After what happened to equity markets in 2008, many financial "experts" began to question whether or not any investing school of thought really worked. Those who believed that the market was efficient found egg on their face when all was said and done. I didn't need 2008 to prove to me that markets were inefficient. The proof positive reason I have for market inefficiency is simple this: the stock market consists of human participants who by their very nature are irrational and inefficient creatures.
The other school of thought that took a beating was that of value investing. I've never really been fond of using the term value investing, since I subscribe to the Charlie Munger view that "all investing is value investing." Further I believe that the value and growth aspects of investing are merely two sides of the same coin. Nonetheless, its because precisely that so few individuals actually subscribe to the tenants of value investing (those being risk aversion, avoidance of crowd psychology, buying businesses in out in favor places, etc.) that we do use the term value investing. So it is in this context that I dispense of the term value investing and how I adhere to it.
Let me use a moment now to throw in a shameless plug for my recent book that was just published by John Wiley and Sons, "The Business of Value Investing" which focuses on precisely how a businesslike mind frame is what true value investors employ in selecting equities. The book focuses on the six essential elements (use of the word element is deliberate - elements are essential to life) that are incorporated in the value investors mind.
Back to the topic at hand. Value investing was left for dead after 2008. I mean when Bill Miller nearly 50% in a year and Mohnish Pabrai drops by nearly 60%, surely the approach is flawed. Never mind that folks criticizing the tenets of value are dismissing over 80 years of results by Ben Graham, Walter Schloss, Warren Buffett, and Seth Klarman. Even I will admit the Gad Partners Funds' had a terrible 2008, down nearly 45 percent. But the value investor sticks to his knitting, obviously willing to tweak his or her approach, but never doubting the inherent success of the foundations of value investing. (By the way, I believe Miller is up nearly 50% this year and Pabrai is up over 100%. As for the GPF, I can't get into the specifics but we are in between Miller and Pabrai. Obviously simple tells you that even those results have yet to get any of us back above 2008 levels, but we are not done, not by a long shot.)
Where many "value" folk go wrong is in a very fundamental sense. Many investors spend far too much time focusing on the income statement first and the balance sheet second. No question, profits are important, but without a solid foundation, those profits are only as good as the business environment. And no business environment stays rosy forever - there are hiccups. And if business setbacks are hiccups, 2008 was a trip to the ICU.
The balance sheet must always be the most relied upon piece of information. In basic value terminology, the balance sheet is the FIRST MOAT. Of course, the balance sheet alone is not enough. The income statement is the SECOND MOAT. A debt free, cash rich company is great, but not so great if that business can't produce profits. Still a profitless company with a sound balance sheet still has value creating catalysts - buyout, liquidation, etc. - that serve to protect the investor. The same is not true for a profitless company loaded with debt or poor assets. The results here can often be massive shareholder dilution in order to keep the company afloat or worse, bankruptcy.
Tuesday, October 13, 2009
Thursday, September 17, 2009
Thursday, September 10, 2009
Macro Matters
Despite the often perceived notion that adherents of value investing ignore the macro economy, nothing could be further from the truth. Make no mistake: the central tenant of value investing is to buy assets at a significant discount to thier intrinsic value, where such an intrinsic value is typically determined by the cash generation of those assets.
The problem to those outside the value circle looking in is that value investors often make such investments during the most pessimistic market environments, which almost always means that the stock price will fall some more once it is purchases. This leads many to believe that a value oriented approach ignores macro economic considerations.
Such beliefs are myths and if you look at the approaches of the most successful value investors, consideration is always given to certain macro economic factors. Understanding this delicate distinction will prove very fruitful to investors going forward in making investment decisions.
If there is anything that trumps all other considerations to a value investor, it’s the price paid for a security. In many cases, a fire-sale price can be overcome by macro considerations. For example, consider the restaurant industry. For many reasons, many restaurants aside from ultra budget friendly places are relatively unattractive investment candidates to many value investors. Restaurants are often characterized by thin profit margins, extremely low barriers to entry, and the availability of numerous substitutes.
But what is also considered are things like the rate of unemployment, the household savings rate, and consumer spending. You might not see this in the value investor's analysis of the company per se, but they are all seriously considered in any worthwhile analysis.
Nonetheless, where the value investor hinges his ultimate bet on is the price paid for the security.
The Future for Investors
So looking ahead, what doest this mean for investors? It means that just because a stock has a P/E of 8, it might not represent a bargain when you consider the macro environment going forward. As noted investment manager Jeremy Grantham remarked recently after the recent market rally, it appears the market is headed for “seven lean years.”
But it also means that value can be ascertained in various forms. For mental stimulation, consider the following example:
For instance at P/E of 20, many value "wannabes" may be quick to dismiss Hutchison Telecom International a company that provides mobile and fixed line telecommunications services in the Asia-Pacific region, specifically in areas like Indonesia, Vietnam, and Thailand. You’re essentially getting a company with a huge option on increased telecommunications use from the world’s fastest growing region.
