Tuesday, March 13, 2012

European Value Investing: Lots of Opportunities

With the macroeconomic turmoil that has sent financial shock waves through Europe, many good companies on the other side of the Atlantic have seen their stocks beaten down. On this site, European stocks are not covered. But investors may notice that American stock markets are at relatively high levels; as such, investors may wish to take profits and apply this capital towards some of Europe's finest value stocks.

Tim Du Toit is here to help investors get started. He is the founder of Eurosharelab, a site dedicated to uncovering European value stocks. He offers newsletters (including a free one) that identify investment ideas on a monthly basis. Recently, I had a chance to ask Tim a few questions about the European market, his investment philosophy and his newsletter:

Saj: What are your favourite stocks right now?

Tim: Europe is the ideal playground for value investors at the moment. I am finding a lot more companies at much lower valuations than in the USA especially in France, Italy and the UK.

One example is Television Francais – TF1 (Pink sheets TVFCF) the French television broadcasting and communication services company. Its main business dependent on the French television advertising market in which there is understandably a lot of uncertainty. But TV viewing is not going to disappear any time soon and the company is doing a lot to move its business to the internet.

It has got very little debt and pays a dividend of 6.3% and at €8.77 is valued at 10.2 times earnings, 6.7 times enterprise value to EBIT.

I also like Imperial Tobacco the world’s fourth largest tobacco company. Until last year the company was paying back a lot of acquisition debt and debt levels have come down to the point where cash returns to shareholders can really increase substantially. The shares are not dirt cheap but the dividend is attractive and sustainable. Also Imperial is substantially cheaper than any of its peers and at £25,42 is valued at 14.3 times earnings and 13.2 times enterprise value to EBIT. Imperial also pays a dividend of 3.8%.

Another attractive company is Faiveley Transport a French company that designs and manufactures equipment and systems for trains, metros and tramways. Last year was a difficult year but the company has a record order book that will ensure this year is a lot more profitable. Also the environmental trend and growth of high speed trains in Asia and Europe makes the company even more interesting. At €52.93 Faiveley is currently valued at 9.7 times earnings, 10.1 times free cash flow and 7.3 times enterprise value to EBIT.

Saj: Do you offer readers a glimpse into your track record, so that they know what they're buying?

Tim: Yes my complete track record is available on my website. There I show the returns of my personal portfolio as well as every recommendation I've made my newsletter.

I not only show the investments that shot the lights out but every company I have recommended. Even if I'm embarrassed to show how it has performed.

You can view my track record here: Eurosharelab Alert Newsletter track record

Saj: How did you get interested in investing?

Tim: From a young age I had an interest in business. For example I was always trading and selling things at school.

In high school I took accounting and it really fascinated me.

In 1986, shortly after finishing school, I enrolled in a stock market correspondent course and that first got me interested in investing.

A year or so later I pooled my limited funds with an investment from my father and started to invest in the real world.

I went on to make nearly every investment mistake you can think of (technical analysis, broker recommendations etc.) until I realised that there must be a books, articles and studies about what has worked over long periods of time in up and down markets. So from about 1998 this is what I have done. Read everything I can find that can help me improve my investment returns.

And this is the reasons I give when somebody asks me why they should listen to me. I made nearly every mistake an investor can make and learned from them (it was very expensive). You can thus make and pay for the same mistakes or you can take a short cut and benefit from my mistakes.

You can read more about my investment journey here.

Saj: There are a lot of types of value investors...low P/E, low P/B etc. What strategy segment do you tend to follow?

Tim: I became a low PE high dividend investor only after making all the classic mistakes a beginning investor could make.

I first lost a substantial part of the money my dad invested with me using technical analysis to purchase gold shares.

I then lost even more money investing in ideas from ”helpful” brokers who of course wanted me to trade as much as possible.

With none of my ideas working I continued to read as much about investing as possible and I somehow stumbled onto a short 84 page book called “Winning on the JSE” by Karl Posel an engineer and former professor of applied mathematics.

This book was my introduction to value investing (low PE investing). It broke investing down into a logical process that made immediate sense to me, giving me a framework that can be applied to investing.

Then for the next 20 plus years I studied the results of every possible book, research paper and investment study I could lay my hands on that showed superior long term performance – and I still do.

This of course led me to Graham, Buffett, Dreman, O'Shaughnessy, Greenblatt, Pabrai, Lynch, Piotroski etc.

All this research led me to develop my own unique investment approach that is completely value based.

I have moved away from only using a PE ratio to also looking at price to free cash flow and EBIT to enterprise value. But it’s all value based.

For example I have recently read a lot of papers and done extensive research using momentum. What I found is that momentum is helpful but only if it is combined with cheap valuation metrics.

