29th December 2006
The Malta
On 24th February 2006 , I had given this stark
warning, through the medium of this column, to investors of Maltese shares
quoted on the local Exchange. It is a warning worth revisiting:
“If you are investing in the quoted shares of our three main banks (HSBC, Bank of Valletta and Lombard), you have to be a momentum investor. Momentum investing is the antithesis of value investing. Whereas value investors search for the intrinsic underlying value based on fundamentals and only invest where they see that the market price discounts such fundamental value, momentum investors do not care much about fundamental intrinsic value.
Instead, momentum investors base their investment decision almost exclusively on the psychology reigning in the market. If there is a momentum building round a particular share or a particular market sector – even if this creates serious and sometimes awesome gaps between the market price and the underlying intrinsic value which would make such investment totally inconsiderable for a value investor – the momentum investor joins the pack and simply assumes that market momentum will continue to push share price(s) forward.
History shows that money has been made under both investment philosophies. The difference is that while value investors may have to wait quite some time for the market to discover the value discount and thus produce the capital gains they desire only on a long term basis, momentum investors can generally reap their returns within a relatively short time. The problem with momentum investing is that when the momentum peters out, as it unavoidably will once the price surge runs out of steam, there would be nothing left to support the wide gap between the market price and the intrinsic value and the value argument will have to come back into the equation. And just like a rocket that runs out of fuel it cannot keep hanging in the air; if it cannot surge forward it will have to fall back to a reasonable distance of the intrinsic value pulled by the investment value gravity.
There is nothing wrong in being a momentum investor, provided one knows what one is doing. Whoever chooses such an investment strategy must however realise that if it is too good to be true, then it is generally not true, and when the whole process would have run its course, there will be winners and losers – but the sum of the parts will be the same. Such investors have to make sure that they leave the party when the champagne is still flowing – as, the moment the champagne stops, there will only be tears for the road.”
The timeliness of this warning can be gauged with the benefit of hindsight, The share price of HSBC Malta is 28 per cent off its end February 2006 value and 35 per cent of the highs reached in March 2006. Bank of Valletta share price is 22 per cent off its end February 2006 value and 28 per cent off its peak in March 2006.Lombard is marginally still
above its end February 2006 values and off only 11 per cent the peak reached in
March 2006.
In spite of this sharp correction in equity prices in the second half of 2006 there is still evidence to suggest that, in comparison with their international peers, local equity prices still carry an unjustified premium, keeping value investors away from the market.
What is puzzling is why the share price of Lombard Bank seems to be living in a different planet from the share of the two bigger banks. There could be several reasons for this. Firstly the share price of Lombard Bank had not reached the dizzying heights reached by the other two Banks so the correction needed could be less pronounced.
SecondlyLombard could be commanding a
premium in its price through a development which occurred during the second half
of 2006 whereby Lombard acquired a strategic
equity stake in Maltapost.
The market could well be pricing in the growth whichLombard could experience if this
strategic acquisition is turned into an effective delivery channel to challenge
the broad branch network of the two larger banks.
Yet Price Earnings Ratios of 15.24 for Bank of Valletta, 23.27 for HSBC Malta and 18.90 forLombard still represent a
substantial premium over the average of 12.58 for international financial
services companies. The higher the price earnings ratio the more expensive the
share price is in comparison to the profit generated by the organisation whose
share price is being assessed for value indicators.
There is no rule that local equities should not justifiably command a premium over international peers but when such premium gets way out of anything that may be considered reasonable, then it is inevitable that sooner or later the market will have to adjust.
The question for 2007 is whether the price adjustment process has been completed or if there are pains yet to come as this process continues into next year.
“If you are investing in the quoted shares of our three main banks (HSBC, Bank of Valletta and Lombard), you have to be a momentum investor. Momentum investing is the antithesis of value investing. Whereas value investors search for the intrinsic underlying value based on fundamentals and only invest where they see that the market price discounts such fundamental value, momentum investors do not care much about fundamental intrinsic value.
Instead, momentum investors base their investment decision almost exclusively on the psychology reigning in the market. If there is a momentum building round a particular share or a particular market sector – even if this creates serious and sometimes awesome gaps between the market price and the underlying intrinsic value which would make such investment totally inconsiderable for a value investor – the momentum investor joins the pack and simply assumes that market momentum will continue to push share price(s) forward.
History shows that money has been made under both investment philosophies. The difference is that while value investors may have to wait quite some time for the market to discover the value discount and thus produce the capital gains they desire only on a long term basis, momentum investors can generally reap their returns within a relatively short time. The problem with momentum investing is that when the momentum peters out, as it unavoidably will once the price surge runs out of steam, there would be nothing left to support the wide gap between the market price and the intrinsic value and the value argument will have to come back into the equation. And just like a rocket that runs out of fuel it cannot keep hanging in the air; if it cannot surge forward it will have to fall back to a reasonable distance of the intrinsic value pulled by the investment value gravity.
There is nothing wrong in being a momentum investor, provided one knows what one is doing. Whoever chooses such an investment strategy must however realise that if it is too good to be true, then it is generally not true, and when the whole process would have run its course, there will be winners and losers – but the sum of the parts will be the same. Such investors have to make sure that they leave the party when the champagne is still flowing – as, the moment the champagne stops, there will only be tears for the road.”
The timeliness of this warning can be gauged with the benefit of hindsight, The share price of HSBC Malta is 28 per cent off its end February 2006 value and 35 per cent of the highs reached in March 2006. Bank of Valletta share price is 22 per cent off its end February 2006 value and 28 per cent off its peak in March 2006.
In spite of this sharp correction in equity prices in the second half of 2006 there is still evidence to suggest that, in comparison with their international peers, local equity prices still carry an unjustified premium, keeping value investors away from the market.
What is puzzling is why the share price of Lombard Bank seems to be living in a different planet from the share of the two bigger banks. There could be several reasons for this. Firstly the share price of Lombard Bank had not reached the dizzying heights reached by the other two Banks so the correction needed could be less pronounced.
Secondly
The market could well be pricing in the growth which
Yet Price Earnings Ratios of 15.24 for Bank of Valletta, 23.27 for HSBC Malta and 18.90 for
There is no rule that local equities should not justifiably command a premium over international peers but when such premium gets way out of anything that may be considered reasonable, then it is inevitable that sooner or later the market will have to adjust.
The question for 2007 is whether the price adjustment process has been completed or if there are pains yet to come as this process continues into next year.
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