In my last article, I started to look into the details of the companies highlighted by my 52-week low screen for value. I covered those that fell loosely into the Retail, Media and Investment Company categories. I found four of the companies warranted further investigation as potential investments: Angling Direct (LON:ANG) National World (LON:NWOR) Logistics Development (LON:LDG) Inland Homes (LON:INL)
In this article, I continue to search for value amongst the rest of the 52-week low screen results, looking first at the Resources companies and then anything else that wasn’t easily categorised.
Resources: understanding the capital markets cycle in key
Unlike many value investors, I am not averse to investing in resource companies. Chosen well, such companies often generate very high cash flows, something which is attractive to the value investor. There are two risks with investing in producing resource companies. The first is that those high cash flows end up short-term in nature. The second is that the cash never finds its way back to shareholders and instead ends up building empires for the directors, usually at the top of the cycle.
When investing in resource companies, it pays to consider the capital market cycle to avoid paying up for cash flows that shortly disappear. And so, let's start with a look at how the capital market cycle works.
When prices of commodities are high, this attracts new investment into the sector. When large amounts of money have been invested in developing new production, the future returns are likely to be poor since the extra supply generated will reduce commodity prices. However, new mines or oil fields can take a long time to develop. Depending on the commodity, the time from discovery to production can be between five and ten years. Therefore, those who own an asset that comes on stream quickly, or remains in production after others have been depleted, benefit disproportionately from price rises due to a general lack of new supply in the market. In these cases, those excess profits can be earned for many years. In contrast, companies who are late to the party because they only started developing a resource once prices were high and investors were willing to invest in new resources tend to suffer when all the new production comes on stream together. For this reason, value investors tend to focus…
