Which Is Better: Value or Yield? Part 1

This is the first part of a two-part transcript in which Fool.co.uk's David Kuo chats with longtime Foolish writer Stephen Bland about his style of investing. Stephen, who is an exponent of both value and yield investing, explains why it is important to understand the difference between the two when a share can straddle both styles. They look at IG Group (LSE: IGG.L  ) , Royal Bank of Scotland (LSE: RBS.L  ) , and Aviva in detail.

You can read the second part of the transcript here. You can listen to or download the full podcast here.

EDITOR'S NOTE: What follows is a lightly edited transcript of David Kuo's conversation with Stephen Bland.

David Kuo: This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and my guest today is a man who is to investing what Black & Decker is to the DIY trade. He makes his tools for investing easy to use, easy to understand, and easy to get the job done. He is Stephen Bland, otherwise known as "Pyad"; he is a longtime writer here at The Fool, and he is with me now. Welcome back to Money Talk, Stephen.

Stephen Bland: Thank you, David -- I'm not so sure about the Black & Decker analogy, but I'm glad to be here.

David: OK, as long as it's Black & Decker and not Black & Wrecker, you're OK? So anyway, as an investor, you wear two very different hats: a value hat and a high-income hat, and for the benefit of listeners, can you describe the difference between the two?

Stephen: Yes, it's quite simple. Value shares are for trading -- they're for people who want to make money buying and selling those types of share. The high-yield portfolio, HYP, is a long-term hold strategy for investors who want income. Even if they're reinvesting it for the future, it is an income-based strategy, whereas value shares are a trading strategy short term, although short term could be some years, but the idea is to sell the share, and not just to sit on it for income, in contrast to the high-yield approach, whose purpose is purely to achieve an income, a rising income, quite often for retired people.

David: We'll go on to some examples of high-income shares, and also value shares, but at this point it's probably worthwhile saying that sometimes a share falls in value -- consequently, it looks as though it's very high yield, doesn't it? So there are crossovers between the two?

Stephen: Yes, there are many shares, for example, Aviva, which could be seen as both an income share and a value share. However, the attitude of the investor is what determines the difference, because somebody buying Aviva as a value share is looking to sell it and make a capital gain, whereas somebody buying it for his income portfolio is seeking it purely to derive a very long-term income from it, so it's the attitude of the investor that determines the difference, even though some shares fit both types of investment strategy.

David: And, of course, you know one thing about Aviva is that, if you were to buy at the current share price, where you're actually getting an 8% yield, even if the share price were to rise subsequently in the future, you would still be getting 8%, or you would still be getting a yield on cost of 8%, wouldn't you? Because you're actually sort of paying at a much lower price.

Stephen: Yes, assuming, of course, they don't cut the dividends, which is always a threat with any income share, and that's why you have to have a portfolio of them, of different industries. Yes, your yield is locked in at the start -- in fact, it should rise. The idea of the income strategy is that not only is it locked in, but it should increase over the very long term, so yes, that's an attraction, but that is specifically looking at it from an income point of view. As a value investor, you don't really care much about the yield -- you're in it to trade it.

David: OK, as somebody who does both, I mean, you do both value investing and also high-income investing. Now generally, what we tend to find with a lot of private investors is, they pigeonhole themselves -- they're either income or they're value or they're growth, and they find it very difficult to switch between the different disciplines. So how easy do you find it to switch, say, from value investing, which you write about, and also high-income investing, which you also write about?

Stephen: Well, it's very easy -- they're two different audiences, that's the point. When I'm writing about my income, HYP strategy, I write in a way that addresses itself to those readers, and when I'm writing about value shares, I write about a share in a manner which is aimed at the value share trader. So I don't have a problem with that, although the whole income idea actually is a sort of remote cousin of value. I was originally writing only of value on the Fool site, it's shortly after that I introduce the income strategy. But I don't have any problems switching between the two, because I think to myself, who am I writing this article for? And that determines how I write the shares.

David: But can you understand how some private investors are pigeonholing themselves, and they say, I am an income investor -- I don't want to talk about growth investing; I don't about value investing because I think it will just complicate my style of investing?

