LONDON -- When a company's prospective price-to-earnings ratio is less than seven and the yield is 7% or more, something clearly isn't right. The hard part is deciding in which direction things are skewed. Either the share price is going to rise to normalize things a little more or the earnings forecasts and dividend will get cut -- or there will be some combination of the two.
The "7-7" screen comes as a result of reading the book Free Capital: How 12 Private Investors Made Millions in the Stock Market by Guy Thomas. Among others, the book profiles well-known private investor John Lee, who writes regularly about his personal investments for the Financial Times.
John Lee follows straightforward value investing principles, paying particular attention to dividends. He describes his basic approach as "DVD investing" -- short for "defensive value and dividends." He looks for "double seven" shares as a starting point for further research.
When I last ran this test, the 7-7 shares flagged up at Christmas had put in a remarkably good performance over the first quarter. At the end of March, the list looked like this:
The top seven 7-7 shares as of March 30
1. Aviva (ISE: AV.L)
3. Smiths News
4. Interior Services
5. GVC Holdings (ISE: GVC.L)
6. Begbies Traynor
This time, the overall performance picture doesn't differ hugely from the market. Over the period since March 30, the FTSE has lost 1.4% -- slightly worse than the seven above, factoring in dividends.
The class dunce has been Interior Services, which has managed to lose close to 17% of its value, followed by Foolish favorite Aviva with a 13.3% eurozone-worry-induced fall. On the credit side, GVC Holdings has put on close to 25%, while Smiths News has managed a 7.4% gain, factoring in the 2.8 pence dividend.
Incidentally, online gaming group GVC nearly made today's list, given its prospective P/E of less than six and its unfeasibly high expected yield of 13.8%. But it was just edged out of the top seven by office2office (ISE: OFF.L) , whose market cap is slightly larger. Bear in mind, though, that GVC's forecasts are based on the views of one broker only.
Before we have a look at today's top seven 7-7 shares, it's worth pointing out this screen's limitations. It serves as a basis for ideas only. There are usually good reasons for a company's appearance on such a list. If you're confident in a company's recovery prospects, or there's significant tangible balance-sheet strength and cash flow, or you're in it only for maintenance of the yield (and you think it can be maintained), then that's fine. But it's essential to be aware of the limitations and understand the risks involved. Nevertheless, it's an interesting starting point.
The latest version of the 7-7 screen gives us the following top seven based on closing prices from July 6 and using consensus broker forecasts for 2013 -- by descending market capitalization:
The top seven 7-7 shares now
Share Price (pence)
1.Man Group (ISE: EMG.L)
5.St Ives (ISE: SIV.L)
The last time I ran this screen, Aviva's shares were at 331.7 pence. Today, they're 288 pence. Despite this fall, the prospective P/E is a smidgeon over seven, as brokers' forecasts are a little more depressed, so it doesn't quite make the shortlist. The prospective yield, though, is now 8.8%.
There are some worryingly high and low figures on there, which clearly indicate the need for further research.
From today's list, Man Group looks like an interesting punt to me, but it's one I haven't taken yet (though I've traded it in the past successfully). Be careful, though; only the most optimistic of brokers expect the dividend to be covered by earnings for 2013, and not one expects this to be the case for the current year.
I also quite like the look of St Ives on a sustainable-yield basis. The company's shares went up 50% in short order after I looked at it in more detail a couple of years ago.
There's too much debt with the others for my liking, and I can't quite make up my mind about Halfords. What do you think?
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At the time thisarticle was published David owns shares in Aviva. He doesn't own shares in any of the other companies mentioned. The Motley Fool owns shares in Halfords.Motley Fool newsletter serviceshave recommended buying shares of Halfords. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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