One of the big investment themes that has been attracting attention recently, and especially since the election of Donald Trump as US president in November, is the resurgence of 'value' investing (you can read my two cents worth on the topic from shortly before the US election here). For nearly a decade, a so-called 'value' investment style (buying stocks and sectors with low valuations relative to peers and their history) has generally underperformed a 'growth' style (buying stocks expected to grow earnings fast). But the tick up in bond yields that started last year, especially following Mr Trump's election, has triggered a reversal in fortunes.
My screen this week is based on a 2000 paper by accountancy professor Joseph Piotroski, which nails it colours firmly to the mast of a value style. Indeed, the performance of the screen last year, following two disappointing outings, lends credence to the view that 'value' is back in vogue.
Over the past 12 months the 10 stocks picked by the Piotroski screen have delivered a 29.7 per cent total return. It is particularly impressive that this is ahead of the FTSE All-Share's 26.2 per cent because the selection of Piotroski stocks didn't contain any resources companies as the recovery in the resources sector played a very significant role in the strong showing from the All-Share index over the past year.
1-YEAR PIOTROSKI PERFORMANCE
| Name | TIDM | Total return (25/01/16 - 19/01/17) |
|---|---|---|
| Creighton | CRL | 141% |
| Punch Taverns | PUB | 63% |
| H&T | HAT | 53% |
| Peel Hotels | PHO | 45% |
| Jimmy Choo | CHOO | 25% |
| Palace Capital | PCA | 9.2% |
| F&C Commercial Properties | FCPT | 8.0% |
| Hansteen | HSTN | 5.0% |
| CLS | CLI | -0.8% |
| Johnston Press | JNPR | -52% |
| FTSE All-Share | - | 26% |
| Piotroski | - | 30% |
Source: Thomson Datastream
The past year has marked something of rehabilitation for the screen, which struggled in the two year's prior to 2016. Still, the overall performance since I started running the screen five years ago looks reasonable based on a 77 per cent total return compared with 58 per cent from the All-Share over the same period. If an annual 2 per cent charge is factored in to account for share dealing costs and spreads (the charge is set high because the screen often alights on small-caps that can be expensive to trade) the return drops to 59 per cent.
Piotroski versus FTSE All-Share index
The screen focuses on a classic measure of 'value'; the price-to-book (P/BV) ratio. Piotroski's approach is to try to separate the wheat from the chaff among the cheapest quarter of stocks based on P/BV. For investors, the idea of looking at companies that have a low valuation compared with book value (also known as 'net assets' or 'shareholder equity') is to identify companies that have seen their asset bases become temporarily less productive but are due to see returns recover.
So once a low P/BV stock is identified, the key question is whether there are grounds to think the market is underappreciating the longer-term potential indicated by the net asset value reported on its balance sheet. Mr Piotroski designed his F-Score, a score based on nine measures of improving fundamentals, to try to pick the winners. The nine tests build on each other to find companies that are producing improving returns without outside help from borrowing or selling new shares. A score of eight or more out of nine is regarded as a high F-Score.
The F-score criteria: ■ Positive profit after tax, excluding exceptional items. ■ Positive cash from operations. ■ Profits after tax, excluding exceptional items, are up on last year, which Professor Piotroski highlights as being of particular importance as a signal that a company may be in recovery mode and in the process of re-rating. ■ Cash from operations is higher than profit after tax, excluding exceptional items, which indicates an ability to convert accounting profit into actual cash. ■ Gearing (net debt as a percentage of net assets) is down on the preceding year, which suggests that the company has not had to look for external sources of finance. ■ The current ratio (current assets divided by current liabilities) is up on the preceding year, which suggests that the company's ability to service upcoming financial obligations is improving. ■ No new shares issued over the past year, which again suggests that the company has not had to look for external sources of finance. ■ Gross margins have risen in the past year. ■ Improving capital turn (turnover as a proportion of net assets), which suggest greater productivity. |
In the 20 years that were tested by Mr Piotroski up to 1996, he found a long-short approach based on his criteria achieved an average annual return of 23 per cent, almost double that achieved by the S&P 500.
For my version of the screen I look separately at the cheapest quarter of the FTSE 350, All-Small and Aim. I conduct the screen in this way so it is not too skewed towards smaller companies which tend to have lower valuations in general, reflecting the higher-level of risk the market judges them to have.
A total of 14 stocks have made the grade this year. I've provided write-ups of three of the stocks from the screen's selection below and the rest can be found in the accompanying table.
