Diana Clement: Deals galore if you play the cards right

Diana Clement

Bear markets affect investors differently. Some private investors simply stick their heads in the sand, ostrich-style, not wanting to buy again until sentiment is better and, by default, prices higher.

Conversely at the bottom of one bear market Warren Buffett said he felt like "an oversexed guy in a whorehouse".

At the moment there are equities and listed investment companies trading at a considerable discount to their book values or net asset values. But are they bargains of a lifetime?

Spicers Wealth Management senior financial adviser Jeff Matthews believes so. Matthews put his money where his mouth is in March, buying a number of US-based equities.

"I looked at the magnitude in drop of share prices in the past 12 months [before deciding to buy]," he said.

American Express' share price had dropped by 81.4 per cent, Bank of America 93.5 per cent, Barclays 92.8 per cent and Citigroup 96.4 per cent. Matthews chose American Express, Wells Fargo and General Electric.

"They are great brands but their prices were trashed. American Express is a US$50 ($88) stock and it was trading just under US$10."

He bought the shares with the expectation of trebling his money over the long term. But the rise has been quicker than he anticipated. Bank stock prices have been on steroids since Matthews made his purchases and all three have more than doubled.

Matthews noted Buffett invested around the same time in American Express equities and General Electric convertible notes, which were offering a 10 per cent return with the right to convert to equities at a later date.

But now Matthews believes the horse has bolted - in the banking sector at least. Unless there is another sharp correction the buying may not be as good again. "You are not going to be able to buy Barclays at US$2.50 again. It's now US$15."

Making buying decisions on price alone is never a good idea. Norman Stacey, director of Diversified Investment Strategies, doesn't agree that equities, despite their low prices, are being given away.

"Some companies will not survive and they are over-priced at any price. You can always lose 100 per cent."

That was at the front of Matthews' mind when he chose not to buy Citigroup shares at rock-bottom prices. There was too much risk that the company would be nationalised, rendering the shares worthless. So far it hasn't happened and the price has risen to US$2.89 from its low of US97c. Nonetheless Citigroup is a particularly risky buy.

There were many reasons why companies might be trading at a discount to their intrinsic value, said Mark Brighouse, managing director of Brook Asset Management.

"Sometimes the future earnings of a company are discounted back or [there is a discount] for structural reasons," said Brighouse. In the case of listed investment companies, the discount might reflect a lack of confidence in an investment strategy.

Stacey added: "Net asset values may also be inefficient or stale-dated relative to market price. For example, illiquid assets such as buildings or unlisted equity holdings may be carried at historic valuations between infrequent valuations. Over time, the market is seldom wrong."

Having said that markets do overshoot and undershoot and plenty of investors feel they've been in Buffett's proverbial whorehouse and have picked up some phenomenal bargains - especially on overseas stock markets.

Investors looking for such good returns from the NZX might be disappointed. Matthews doesn't think the NZX offers the same value as some overseas markets.

When he was buying American Express at a fraction of its former price, the Australian-listed banks such as ANZ, National Australia Bank, CBA and Westpac were trading only 40-50 per cent off their top and have recovered by up to 30 per cent since their lows this year.

"But that is not as stunning as 300 per cent," said Matthews. "With the American banks we are talking world-leading brands down 90 to 95 per cent."

Commentators have seen some big discounts open up in recent times between the price of listed equities and intrinsic value. Brighouse said some discounts were historically large but we were in an environment of unusual economic uncertainty. He could see cyclical elements in the current market.

"If you believe there is an underlying trend to economic expansion and we will return to that trend, then you might conclude there are some abnormally large discounts opening up."

Diversified Investment Strategies bases its recommendations on prospective value rather than price and Stacey said there weren't many industries with the likelihood of rising revenues over the coming year other than receivers and debt collectors.

"The alcohol industry tends to have defensive earnings too - but is often excluded by our socially responsible investing screen.

"We find value in gold mining companies currently and advocate swapping some bullion for producers' shares. Gold producers are likely to see their earnings rise by up to 40 per cent this year simply because their revenues are higher on a stronger gold price - especially in Australian dollars - while input costs, and notably energy, are much lower. You have to check your other facts like indebtedness, foolish use of derivatives and reserves."

There are arguments that large cap stocks are the best to buy in recession. Stacey doesn't agree.

"It is hard to make any case that large cap or small cap companies are intrinsically different. Empirically, companies that are focused on their core business with adept hands-on management and are nimble in the face of a changing commercial environment, are more likely to survive." Big financial companies had suffered, he noted, and it would be hard to contemplate worse fates than Bear Sterns, Lehman Brothers, HBOS, Citigroup and UBS.

"The level of debt to equity may be a better guide. A company of any size that is highly geared and suffers sudden diminution of earnings is likely to come unstuck."

When it comes to property there are bargains in the United States, although accessing the residential market isn't really on for most Kiwis and anyone should be wary of investing in markets from afar.

The US commercial property sector could offer some bargains, said Matthews. He cited Boston's tallest building, the John Hancock Tower, which sold recently for US$660 million at foreclosure, down from the US$1.3 billion it last sold for in 2006. Many commercial property funds in the US had fallen 50-60 per cent, he said, some justifiably, but others not.

On New Zealand's residential property investment front there had been a modest fall in prices and the fundamentals of price to earnings and rental yields still didn't add up.

The listed commercial property sector, on the other hand, said Matthews, had "taken a pasting" with prices down 30 to 40 per cent.