That's because many companies appear lowly rated for a very good reason and realistically also lack a catalyst to change the apparent undervaluation. In fact, every year I rip through the annual report and accounts, trading statements and broker notes on around 50 companies during a three-week period at this time of year while researching my annual Bargain Shares portfolio. Having gone through this lengthy process, I then whittle this number down to 10 stocks, which must not only offer great value but importantly have a realistic chance of re-rating over the following 12 months.
This process involves a great deal of work on my part, but this balance sheet approach to investing has been well worth doing and has undoubtedly stood the test of time. In fact, over the past decade, an investor would have generated an average annual return of 16.8 per cent by buying each portfolio and subsequently reinvesting the proceeds into the next portfolio the following year. To put that into perspective, an investment of £10,000 in February 2003 would now be worth over £47,000, which compares rather favourably with the same investment in the FTSE All-Share which would now be worth £26,411 including the reinvestment of dividends. In other words, my Bargain Shares portfolio have generated a return double the 8.4 per cent on the benchmark index over a 10-year period that has covered two bull markets and one savage bear market.
That's not to say that my Bargain Shares portfolios are sure-fire winners every year. No investment technique can ever guarantee that and I have had two bad years in the past decade: in 2008 when the stock market crashed and, in 2011, when heightened risk aversion meant small caps were largely shunned again by investors that year. But if you take a long-term view when it comes to investing in equities, then the rewards can be significant from following this particular investment strategy, even after factoring in those two down years. Moreover, there is always scope for share prices to recover after a bad year, which is why I am revisiting the investment case of solar-wafer manufacturer PV Crystalox Solar (PVCS: 12.15p), a company that proved an unmitigated disaster in my 2011 portfolio.
The problem facing the company, and one which I underestimated when I advised buying the shares two years ago, has been savage price cutting by Asian rivals resulting from both overcapacity in the industry and oversupply, primarily from China. In turn, this has led to a 77 per cent plunge in spot wafer prices since April 2011 - taking them way below industry production costs - which has forced PV Crystalox to take some dramatic action itself. In fact, following a strategic review, the company has discontinued its polysilicon production facility in Bitterfeld, Germany to cut cash losses there of €9m a year; and substantially cut production at its UK ingot and German wafer operations. These actions will mean large job losses both in the UK and in Germany, but it also means that the cost base of the ongoing operations will be reduced to enable the business to hopefully be cash neutral in 2013 as the company adopts a cash preservation strategy.
That's important because, at the end of June, PV Crystalox was sitting on €122.3m (£102m) of net cash in the bank - more than double its own market value of £50.5m and representing a large chunk of its net assets of €192m (£160m). The company also has other substantial assets including plant and equipment valued at €58m and inventories of €46.6m. True, we can expect some significant asset writedowns when PV Crystallox next reports full-year results at the end of March, but even taking these charges into consideration (as well as the losses incurred in the second half of 2012), there is scope for share price upside if the company does manage to turn cash-neutral this year.
In fact, we don't have long to wait for a share price catalyst as management has already said that it will make an announcement in the second quarter regarding a return of cash to shareholders. Analyst Andrew Shepherd-Barron at broking house Peel Hunt has placed a liquidation value of £53.8m on the company, or 13p a share - 7 per cent above the current offer price of 12.15p in the market (correct at 9am on 21 January 2013). However, that could prove conservative in my view and the risk still looks weighted to the upside given that the board is committed to returning cash to shareholders. Not for widows or orphans, but PV Crystalox's shares rate a highly speculative trading buy on a three- to four-month basis and I have a target price of 16p a share which if hit would provide us with 30 per cent upside.
Finally, I will be taking a four-week break during April to complete a book on 'Profitable stockpicking', my follow up to Trading Secrets: 20 Hard and Fast Rules to Help You Beat the Stock Market. The book will be published in early summer.
My next online column will appear at 12pm on Tuesady 22 January 2012 and will be available on my homepage.
MORE FROM SIMON THOMPSON ONLINE ...
In the past few weeks I have written a number of online exclusive articles, all of which are available on my homepage. These include articles on the following companies or investment strategies:
Bloomsbury Publishing (A publisher for the digital age, 18 January 2013)
Housebuilders first-quarter effectand performance table on all my recommendations from the final quarter of 2012 (Stockpicking Marvels, 16 January 2013)
Eros (A share firmly in the picture, 15 January 2013)
Netcall (Jumping the gun: take two, 15 January 2013)
Moss Bros, Communisis (Jumping the gun, 14 January 2013)
Stanley Gibbons, MJ Gleeson, Spark Ventures (Small cap wonders, 11 January 2013)
IQE, Trading Emissions ('A tech share worth buying now', 10 Jan 2013)
S&P 500 portfolio of dog shares (Dog shares barking back, 8 January 2013)
Air Partner (A share ready to take off, 7 January 2012)
FTSE 100 traded options strategy (Highly profitable options, 3 January 2012)
Telford Homes, MJ Gleeson, Molins, Noble Investments (Rampant bargain shares, 31 December 2012)