PIOTROSKI VALUE PLAYS
| Name | TIDM | Index | Mkt cap | Price | P/BV | Fwd NTM PE | DY | Fwd EPS grth FY+1 | Fwd EPS grth FY+2 | 3-mth mom | Net cash/ debt (-) | F score |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Peel Hotels | PHO | Aim | £18m | 130p | 0.76 | - | 1.5% | - | - | 7.5% | -£9.4m | 9 |
| Highcroft Inv | HCFT | All Small | £47m | 913p | 0.87 | - | 4.3% | - | - | 4.7% | -£4.8m | 9 |
| Camellia | CAM | Aim | £298m | 10,803p | 0.91 | 28 | 1.2% | -17% | - | 28.5% | £250m | 9 |
| Acacia Mining | ACA | 350 | £1.8bn | 432p | 1.31 | 12 | 0.8% | 2057% | -57% | -12.2% | $170m | 9 |
| Victoria Oil & Gas | VOG | Aim | £38m | 35p | 0.44 | - | - | - | - | 5.3% | $6.3m | 8 |
| LXB Retail Prop | LXB | Aim | £61m | 37p | 0.64 | - | - | - | - | -47.8% | £16m | 8 |
| SigmaRoc | SRC | Aim | £43m | 42p | 0.76 | - | - | - | - | 7.4% | £0.7m | 8 |
| Serabi Gold | SRB | Aim | £37m | 5p | 0.79 | 10 | - | - | - | 0.0% | -$2.2m | 8 |
| CLS | CLI | 350 | £649m | 1,592p | 0.82 | 14 | - | 45% | -12% | 2.2% | -£720m | 8 |
| Waterman | WTM | All Small | £25m | 81p | 0.88 | 11 | 4.5% | -0.9% | 25% | 2.5% | £5.4m | 8 |
| Axa Property Trust | APT | All Small | £36m | 63p | 0.93 | - | - | - | - | 0.6% | -£6.3m | 8 |
| Universe Group | UNG | Aim | £20m | 9p | 0.95 | 10 | - | 35% | 8.9% | -4.2% | £2.4m | 8 |
| Bovis Homes | BVS | 350 | £1.1bn | 819p | 1.14 | 8 | 5.0% | 7.5% | 2.1% | 0.8% | -$7.6m | 8 |
| Pets at Home | PETS | 350 | £1.2bn | 238p | 1.39 | 15 | 3.1% | -0.7% | 2.4% | -1.3% | -£164m | 8 |
Source: S&P Capital IQ
Acacia Mining (ACA), formerly known as African Barrick, is one of several resources plays to make it into the Piotroski screen's picks. The company has indeed shown impressive underlying trading improvements this year. Production rose for a fourth successive year in 2016, while its all-in cost for mining an ounce of gold dropped by 14 per cent for the year to $958 and is expected to be between $950 and $980 for 2017. Meanwhile, net cash jumped by $114m in 2016 to $219m. The company continues to work on ways of boosting returns from its North Mara mine where production increased substantially in 2016, and it is also pursuing prospects in Kenya that could substantially add to its resource base this year.
Corporate activity could also provide a fillip for shareholders. The company is in discussions with its marginally smaller Canadian peer Endeavour Resources about merging the two companies. Endeavour is also focused on gold mining in Africa and is targeting territories that are complimentary to where Acacia is already active. The tie-up could lead to falling capital requirements and cost savings, which would further boost returns.
Last IC view: Hold, 556p, 22 Jul 2016
At a time when housebuilder valuations are flirting with multi-decade highs, Bovis's slim premium to book value (1.14 times book value) certainly stands out. It compares with an average rating of its seven key UK-listed peers of 1.89 times. But there are reasons for the company's relative cheapness. The problems at Bovis were underlined earlier this month when, amid signs of operational difficulties, the chief executive stepped down, leaving the company's finance director to temporarily take the helm.
The problem for Bovis is that while business has been improving, which the Piotroski screen has picked up on, the progress being made is far less impressive than that of competitors. Indeed, the low valuation of the shares compared with its net assets is a reflection of the fact that the return it makes from these assets is one of the lowest in the sector - based on Bloomberg data, return on equity (RoE) stands at 14.4 per cent compared with an average of 21.9 per cent for its peers.
There are two basic ways Bovis may be able to address its place as a sector laggard aside from ratcheting up debt, which the market would be likely to judge as a foolhardy approach. Bovis can either increase the rate at which it builds and sells homes, thereby raising the 'capital turn' monitored by the Piotroski screen, or it can try to make more profit on each house sold, which would push up the 'gross margin' measure the screen looks at. On both capital and margin, Bovis currently compares poorly with peers, which suggests there is scope for management to raise returns and trigger a re-rating. However, a new boss's ability to do this will depend on how deep-rooted the operational issues that have held returns back so far turn out to be.
Last IC view: Buy, 815p, 28 Dec 2016
Last year property and infrastructure engineering consultancy Waterman (WTM) completed an ambitious three-year plan to treble pre-tax profit. The company managed to over-deliver on its targets during the period, but expectations are that the current financial year to mid-2017 will mark a bit of a breather, with broker N+1 Singer forecasting flat profit. However, there are attractions to tide investors over to the 2018 financial year, which will begin in just over five months' time, when noteworthy earnings growth is forecast to resume.
The shares are forecast to pay a 4p dividend for the year to the end of June and 4.8p the following year, equivalent to a 4.9 per cent yield, rising to 5.9 per cent. What's more, the net cash position means the company looks well placed to deliver on its commitment to a progressive dividend policy despite the expected hiatus in earnings growth this year.
The company, which generates about 90 per cent of its sales in the UK, so far seems to have avoided any major trading hit as a result of Brexit. And looking further ahead, Waterman could actually be a beneficiary of a push to increase spending on infrastructure given its involvement in highways work. A trading update last month also provided reassurance. The company said the first four months of the financial year left it confident it would meet expectations and that cash collection was strong. Waterman also said it expected revenue to be a little ahead of last year.
While there are still uncertainties about prospects, should investors become more convinced about the potential for earnings growth to resume with gusto - broker N+1 is currently pencilling in a 25 per cent EPS rise to 9.5p in the year to June 2018 - the lowly valuation means there should be plenty of room for re-rating upside.
Last IC view: none
