All bargain-hunters know before setting out for a jumble sale that at least 99 per cent of what’s on offer will be worthless. The joy of bargain hunting is in finding the priceless Charles Dickens love letter tucked inside a pile of Aunt Dolly’s old shopping lists. 
The same is true for value investors. We know our best chance of finding bargains is in sectors where others have completely lost interest. An example is retail. Ten years ago, on-screen reading was expected to replace physical reading, but today we know that it still hasn’t happened. It seems there is a place for on-screen reading and a place for physical reading.
The book trade has had to re-invent itself and fight back. In the same way, there is a place alongside online retail for a revitalised physical retail sector as part of a multi-channel offering. An investment opportunity exists because most investors have written off the retail sector entirely, together with the property sub-sector that serves it.
Where there's muck there's brass
New River REIT owns retail parks and around 600 pubs. Acutely aware of the threat from online retail, New River’s managers identify successful physical retailers as those who offer convenience, value or service, and actively look for tenants who demonstrate these qualities.
Retail assets have become so cheap now (well below the cost of rebuilding) that the sector is attracting new investment, from private equity, local councils and others. New River REIT offers a third-party management service to these new owners and has signed several new contracts in the last few months. Around 96 per cent of the company’s floor space is let.
Construction is another sector which has been dismissed by most experts as un-investable, despite the presence of excellent companies in the sector, the obvious ongoing need for construction, and the fact that fiscal stimulation, widely expected as a replacement for the monetary stimulation which has by now run its course, involves infrastructure projects which are hard to deliver without construction companies.
The surviving construction companies have learned the lesson of the last decade and are no longer prepared to sign up to large fixed-price, low-margin government contracts on terms which as often as not end up loss-making.
Room to build
A combination of Brexit uncertainty and a wider global market panic pushed Henry Boot’s share price down to its recent depressed level, despite no negative company-specific news. The company’s principle activity, Hallam Land, takes development land through the planning process and then sells it to housebuilders. Over the years, the land bank has steadily grown in size and the acreage sold has increased every year. Despite Brexit, demand for new houses remains strong and sales of land continue at a high level.
On the construction side, Henry Boot avoids large and unprofitable contracts. It builds development properties, always either pre-let or pre-sold, and undertakes construction work for third parties. This work is of a very high standard. Henry Boot’s housebuilding subsidiary, Stonebridge Homes, serving the area between Leeds and York, has grown from nothing in the last few years and now sells around 150 houses a year. Build quality is high and the company can sell as many homes as it develops. Growth over the next few years is likely to be rapid.
It is never prudent to predict what might happen in the short to medium term, but any of the following could trigger a major rally in ‘value’ shares – a rise in inflation, a rise in interest rates, an increase in infrastructure spending, the abandonment of QE, and evidence of slowdown in the growth rates of growth shares. The extreme valuation dispersions evident in the today’s market suggest that if such a rotation took place, it could be substantial and quick.
Ingredients for success
But before investors dive in they need to ensure that the ‘cheap’ shares you’re buying are genuine bargains, and not ‘cheap for a reason’.
For us there are three essential considerations that an investee company must fulfil.
Firstly, it must have a sustainable business model with a product or service which addresses a core need rather than an ‘impulse buy’. We prefer companies whose activities are more likely to be supported than challenged by legislation.
Secondly, a competent, motivated management which is running the company in its best interests and for the long-term is an essential part of the investment case.
Lastly, a company should have a sound balance sheet, ideally with net cash.
With all these ingredients present, investments can still go wrong, but a consistent focus on the essentials does seem to cut down the failure rate in our experience.
Tony Yarrow is portfolio manager of the Wise Multi-Asset Income fund. The views expressed above are his own and should not be taken as investment advice.