Value Trapped
I’ve gone into podcasting, with Mark Simpson of Excellent Investing fame. We decided to call the podcast ‘Value Trapped’ as a pun. A ‘Value Trap’ is an investment that has alluring numbers, for instance a low price/earnings multiple, maybe a high dividend yield – the numbers are very attractive. Then it turns out that there is more going on, the enticing multiple is actually cheap for a reason. You’ve been tempted into a value trap!
Northern Rock, which was taking mortgage market share and had grown at mid-teens revenue growth for many years, is an example. The former bank reported a 20% Return on Equity, but only traded on a 12x multiple of earnings. The earnings weren’t sustainable though and it failed spectacularly in mid 2007. Banks have given equity investors many painful lessons over the years – anyone still on the shareholder register of Credit Suisse probably has masochistic tendencies.
Value traps are an aspect of investing that makes the world interesting. If investing just involved buying shares on below 10x earnings, life would be easy but there’d be no intellectual challenge. Where’s the fun in that?
Here’s a link to the podcast:
We talk about what has happened to the $18 trillion of debt that had negative yield at the end of 2020. Someone still owns that debt, and the value has likely fallen a long way, given how inflation and interest rates have reduced the value of long dated assets. I say inflation AND interest rates, because interest rates are used to value that debt, but it is inflation that reduces the value of future cashflows. Central Banks might cut interest rates, but if inflation remains above target, then the value of long dated fixed income payments will be eroded.
We talk about some undeniably cheap South African companies listed in London, Sylvania Platinum and Tharisa – but worry that they may be value traps (time stamp 8:55). We don’t argue about the facts, there’s $134m of cash on SLP’s balance sheet (38% of the company’s entire market cap) – but we do disagree on whether that cash will be invested wisely to generate a return for investors. I think that on balance it will, but can see there’s a reasonable argument that it won’t be.
Another stock is Arcontech (time stamp 17:54), in a completely different sector (providing software to banks), which is very profitable but has struggled to grow in the past few years. Again, we don’t disagree on the EBIT margin, which is a very healthy 28% (and even better 35% 3 year historic average) but we do disagree on the prospects for the business.
We finish up with a discussion on the Bank of Georgia (time stamp 34:07). This is a bank that has an impressive track record of growth and profitability, yet trades on 5x earnings. Am I missing something? Or perhaps the risk is in plain sight, the closeness to Russia and political tension in the capital, Tbilisi, over the last week.
Have a listen and see what you think. If you like this episode then please let us know by subscribing for future podcasts or leave us a positive review.
Photo by Hennie Stander on Unsplash
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