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Don't just follow the share price, do your homework

16/02/2017

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

If a week is a long time in politics, as Harold Wilson once famously observed, then it is a wonder 2016 ever came to an end. While last year may not have been as eventful in stockmarket terms as it was politically, some companies are not going to forget it in a hurry – and that presumably includes Anglo-American, whose share price 12 months ago was languishing at its lowest level since the turn of the century.

On 26 January 2016, the company’s share price closed on £2.21 – having traded as low as £2.15 during the day. A year later, however, the price stood at £13.55. Here on The Value Perspective, we were more confident about Anglo-American’s prospects than the wider market – steadily buying more shares as the price fell and consequently reaping the benefit as they regained all the ground they has lost over the previous year.

As we touched on that happy outcome recently in When to buy a company with a falling share price, we will not revisit it further. The aspect of all this we thought would be interesting to revisit, however, is what the company analysts at various investment banks were saying about Anglo-American this time last year. We will not name names but we trust it goes without saying that few, if any, shared our view of the company.

“Working for the banks” was the title of one research note. Published on 25 January 2016, when the shares were trading at £2.27p, the note flagged a price target of £3.00 on its front page. This was notwithstanding the fact that, also on the front page, the research had concluded Anglo-American was trading at a 75% discount to its net asset value – that is, to the value of its assets minus its liabilities.

So even though the writer of the note acknowledged how cheap the business was, they were only willing to offer a ‘neutral’ rating and a target price that was effectively ‘anchored’ on the current share price. Interestingly, the research also included an ‘upside scenario’ where, in the most bullish of circumstances for commodity prices, the Chinese economy and so forth, the share price might just edge up to the heights of £6.

Clearly the last 12 months will have come as an enormous shock to that analyst then – but they would have had plenty of company. A day later, as Anglo-American hit its low, another research note – “Rights issue? It’s complicated” – also flagged a £3 target price while a third, this time from 21 January and entitled “Structural headwinds too strong”, envisaged a target price of £2.00. That was 24p below that day’s share price.

Overall, in January 2016, the target price averaged by the analysts who followed Anglo-American for a living was £4.15. Wind the clock forward a year and the average target price is almost exactly three times that at £12.50. A year ago, the analyst community had 14 ‘Sell’ recommendations on the company, compared with just two ‘Buys’, whereas today there are five ‘Sells’ and nine ‘Buys’

So what, you may well ask, has changed over the intervening 12 months? In Your reporting season survival guide, we recently noted that large swings in a share price do not necessarily denote any real changes in the underlying business. And that would certainly appear to be the case with Anglo-American over the course of the last year.

The business has sold off some of its assets – for prices that have been neither particular exciting nor particularly disappointing – and it has generated a bit of cash. But to suggest Anglo-American has transformed itself or done anything one might imagine would justify a six-fold increase in its share price would be a stretch.

No. All that happened was something we return to again and again, here on The Value Perspective. One year ago the share price had an eye-wateringly cheap valuation and then market sentiment improved. Granted, we would never have expected the shares to do so well in the space of just a year but, because they were so cheap to begin with, the odds were very much in favour of them performing very strongly in the longer run.

Many investors assume that analysis will tell them what a company’s share price is going to do but what this episode highlights is that, often enough, a share price will do what it does and the analysts who are paid to follow the company instead follow the share price. And so, if analysis follows a share price rather than driving it, how should investors go about working out a company’s prospects?

They should do their own work and they should form their own view. And, as we always do, we did.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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