Why there are still opportunities to make money in Irish shares
Published 27/10/2011 | 05:00
Renowned investment manager Gervais Williams has long been a cheerleader for smaller stockmarket-listed companies. In an exclusive extract from his new book, Williams says companies like Greencore, FBD and Smurfit Kappa have the potential to offer good returns for investors and outlines his stock-picking strategy.
INVESTORS are wondering how to make good decisions in these uncertain times. The problem seems more difficult than ever now as the financial crisis has scuppered the trends that have successfully guided investors over the past 25 years.
But there are still good opportunities for making money in the stockmarket, even amongst Irish companies.
The conundrum facing investors now is the central theme in my new book, 'Slow Finance'.
In it, I start by emphasising that the first and most critical point to appreciate is how important credit growth has been in driving stockmarket trends in the past two decades or more.
Before 1986, credit growth grew broadly in line with economic growth, but a powerful combination of deregulation, innovation and globalisation allowed this relationship to change.
Much faster credit growth contributed to higher asset prices and this subsequently encouraged speculative activity to grow year after year in the financial markets.
So, at the end of the credit boom we have a financial sector that is enormous and is out of a scale with what is needed in the world's shrunken economies.
If the credit boom has come to an end, then the drivers of the previous trend will cease. And if the previous debt mountain starts to be repaid, then the previous trend will reverse.
This means the financial sector will be forced to scale back to something more in balance with the underlying economy.
We know that the process is going to take some time, but the key question for those with savings is what might be the new investment trends that attract support in the coming years?
Already there have been indications of a profound change of attitudes to the financial sector. The speed and the growth of the Occupy demonstrations worldwide are a firm indication of that.
In my view, we are likely to see an equally profound change in the values and beliefs of those involved in the investment markets.
Indeed, following the globalisation of the food sector, the subsequent trend has been for many individuals to seek to take a more active role in deciding the quality of ingredients, for example.
I believe we are likely to see a similar trend in the financial sector and savers will expect to want a lot more influence on the decisions that determine where their savings are allocated.
Investors in recent years have all been looking for growth. If growth is good, then the fastest growth has delivered the best returns.
With the end of the credit boom, though, it seems the faster growth of recent years is being replaced by something of a growth hangover.
This, in essence, is the problem that western governments are now grappling with.
Governments are also struggling to find the money to maintain spending in the economy and the uncertainty of austerity is causing investment markets to become highly volatile.
In this scenario, investors would be well advised to reflect on what has happened in the past and what guided seasoned investors at times of even greater uncertainty.
Perhaps the most notable is Benjamin Graham, author of 'The Intelligent Investor'.
Graham's book reminds us that many investors seek to buy shares that are on the rise in the hope of selling them later at a decent profit.
He characterises this as speculation, rather than true investment. The better way to make good returns, Graham argues, is to get involved with assets when they have intrinsic value and then to be willing to hold on to these investments over a long period.
By doing this, investors begin to act as part owners of the companies they invest in and take on all of those responsibilities, rather than relying on making a profit though making a few transactions.
If the investments are selected based on the underlying value of the company, the short-term movements of markets are not so unsettling, since markets do stabilise in time and the real value of an investment does deliver. For that reason, my book characterises this trend as 'slow'.
The implications of such a change in attitude are far-reaching. If savers seek to invest with a longer timeframe, then the underlying stocks had better be really worthwhile.
This suggests that selecting stocks that are undervalued based on their share price will become a lot more important, rather than just investing in the largest quoted businesses listed on a stockmarket index.
And while there are benefits to investing in stockmarkets outside of Ireland to diversify your investments, the chances are that the best opportunities to identify those with real underlying value are likely to be nearer home.
The Irish stockmarket is way out of fashion with international investors, so it seems logical that there must be some stocks that offer a good entry price for investors.
Graham suggested one way of identifying these shares might be to compare the tangible assets within a company with the stockmarket value of the company -- a concept known as 'value investing'.
There are many academic studies that show that using this method over time does indeed lead to premium returns for investors.
Other academic studies have demonstrated that those companies with good and growing dividends also tend to deliver handsomely.
During the credit boom, the prospect of quick capital gains outshone the huge benefit of holding dividend-paying companies and reinvesting that income, which has traditionally proved to be a good bet.
So despite the fact that the prospects for the Irish economy are unexciting, my clients' portfolios do hold some Irish companies.
They have selected stocks that appear to offer good underlying value and have the potential to deliver income from dividends.
Our largest holding is Greencore, the food-manufacturing business. Although this company has made a series of acquisitions, so it doesn't have a high tangible-asset value, its strong market position has attracted interest which this week resulted in a potential takeover approach.
Another is FBD, the insurance business, which in spite of the Dublin floods this week, seems to me to have attractive long-term prospects of decent dividend growth.
We also hold smaller investments in DCC, CRH and probably most controversially in Smurfit Kappa. The wisdom or otherwise of my investment selections will become apparent in time.
The point is that simple strategies like reinvesting dividend income, using the power of compounding to grow wealth slowly, can be sustained irrespective of whether Greece does or does not default.
With change all around us, do check your assumptions about where to focus. The growth story has been at the forefront for most of the past 25 years. But it has been recognised for a long time that investors tend to overpay for growth.
And the bottom line is that, since 1975, returns from more mature economies have often matched or outstripped those from rapid-growth economies.
Gervais Williams ran Gartmore, the successful investment-funds group, for 17 years specialising in investing clients' funds in smaller, publicly quoted companies.
He now has a new role at MAM Funds, a company listed on London's Alternative Investment Market (AIM).
His new book, 'Slow Finance', is published by Bloomsbury and comes with a free smartphone App, highlighting value, dividend yield, size and investment miles in UK-listed companies, using data from Thomson Reuters.