Saj: Are there any particular industries you especially like or don't like, and for what reason?

Tim: Let's start with industries I don't like. I avoid pharmaceutical companies because I don't know to put a value on their product pipeline.

I also avoid mining companies mainly because they have no control over the price they get for their production.

I used to invest in banks but not anymore. Since the property bubble in the US deflated and the balance sheet of a lot of banks along with it I've avoided the sector. The fact that regulators are looking at them more closely as well as increased capital requirements will make banks less attractive investment for quite a few years to come.

Industries that I do like investing in is asset management companies because it’s a business that scales very well and dull undervalued companies with a large market share in boring industries.

I must add that irrespective of what industry it is in only if a company is undervalued do I get interested. I look at companies not industries.

Saj: What books were most influential in developing your investing viewpoint?

Tim: The first one I've already mentioned, the mathematician Karl Posel with his book called Winning on the JSE.

David Dreman with his book The New Contrarian Investment Strategy also had a big impact with his research showing that analyst forecasts are not worth the paper they are written on as well as all his long-term studies that showed value investment is a market beating investment strategy irrespective of what measurement of value you use.

Sir Jon Templeton, I think it was in his book Templeton Plan: 21 Steps to Personal Success and Real Happiness, with his advice that you cannot outperform the index if you look like the index and that you have to find your own ideas. But maybe more importantly his advice that the only thing that matters is the real after-tax return on your investments.

James Montier through his research papers and book Behavioural Investing: A Practitioners Guide to Applying Behavioural Finance also had a big impact. The main thing I learned from him was that a well-researched quantitative approach to investing is most likely the best investment strategy you can follow because it gets rid of all the behavioural investment problems the human brain is prone to.

Joel Greenblatt with all three of the books he wrote also had a big impact. Especially the book called The Little Book That Still Beats the Market that introduced me to the Magic Formula for selecting investments. This also confirmed what I learned from Montier that a quantitative approach to investing can work very well.

The research paper called Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers by Joseph Piotroski where he successfully showed that buying low price to book companies along with a fundamental quality score can vastly improve your investment returns.

If you're interested Piotroski's research you can take a look at the article Academics can enhance your returns.

As you can see my investment approach started with no structure at all, went to classical value investing and is slowly but surely moving on to more of a quantitative approach to investing.

What I find encouraging is all these factors have contributed to the building of an investment approach where the returns keep on getting better.

You can read about my favourite investment books in the article Nine books every investor should read

Saj: What kinds of things do you look for in the companies that you analyze?

Tim: As I mentioned, I only really start a look at the company if it is undervalued, I therefore use stock screening a lot.

Once I've identified a company that is undervalued I pull together five years of financial statements in a spread sheet where work through a 50 point checklist that allows me to quickly determine if a company is worth analyzing further.

The checklist is something I have developed over the last 15 years. It mainly consists of items I have identified reading investment newsletters and books of other great investors as well as newspapers and magazines.

It’s not rocket science but it forces me to think systematically and not to overlook anything.

You can read more about the check list I use in the article What does your investment check-list look like?

Only after I have worked through the checklist and still find the company attractive do I start reading financial statements and presentations.

In the financial statements I clarify any anomalies or other points I identified when I worked through the checklist.

The main points that make an investment attractive to me are:
• Low debt to equity, not more than 35%
• High return on tangible assets (classic magic formula companies in other words)
• A low price to earnings ratio or EBIT to enterprise value ratio
• A dividend payment (ideally over 3%)
• Management ownership of over 10%, or for a large company more than five times management’s yearly gross salary
• Share buybacks are a definite plus but only if the company is undervalued.

And something I have only started looking at recently is that the company share price must have good relative strength or price momentum.

This is something that I still find very difficult to implement because as a classic value investor the more a company share price has fallen the more I tend to like it.

However a lot of good research by very credible investors has shown that companies with positive momentum tend to perform a lot better than companies that don't.

This was further confirmed by a study a friend and I completed recently to find the most successful investment strategy in Europe over the last 12 years. As you know the past 12 years were a dreadful time for investors in Europe but in the study we found a simple two factor strategy that returned over 1100% compared to the 30% of the market over the same time.

This strategy consisted of six month price momentum combined with a valuation factor. In fact all 10 of the top performing strategies in the study all had price momentum as one of the factors.

You can find the study here: Quantitative Value Investing in Europe: What Works for Achieving Alpha

Once I am comfortable that it’s a good business, there is a margin of safety and price momentum do I invest.


Tim has offered all of this blog's readers 20% to 30% off his main newsletter, with a 6-month full money-back guarantee if you are not satisfied. This offer is available for the next seven days. Click here to sign up.

Disclosure: Author has received a review copy of the aforementioned newsletter

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