Interactive Investor

These 10 cheap shares are on the move

20th July 2016 13:26

Ben Hobson from Stockopedia

Market volatility caused by events like the EU referendum tends to trigger a noticeable surge in opinion and commentary telling investors how they should react. In many ways it's easy to see why investors would be crying out for this kind of guidance. A glance at the main indices suggests that there's nothing amiss and stocks have happily bounced back. But those index benchmarks mask a great deal of uncertainty that's left many nursing painful paper losses.

Deciding whether to trade in or out of shares is a very personal choice. But in times of uncertainty it's worth remembering some of the most influential and time-tested investment philosophies.

Back in the early 1990s, a highly successful investment manager called Seth Klarman wrote a book called Margin of Safety. In it, he set out his reasoning for pursuing a value investing strategy. He pointed out that investing in shares priced at a deep discount to their underlying value has a stellar track record of producing excellent results. Indeed, Klarman became a billionaire by running his firm Baupost, using these principles.

Deep value investing is very much a contrarian approach to the stock market. It involves finding shares that other investors hate the look of. Klarman summed it up by explaining:

"Value investing by its very nature is contrarian. Out-of-favor securities may be undervalued; popular securities almost never are. If value is not likely to exist in what the herd is buying, where may it exist? In what they are selling, unaware of, or ignoring. When the herd is selling a security, the market price will fall well beyond reason. Ignored, obscure, or newly created securities may similarly be or become undervalued."

The search for value

The same value principles have been adopted and executed with great success by other investors, too. One of them is Josef Lakonishok, another US-based fund manager. His academic work found that investors generally rely too much on the past to make predictions about the future, and frequently pay too high a price for the shares that they buy.

But while Lakonishok is committed to the rules of value investing, he gave his strategy a twist by looking for shares that the market was beginning to notice. So he combined conventional measures of cheapness with signs of positive momentum. He looked for measures like price/book, price/earnings, price/cash flow and price/sales ratios, together with a recent period of positive price momentum and earnings surprises. In other words, he goes looking for shares that are on the move.

At Stockopedia we track an investment strategy based on Lakonishok's rules and it has generated an annualised return of 14.2% over the past four years.

If you look at the companies passing these rules now you often see instances of stocks in a period of recovery. A good example from the list is De La Rue, the banknote printer, where a major cost-cutting programme combined with the weakness of sterling has offered some optimism. The same goes for Indivior, the pharma group, which has recently received good news about litigation over its main drug treatment.

At the other end of the list you have companies like Plus500, which appears to be clawing its way back from a huge period of uncertainty over its financial trading business. Likewise, Anglo American, the mining giant, is forecast to swing into profit in 2016 after several years of losses as a result of depressed commodity prices.

Name

Mkt Cap £m

PE Ratio

Value - Momentum Rank

6 Month Relative Price Strength

EPS Surprise % Last Year

De La Rue

626

12.8

97

+33.7

9.6

Indivior

1,938

11.6

96

+54.9

10.3

3i

5,749

6.85

96

+23.9

74.9

Premier Foods

392.7

9.25

96

+17.2

0.8

PPHE Hotel

354.5

10.4

95

+20.7

8.6

Lifeline Scientific Inc

55.7

6.17

94

+23.8

25.6

XLMedia

152.3

10.5

94

+7.93

18.1

Plus500

850.2

11.7

93

+63.1

19.9

Bloomsbury Publishing

123.9

11.8

92

+0.42

4.6

Anglo American

11,409

15.1

90

+193.5

2.1

Taking a value approach

In periods of uncertainty, the wave of market commentary can lead to more questions than answers for investors considering how to position themselves. Value investing strategies come in a multitude of colours, but very few argue with the logic of buying shares that are priced below their true value.

In the case of investors like Lakonishok, blending value with signs of recovery and positive momentum has proved successful. It's an approach that offers an extra layer of comfort in the search for shares that everyone else is ignoring.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

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