In my piece last week on BAE Systems, a subscriber asked whether basing my assessment of stocks on backward-looking measures was still a valid approach. With much of the world economy at a halt, it seems a fair question. For many companies - perhaps even most - 2020’s financial results will not look like 2019’s.
This week I want to try and explain why I am still placing a lot of trust in historical data.
I also want to take a look at a company which almost qualifies for my Stock in Focus screen. Bingo and gaming group Rank (LON: RNK) was enjoying a resurgence until the COVID-19 pandemic shut down the consumer economy. The shares have retreated to a level that looks fairly cheap to me on an historic basis. Could this be a buying opportunity?
Why I’m still using historical data
I’m continuing to rely quite heavily on companies’ historical financial performance. Broadly speaking, I’m trying to find companies that were profitable, well-run, and on a positive trajectory before the pandemic. My hope is that by buying these firms at a discount to their previous valuations, they will offer better-than-average recovery prospects.
For example, last week’s pick, BAE Systems, has traded successfully through many previous recessions and political storms. In my view it is very unlikely that this business will suffer any lasting damage from COVID-19. I’d also argue that the group’s history of stable profitability, modest leverage and good cash generation will make a prompt recovery more likely than for some other businesses.
Drilling down a little more, there are three main elements to my focus on historical performance.
Value investing: Traditional value investing has always used historical financial data. One reason for this is these are the only facts we have to go on. We can speculate about the impact of COVID-19 on spending, the economy and the nation’s political mood. And we can forecast individual companies’ likely performance. But we are only guessing.
By looking for companies with attractive historic metrics, I’m trying to limit my downside risk by owning companies that have previously performed well. My logic is that these companies are more likely to perform well in the future, too.
As Mark Twain is reputed to have said, “history doesn’t repeat itself, but it often rhymes”.
There’s nothing else: 2020 has become…
