Cigar butt approach to bargain buys

A share may not offer much, but if you buy at a low enough price there will nearly always be a chance to make a profit.

Warren Buffett, the big American investor, calls it the "cigar butt" approach to investing. "A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the bargain purchase will make that puff all profit." Ergo: if you buy a share at a low enough price you'll nearly always get a chance to make a profit at some stage.

Warren Buffett, the big American investor, calls it the "cigar butt" approach to investing. "A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the bargain purchase will make that puff all profit." Ergo: if you buy a share at a low enough price you'll nearly always get a chance to make a profit at some stage.

Barbados-based investor John Harvey obviously agrees with this approach. Ten days ago he popped up in the bus and trucks maker, Mayflower, having spent about £9m of his own money buying a 4 per cent stake. The shares have since jumped about 12 per cent.

Mr Harvey's investment looks to be classic "cigar butt" investing. Mayflower's shares are depressed on fears the US truck market is turning down sharply just as orders for buses in Britain are slowing. It also serves as a reminder not to lose sight of those measures that constitute cheapness in a share.

In Mayflower's case, the key measure is "price-to-sales" - the relationship between the value put on the business by the stock market and the company's annual turnover. May-flower is capitalised at £250m, which compares with sales running at about £670m a year. And it is still expected to make upwards of £60m pre-tax this year.

As a rule of thumb, any company valued at significantly less than one year's turnover is worth a second look - though I confess there are a few of them around in manufacturing right now. Rolls-Royce, the aero engine maker which upset the City a month ago when reporting its figures, is the most celebrated example.

Rolls is now valued at less than half its sales and at under a quarter of the value of its order book (which got another boost last week). The shares may take a while to recover because Rolls' management committed the cardinal sin of springing nasty surprises on the brokers' analysts that follow it, making them look less than prescient in the eyes of clients.

But it is bursting with orders, has taken the knife to costs, and within a couple of years will be making a fortune out of spare parts to service the bulging fleet of Rolls engines now powering the world's airliners.

At the other end of the spectrum, much the same argument can be made for the shares of United Overseas Group. UOG specialises in buying up stocks of toys, toiletries and household goods that the manufacturers are finding hard to shift - and then wholesaling them on at a discount to the big retailers. After buying up a Dutch competitor, it is the European leader in this game.

That did not help much when it got itself stuck with a mass of slow-moving toys 18 months ago and plunged into loss. But there have since been management changes and UOG is back in profit.

The businesses in Europe, the UK and the US are starting to work together more closely, stocks are coming down steadily, and a new broker has been appointed in the shape of Williams de Broe.

At 21p, the company is valued in the market at £29.4m. That is a small discount to asset value and less than half annual sales.

Peter Shearlock is the author of the 'Growth Company Investor Weekly Digest'

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