In last week’s article, I looked at the value investor’s mindset and introduced one of the most basic value screens: the 52-week low. Given the weak markets, looking for 52-week lows alone yielded far too many results to analyse. Hence, I narrowed down the field with a few additional criteria. Firstly, I only looked at companies with a market cap between £10m and £600m. The lower limit helps ensure the liquidity to invest if I find something interesting. The upper limit is because the academic research on 52-week lows suggests the outperformance is concentrated in the smaller stocks. In addition, I required a Stockopedia Value Rank above 80 and a strong balance sheet, as measured by the current ratio. Finally, I excluded funds, REITs and banks, leaving 26 companies that merited further investigation. Over the next few articles, I will lead readers through a first-pass analysis of the screen results.
The approach investors take when conducting an initial analysis of potential investments matters. This is because we suffer from something called Information Order Bias; when assessing a complex situation, we tend to put more weight on the first piece of information received. Information order bias has been shown to affect how we vote (disproportionately for the first candidate on the ballot paper) and, perhaps even more worryingly, in one study, how accurately air defence operators can identify aircraft as friend or foe.
Many investors start their analysis by reading the management commentary from recent results or, perhaps, a broker’s note. Unfortunately, the management of most companies will be, consciously or unconsciously, biased to think positively about the future of the business they lead. Many CEOs reach the pinnacle of their organisations because they are strong salesmen or adept at getting people to like them. This sales instinct often remains when they take on the top job.
Similarly, the brokers are incentivised to look on the bright side of life and write positively about their clients. You only have to compare the number of ‘buy’ recommendations to the number of ‘sell’ recommendations to see where this incentive system leads. Those who read management commentary or brokers’ notes first are, therefore, likely to be putting on a pair of permanent rose-tinted spectacles.
In contrast, legendary value investor, and 52-week low screener, Irving Kahn, said that investors should:
“…start at the back [of an annual report], where you tend to get the…