Hutchison used to be a huge amalgamation of telecom businesses throughout the emerging world. However, the company recently spun-off the Hong Kong and Macau operations into Hutchison Telecommunications. HTX is now the more “volatile” growth targeting emerging markets provider. Even after the spin-off Hutchison Telecom owned 51% of Partner Communications the number 2 telecom based in Israel. Subsequently the stake was put up for sale for $1.38 billion
Quickly looking at Partner, Hutchison Telecom may seem like an absurd bargain. Hutchison currently has an enterprise value of some $1.5 billion, while the 51% stake in Partner is will fetch HTX $1.4 billion. This might seem that investors are getting to bet on telecommunications growth in Indonesia, Veitnam, and Sri Lanka for free. Unfortunately, the market is already aware of about $900 million in cap ex that Hutchison is planning for expansion into the emerging countries. Still, if any of those emerging countries do as well as India or China in terms of penetration, there’s huge upside.
So Hutchison offers a very interesting play in the fastest growing region in the world. Underlying this thought is a favorable long-term macro view: as a country develops its citizens will need communication capabilities.
If you train yourself to look at a company in such a fashion, you begin to understand what matters most when looking at a business.
Put the Process Before the Outcome
Value investing works if pursued patiently and meticulously. The goal is to always seek out market mis-pricings because when you can, the margin of safety protects you from sudden or temporary shifts in the macro-economic environment. But that doesn’t mean value investors ignore the macro economy, instead it’s always factored into a thorough and quality analytical framework.
The problem to those outside the value circle looking in is that value investors often make such investments during the most pessimistic market environments, which almost always means that the stock price will fall some more once it is purchases. This leads many to believe that a value oriented approach ignores macro economic considerations.
Such beliefs are myths and if you look at the approaches of the most successful value investors, consideration is always given to certain macro economic factors. Understanding this delicate distinction will prove very fruitful to investors going forward in making investment decisions.
If there is anything that trumps all other considerations to a value investor, it’s the price paid for a security. In many cases, a fire-sale price can be overcome by macro considerations. For example, consider the restaurant industry. For many reasons, many restaurants aside from ultra budget friendly places are relatively unattractive investment candidates to many value investors. Restaurants are often characterized by thin profit margins, extremely low barriers to entry, and the availability of numerous substitutes.
But what is also considered are things like the rate of unemployment, the household savings rate, and consumer spending. You might not see this in the value investor's analysis of the company per se, but they are all seriously considered in any worthwhile analysis.
Nonetheless, where the value investor hinges his ultimate bet on is the price paid for the security.
The Future for Investors
So looking ahead, what doest this mean for investors? It means that just because a stock has a P/E of 8, it might not represent a bargain when you consider the macro environment going forward. As noted investment manager Jeremy Grantham remarked recently after the recent market rally, it appears the market is headed for “seven lean years.”
But it also means that value can be ascertained in various forms. For mental stimulation, consider the following example:
For instance at P/E of 20, many value "wannabes" may be quick to dismiss Hutchison Telecom International a company that provides mobile and fixed line telecommunications services in the Asia-Pacific region, specifically in areas like Indonesia, Vietnam, and Thailand. You’re essentially getting a company with a huge option on increased telecommunications use from the world’s fastest growing region.
Hutchison used to be a huge amalgamation of telecom businesses throughout the emerging world. However, the company recently spun-off the Hong Kong and Macau operations into Hutchison Telecommunications. HTX is now the more “volatile” growth targeting emerging markets provider. Even after the spin-off Hutchison Telecom owned 51% of Partner Communications the number 2 telecom based in Israel. Subsequently the stake was put up for sale for $1.38 billion
Quickly looking at Partner, Hutchison Telecom may seem like an absurd bargain. Hutchison currently has an enterprise value of some $1.5 billion, while the 51% stake in Partner is will fetch HTX $1.4 billion. This might seem that investors are getting to bet on telecommunications growth in Indonesia, Veitnam, and Sri Lanka for free. Unfortunately, the market is already aware of about $900 million in cap ex that Hutchison is planning for expansion into the emerging countries. Still, if any of those emerging countries do as well as India or China in terms of penetration, there’s huge upside.
So Hutchison offers a very interesting play in the fastest growing region in the world. Underlying this thought is a favorable long-term macro view: as a country develops its citizens will need communication capabilities.
If you train yourself to look at a company in such a fashion, you begin to understand what matters most when looking at a business.
Put the Process Before the Outcome
Value investing works if pursued patiently and meticulously. The goal is to always seek out market mis-pricings because when you can, the margin of safety protects you from sudden or temporary shifts in the macro-economic environment. But that doesn’t mean value investors ignore the macro economy, instead it’s always factored into a thorough and quality analytical framework.
