Value investor not conservative enough

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Richard Pzena, a "conservative value investor", explains his methods in Forbes:
The companies at the top of the list are selling for a low price relative to what their histories suggest they should be earning in the future. Now, typically, they're not earning what their histories suggest, which is why they are at the top of the list. Something has gone wrong, and the stock price has gotten killed. So now you have basically three questions to answer: Is the business any good? Are the problems temporary or permanent? Is it rational to expect that the earnings will return back to that historic trend? We spend all our time trying to answer those three questions. That is the hard part. It's easy to do the screen, to come up with a list of companies.
His style is very similar to one I favour, I've plucked this explanation from a comment I left on Graeme's Moneyterms blog:
I would say my own method is 80% mechanical. I search for stocks that have low long term PEs, high interest cover and cashflow roughly equaling or exceeding earnings over the long term. Then I rank them and look among the low pe shares for companies that are in businesses that are still relevant. Judgement only comes into the last bit.
Mr Pzena's down 38%, in twelve months - undone by a premature foray into financials. I'm not sure how many years of a company's historic earnings Pzena uses, but in the UK I reckon banks are not cheap enough - relative to their nine year earnings histories.

On this occasion, I don't think he was conservative enough.


It will still be premature for the banks that go under. The bubble in financials was so enormous the bottom won't be in until after you start seeing banks go out of business.

I read the Forbes link and this theory about 5 times historical earnings, well, what happens to those earnings when a mortgage was for more that people can pay and what people can really afford to pay is in the range of half. That's enormously inflated earnings as they are taking a spread off an unsustainable level of lending, hence the enormous losses.

And, the speculation means that sales were happening at unsustainable levels, so they were also taking the spread off unsustainable level of issuing mortgages (and commercial lending as well).

And now they are having to issue equity at an explosive rate to fill in the holes in their balance sheet. Expecting double the number of shares by the time this mess is fixed would not surprise me.

On this occasion I don't think he's truly considered the degree to which financial earnings were a mirage and the degree to which share dilution to pay for the mirage will kill the opportunity he hopes to exploit.

Hi Deborah,

Thanks for the comment, and the link. You're right, it is important to consider the viability of banks - I've posted an 'update' here.

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