Are you buying value, quality or a story? Value Investing panel at UK Investor Show 2014

Bulletin Board favourites are mostly story stocks with poor quality and value ratios

Click to enlarge

The ever-smooth Ed Croft blew bubbles on the screen. Are Stockpedia's Quality Rank and Value Rank the
solution to our tendency to buy a great story stock, most of which will disappoint?
Addressing us in the old-fashioned way without a projector were investors Nigel Wray, Chris Bailey and
Paul Kavanagh of Killik & Co.

To kick off, Croft asserted that evidence is clear that, however you measure it, over the long term (4
years+):

• cheap stocks beat expensive stocks and 
• quality stocks out-perform junk stocks

Cheap means low PE, low PBV, low PCF or some combination.
Quality indicators are companies with strong franchise, positive earnings direction and low risk. ROCE is a strong quantitative measure.

Use Croft's interactive webpage. Click the Top Bulletin Boards button above the bubble chart.

Wray agreed about the out-performance and pointed out a further advantage of shares that generate good long term returns: the longer you hold a successful pick, the better the return if you are a capital gains tax (CGT) payer. The magic of compounding means that deferring the CGT hugely improves the final post-tax value compared to jumping in and out of positions and realising profit every year.

Why do people buy shares whose numbers show them to be expensive or poor quality?

Investors love a good story, promising outsized returns. I would add that 'doing the numbers' is not on everyone's checklist and in any case, once enthused, confirmation bias means we humans are willing to give good stories a lot of slack when it comes to balance sheets, tangible assets and real hard cash coming in.
Croft is not saying avoid all story stocks, just that they need more justification than quality-value ones. And judging a story is a lot harder than looking for booby traps under an otherwise good-value quality-brand car.
I've seen many AIM promotions, particularly mining and oil companies, that entirely rely on CEO charm, an exciting sounding potential resource (that is often a cast-off that cost them a tenner) and the difficulty of evaluating the risks, timescale and costs of development into production. The latter is called information asymmetry. Unethical directors will manipulate you as much as they legally can (and more) and it is your arch enemy.

Kavanagh did admit to picking some oil exploration shares "But it's lottery ticket type money."