Martin Hawes: Picking cheap n' classy over cheap n' nasty

A reader asks: "In your writing you talk a lot about 'value' and 'quality'. What do you mean?"

I am a value investor. That means I look for investments that are selling at prices less than their intrinsic worth. While nearly all the literature on value-investing concerns shares, the principles are just as valid for property.

Value investors gauge the intrinsic worth of an investment by looking at the fundamentals. In the case of shares, they look at the company, its business model, its governance and management and, most importantly, its finances.

In the case of property, a value investor looks at location, the nature of the building, the tenant and lease and, most importantly (again), the financials.

The critical thing surrounding any investment is the amount of income (or profit) that accrues to the investor compared to the price of the investment. This is measured in different ways for different investments, but we are really talking about investment yield - the percentage of annual income compared to the price of the investment. A poor investment would have to offer a very high yield to find an investor, while a good investment will sell at a lower yield.

How is quality judged? What makes one investment poor and another good? There are three things regarding income that dictate whether or not an investment is a quality one:

1 The nature of the income. That is, whether it is in cash or some other form. For example, some companies report good profits but do not spin off much cash. This is a much less attractive investment than a business which has very strong positive cash flow.

2 The sustainability of the income. A basic question for all investors is whether the income will continue. Commercial property has some certainty of continuing income - there are usually long-term leases, often to good tenants.

Shares with strong brands usually keep their profits coming in good times and bad.

3 Growing income. An investment with income that is likely to grow is better than one where the income is expected to remain static.

Good companies have long track records of being able to grow their profits, sometimes through good management and sometimes because of the industry they are in (and sometimes a combination of both). Properties in good locations tend to have growing rentals because there is demand from tenants for this kind or property.

So, when I write "value is starting to appear", I mean there are investments available at good prices that have good sustainable income which is likely to grow.

I do not want to pay too much for any investment, so I like to buy into it before the rest of the market has woken up to how good it is. This is often not as difficult as it sounds, as many in the market are either off chasing the next speculative bubble or paralysed by fear of volatility.

* Financial author Martin Hawes shares strategies to help you grow your wealth. Email questions to info@wealthcoaches.net