyds TSB and on paper, if I value my fully invested current portfolio of Lloyds TSB and RSA and compare that with the value of my portfolio a year ago, which then consisted of cash plus Allders, I enter 2003 with a small paper loss of around 6% because of the subsequent fall on my second Lloyds TSB holding balanced by a modest gain on RSA.

For what it's worth, since I started writing for the Motley Fool in September 1998, this is the first year of loss and brings the cumulative gain, which last year stood at a rough 625%, down to a rougher 587%.

I wish all value players, indeed all investors, a successful 2003. As always, try and ignore markets and what anybody says. Stick with individual value shares and back your own judgement to the hilt.

The author owns shares in Lloyds TSB and Royal & Sun Alliance