Neil Woodford’s reputation as a shrewd stock picker is in tatters. And he pulled off that feat by switching investing styles, it seems.
He built his reputation during his 25 years at Invesco. There, he invested in mainly large companies. And he had a knack for getting the big calls right. For example, he avoided the worst effects of the 1990s dotcom bubble by steering clear of over-priced stocks. And he navigated the 2008 financial crisis by taking actions such as selling his holdings in bank shares some time before the stock market collapse.
Neil Woodford’s shrewd stock-picking
His big gains came from pouncing on shares in out-of-favour sectors such as tobacco. Then he held on to his stocks for a long time. Over around 20 years, the tobacco sector became the best-performing in the UK stock market. Indeed, shares such as British American Tobacco and Imperial Brands (Imperial Tobacco as it was back then) powered ahead, driven by powerful cash flow and rising dividends. The valuations up-rated over time, and previous low earnings multiples became chunky double-digit numbers.
Woodford repeated the trick with another defensive, cash-generating sector – pharmaceuticals. When everyone was worried about patent cliffs and falling earnings back in the mid-to-late noughties, he loaded up with stocks such as AstraZeneca and GlaxoSmithKline. The valuations were modest. Now, worries are fading and the valuations are rating higher – just like tobacco stocks did.
But Woodford didn’t stick to the strategy that brought him so much success. Instead, when he started up his own Woodford Investment Management company, he gradually ditched the big-caps and started buying smaller cyclical companies. But those firms had previously enjoyed several years of high earnings. And the valuation measures looked low, such as modest P/E ratings and high dividend yields.
Peter Lynch knew better!
It proved to be too early to head for the cyclicals, and many plunged after he bought them. Indeed, Peter Lynch cautioned against buying cyclicals under such conditions in his books One Up on Wall Street and Beating the Street. Lynch argued that the best time to buy cyclical shares is when earnings and share prices have plunged, and when valuations superficially look high when measured against lower profits.
Recently, the coronavirus pandemic has created the ‘right’ conditions for buying cyclical shares. Many are now springing up from their lows. For example, banks look attractive, along with housebuilders, retailers and others. Indeed, investing in cyclicals over the past few years looks like one of the big calls that Woodford got wrong.
But it wasn’t the only cause of his troubles in the markets. He started investing in speculative, often profitless ‘jam-tomorrow’ stocks with a great story. And few of those types of stocks tend to outperform over time. Yet Woodford really went for it and loaded up with many of them. But he had little obvious previous experience with that investing style.
My guess is Woodford could have achieved great results if he’d stuck to his original investing style of picking good-quality, defensive stocks when they are selling cheaply. The market is ripe for such an approach today, and we don’t have to make the mistakes that toppled Neil Woodford.