How long do you wait for a value share to out? There's no easy answer.
You hear the term "value trap" used about a share offering ostensible value but which never seems to rise in order to realise what the investor perceives as its undervalue. I don't much like this expression because it suggests that the share will never out, and I'd guess it is probably used by disillusioned investors who have held for some time and are fed up with waiting.
I think most, if not all, value players -- certainly including myself -- have experienced this disillusionment. I'm not referring to a situation where the fundies have deteriorated so the value has actually been outed, though on the downside. That would be a clear sell to a value investor, even if a loss was the outcome.
I'm talking about a situation that continues to offer value in the investor's view, yet other investors, the market if you like, continue to disagree and stubbornly refuse to price up the share. It may have net cash, be on a low P/E, a high yield, trade below tangible book and any combination of these and other classic value criteria. And yet this goes on for years and you are scoring little or no profit or maybe losing.
To dump or not to dump?
To dump or not to dump? That is the question. Okay, if it has a decent yield, at least you are compensated to some extent for holding over a long period, which is one reason why I like a good yield in my particular version of the value game, the other being that yield is also a value indicator. But we're not here for the income, this is a capital gains approach and therefore thought should be given to what to do with a long-held play that just hasn't done the business despite all the indicators suggesting that it ought to have.
The basic faith of the value player is that, sooner or later, value must out -- it just must because it is seen as an anomaly that will be arbed out by the market eventually. But I don't see any way to estimate when "eventually" will occur. In an extreme case, it may not be even within the investor's practical investing lifetime -- especially if, like me now, they were grave dodgers when they first bought the share.
I have read at least one value writer who advocates selling a play that hasn't performed within a given period. I forget the exact details but let's say it's five years. If, after that time, it hasn't done it for you, then even if it continues to offer value, his view was that you should sell because it has become a value trap.
Better out than in?
But consider this. After those five years, a new value player arrives on the scene and discovers your share which, remember, still has attractive fundies. Because she is new to the share, she has no reason to share your disillusionment and on the contrary will be enthused by it.
So who is right? The weary old value player who has seen no action over five years and is seriously on the verge of dumping it, or the new value player who spies a potentially lucrative opportunity? If we assume they both have similar skills at spotting plays using the same criteria, they can't both be right.
The answer has to be that the new investor's opinion is the right one and that in consequence the existing holder should stay in. Tomorrow might be the day it outs. Or it might go another five years of nowhere, that's the risk both the existing and the new player takes.
This then begs the question whether the fact that a value share has done nothing for many years increases or decreases its attractions, or is irrelevant. Several arguments could be made either way. For example, the fact of not having outed for a long time could mean that it is now nearer doing so. But it could also mean that not enough investors care about it, so that it may go on for a further lengthy period out in the cold. The best answer in my view is that it's irrelevant.
The bottom line for me is that there is not really such a thing as a value trap, they are probably just value shares that haven't yet outed and we cannot know when that may occur. I accept that it is certainly exceedingly frustrating to hold a play for years and to see it doing nothing despite continuing good fundies. I've been there myself many times.
This creates a great temptation to dump it, but to counter that, imagine you are a new value investor coming at it without the knowledge of its past price action. You'd buy, so why sell?
And that's why I have always said that enormous patience is required for the strategy.
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