Stephen: Yes, I mean, the private investor, a lot of them don't know what they want. Are they income investors, are they traders? Are they value traders, or are they using some other trading approach, like charting, for example? That's not my fault -- that's for the private investor to ask themselves, what do they want out of the stock market? They have to make that decision, and the inability to make that decision, and constantly chop and change between various strategies, is why a lot of them go wrong. They have to decide how they want to approach the market, what they want from it, and what they intend to do to achieve that aim. I faced that problem early on, when I was just little more than a teenager. I didn't really know what I wanted -- I bought and sold on tips and lost money. You have to evaluate the strategy which suits your personality, and your situation in life. A retired person, for example, is very likely to want an income portfolio; a younger person may want a value trading portfolio, or want to use some other technique, like charting, but that's for the investor to sort out. I can't do that for people. They have to look at themselves, analyze themselves, and decide what sort of personality they have. They may not have a share personality at all -- probably a lot of share investors don't; they're better off in a fund, or just keeping their money in the bank. They just can't deal with it. So the investor has to decide, by analysing themselves and being honest about it, which a lot aren't, what they want from shares. 

David: OK, so let's have a look at some of the shares. I mean, this is one that you used to have in your portfolio, but you no longer have it now. It's IG Group -- the ticker code is IGG. Now, in this case here, I've looked at IG Group. It has a P/E of 12, it yields 5%, price to book is five, it has no debt. Now, what kind of share would you say this was?

Stephen: I would say, I first bought this share at about 250, and it's now round about 450, so for me it was a superb value play, and it also was in the value portfolio that I run on The Motley Fool; it's been in there and traded at a good profit, so it was a value share, a strong value share. Now, I'd say it's a mild value share with a P/E of 12, and no asset cover, and asset cover is the biggest attribute I seek in a value share, which doesn't exist here -- I'd put it as a mild value play, but it's much more of an income share. It's got a good increasing dividend -- I don't think it's cut its dividend since it came back to the market a few years ago. The yield is good; the business is perhaps a bit chancy -- it's a spread-betting bookmaker. But I'd say it's far more of an income share now than a value play, but it might have a little mileage in it as a value play.

David: OK, but this is what I mean when I'm talking about examples of shares where people, on the one hand, when you tipped it, it was a value share, but other people would have seen it also as an income share, at that time?

Stephen: Yes, it could have been both. Many shares are both -- I mentioned Aviva earlier, for example. That at the moment, and for some time, has been both, and what the investor wants from it is up to him. You could have it in an income portfolio, you could have it in a value trading portfolio.

David: OK, so let's have a look at some of the shares that you have in your portfolio at the moment. One of those is Royal Bank of Scotland. Why have you selected RBS as a value share, when everybody says it's a dog?

Stephen: Because of my four PYAD value ratios, the most important one, what I've called the king, is price to book -- in other words, the share is trading below its tangible book value. Tangible is very important -- it's not just total book value; we take out intangibles. RBS, the only thing it has is value, but it's the lead value ratio, it's an extremely low price to book of about 0.5 -- that is very low. On top of that, RBS actually mentions its tangible book value in its regular reports -- that's extremely unusual. Companies, if they mention book value, they mention total book value. RBS actually highlights tangible book value in its reports, suggesting that they attach a lot of importance to that figure, and also, of course, RBS is totally trashed, at a tiny fraction of its earlier price before the credit crunch. So I think it's got a lot of upward mileage, and it's trading on a low price to book. It hasn't got anything else -- it's got no profits, it makes losses, it's got no dividends, and, of course, being a bank, it's going to have debt anyway -- all banks have debt. So its sole value attribute, but the most important one, is this extremely low price to book.

David: So why isn't its share price double what it is now, if the price to book is 0.5?

Stephen: A very good question -- well, the continuing losses don't help; the continuing bad news that it seems to be, progress from one problem to another, mostly problems of the past. But there's been so much bad news on banks for the last few years, not just the credit crunch itself, which RBS was bankrupt and was saved by the government, but since then we've had a series of scandals, as everyone knows. RBS most recently had a problem in NatWest, I think, with its computer systems -- that's only a few weeks ago. It staggers from one problem to another, so that's one reason why it's bombed out. Also, there's no real sign of a recovery yet -- that's the second reason. Every set of accounts I've read, and I read them all, every quarterly report for the last few years, it shows bottom line losses. Well, that doesn't help them to push the price up, so there's a lot of negative sentiment around RBS, essentially because it's not making any money.

David: Now, you use this thing called the PYAD ratio, which stands for Price to Earnings, Yield, Asset and Debt. Now, there's no mention there of management -- why don't you care about how managers run a business?

Stephen: I think they're irrelevant. I realize that's controversial. If a business has assets, something you can kick, then it's got assets, regardless of the management. In fact, value shares often have become value, that is low-rated, precisely because they've got poor management, so you could argue that I actually prefer lousy management, because sooner or later, someone's going to come -- it's either going to be taken over, or someone's going to reorganize it, and thereby drive the price up. So if I have to prefer management at all, it's lousy management, which sounds odd ... but essentially I'm not interested. I mean, people write all over The Motley Fool and other message boards, referring to the chairman or the chief executive, by nicknames, if they know them personally. I never know most of the time, unless I happen to read it on a message somewhere, who the management are -- it's the least interesting thing to me of all. I'm just a numbers man -- I don't think managements are important at all.

David: But in the case of Royal Bank of Scotland, we have a bank here that's been involved in payment protection insurance transgressions; it's been involved in Libor scandals; it's had an IT problem -- doesn't that tell you something about the way that this bank is run?

Stephen: Yes, but that's the old management. Stephen Hester, who's the CEO, I think he remarked recently that he's gotten rid of almost all of the old management, Fred Goodwin, etc., who ruined the company. So if you want to look at management, that company has new management in progress -- it's just that it's a gigantic job to turn it round, and they're not making a lot of progress, although they claim they are in the reports, but it still makes losses. So yeah, in the case of RBS, I suppose you could argue that it's the new management that will turn it round. The problems are mainly from the old management, although the recent scandal of the computer systems failure was, of course, one of the current management, but I don't attach any importance to it. If they turn it round, fine, but it's not something I look at. I don't look at the management when I analyze a share -- I only look at the numbers.

David: OK, now one thing that you do attach a lot of importance to, and you've already mentioned it on this podcast, it is the price-to-book ratio. Now, I've looked at Royal Bank of Scotland -- it's got a price to book of 0.5, and Barclays (LSE: BARC.L  ) also has price to book of around 0.5, but in the case of Barclays, it makes a profit, it pays a dividend -- so why did you pick RBS, rather than Barclays?

Stephen: Because I think RBS, because it's bombed out because it was bust, Barclays never went bust. As far as I know, it never had any government aid. RBS was almost wholly nationalized, over 80%, because it was bust, therefore it had gone down much more. There's much more upside in RBS than Barclays, despite the somewhat similar figures, and the superficially more attractive situation of having a small yield, as you say. I think RBS, because it's so low, it's got way more upside than Barclays. Don't hold your breath -- we're talking about a lot of time here, but that's my view, and that's the reason I prefer RBS to Barclays.

David: So what you're actually sort of saying is that, in a two-horse race with RBS and Barclays, RBS is more likely to come from the rear and win the race before Barclays?

Stephen: Yes. Although the PT/B's the same, I have the feeling that RBS has more upside. As you say, it's likely to overtake Barclays, providing it recovers. Don't get me wrong -- there's huge risk there, with the government. There's been vague talk in the media of the government taking over the remaining few percent it doesn't own. There's a lot of risk here. But assuming RBS recovers, and that's what I believe, and assuming Barclays does better as well, I think all banks will recover in the end, the ones that haven't gone bust. I think the upside potential is far greater in RBS than in Barclays, and Barclays will do well also, if banks recover -- they'll all recover. I think RBS will recover more than Barclays. The percentage rise to recovery, I think, is much greater in RBS than Barclays. I could be wrong -- it's just my view.

David: OK, now I've heard some people say that bank shares at the moment, and that's including both Barclays and also Royal Bank of Scotland, and in the case of Barclays, I am a shareholder myself; now, what they're saying is that these are value traps, rather than value shares or value play. What do you say about that -- this term, value trap, for banks?

Stephen: Well, it's not only used for banks -- I've heard it for years. I don't like the expression -- it's used by disillusioned value players, they buy a value share, and if it doesn't out, they call it a value trap, and you can sell it. So I don't know what a value trap is. It's supposed to be a value share that's never going to out, but how the hell do you know that? So I think it's more of a sort of derogatory expression from people who have just given up, because you need enormous patience to be a value investor, and some people just don't have it, and yet still go into the strategy, and then become disillusioned and they will then call a share that hasn't done what they expected it to do in the time they held it, a value trap, but I really don't know what that means, other than what I've said. A value share is a value share. I think value will out in the end, as long as it hasn't evaporated by the assets disappearing, or something. But I don't really like that expression at all -- it's just a value share that hasn't yet outed.

That was the first part of a two-part transcript in which Fool.co.uk's David Kuo chats with longtime Foolish writer Stephen Bland about his style of investing. Stephen, who is an exponent of both value and yield investing, explains why it is important to understand the difference between the two when a share can straddle both styles. They look at IG Group, Royal Bank of Scotland and Barclays.

In the second part of the transcript, Stephen explains why he has 60% of his portfolio in Aviva. Just click here to continue reading.

David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors for 2012" -- while it's still free!

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Stephen holds shares in Aviva, IG Group, BP, and Barclays. David holds shares in Barclays and BP. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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