Tuesday, April 28, 2009
Invest Like It's The End of the World and Be Rewarded
It's been nearly four months since I last posted - it's always about quality not quantity, eh? Needless to say, I've been - and happily so - swamped with reading annual reports and finishing up my first book, due out in October. Nonetheless, with investors of all stripes turning thier heads looking for answers, I'm here to say I don't have any. But I do have some thoughts on what seems to be a prudent approach to our craft.
I have a lot of respect for Ian Cumming and Joe Steinberg, the top brass at Leucadia. Like everyone else, they had a dismal 2008. Many of Leucadia's investments - commodities, real estate, wineries - are simply dependant on the economy turning around. But one year a track record doesn't make. But 30 or so years it does and Leucadia's results over that time have been off the charts: book value per share has increased at a 17.3 compounded annual growth rate from 1979 - 2008.
So naturally, I enjoy reading the company’s annual letter to shareholders for any nuggets of wisdom or investment ideas since Leucadia is nothing more than a conglomerate of investment holdings. Reading Leucadia's annual letter over the weekend, I was intrigued by Cummings and Steinberg's assessment of the future.
"Out of prudence we have a pessimistic view as to when this recession will end. To think otherwise would be to gamble about the beginnings of good times whereas by imagining a bleak future we will most likely survive for the good times to arrive."
So naturally, I enjoy reading the company’s annual letter to shareholders for any nuggets of wisdom or investment ideas since Leucadia is nothing more than a conglomerate of investment holdings. Reading Leucadia's annual letter over the weekend, I was intrigued by Cummings and Steinberg's assessment of the future.
"Out of prudence we have a pessimistic view as to when this recession will end. To think otherwise would be to gamble about the beginnings of good times whereas by imagining a bleak future we will most likely survive for the good times to arrive."
I find the above statement to be one of the greatest pieces of investment wisdom I've come across recently. Investors would be well served to take the above assessment and apply it to their investments going forward. I like to call it an “invest for the worst and hope for the best” kind of approach to investing today.
My approach stems from the fact that investors are crazy if they are analyzing most businesses based on 2007 profits/multiples. Don't get me wrong: we could very well be easily sitting in the midst of the greatest buying opportunities of a lifetime. Indeed, I lean towards this view. However, it's with prudence that investors must assume that the market will remain in a funk in order to profit handsomely when spring does come. Because if you assume the worst, your investment process, by default, will become much more skeptical. All investors should arm themselves with a healthy does of skepticism at all times.
The wonderful thing about 45% market declines is that many stocks fall a lot a harder, thus setting the setting for phenomenal returns. Forget the preverbial 50 cent dollar - they are a dime a dozen today. Thirty cent - even ten cent dollars - can be found today with a little extra effort.
True value investors are not afraid to pounce if a security is widely undervalued. They time stock prices and not stock markets. In a recent interview Buffett said he would relish the opportunity to be in his 20's all over again today.
We're certainly not out of the woods yet, and it seems that it really won't be until 2011 until the economy recovers again. But it's a guessing game as to when the stock market will turn - they are forward looking creatures after all. But then again, value investors aren't timing stock markets.
Monday, January 5, 2009
What Really Matters In Investing
Why Prudent Investors Focus on Holding Period Returns
With 2008 finally over, many investors have equity portfolios that have shriveled by 30% to 70%. Simple arithmetic will tell you that if you're down 50% in 2008, you need a 100% return to get back to even. While possible, it will be a remote possibility for many to earn a triple digit return in 2009 considering that many consider it to be a healing year at best.
Whether we like it or not, investing is most beneficial and pays off when done for a period of many years. As such, investors holding securities are better off focusing on holding period returns, which is what really matters. The stock market swings wildly in the short run, but over time, stock prices have always caught up with the underlying fundamentals of the business. Skeptics will correctly argue that investing a dollar invested in the market over the past decade would be worth slightly less today. But I’m not talking about investing in the broad market, but instead individual securities.
One thousand dollars invested in steel producer Nucor would be worth about $20,000 at the end of 2008. The same $1,000 invested in UnitedHealth Group in 1998 would be worth over $15,000 today once you factor in three 2 for 1 stock splits that occurred in 2000, 2003, and 2005. Even boring old Wal-Mart shares would have been worth about $3,000 today in exchange for putting up $1,000 in 1998, and this is not including the dividend. And even and investment in 1998 in Whole Foods which today trades around $9 share, down from an all-time high of $80, would be up over twofold when accounting for the two stock splits.
The market is tough to beat, but you could have easily made satisfactory returns over the past ten years in which the market went nowhere. And these returns would have outperformed real estate, bonds, and just about any other asset class.
The next decade will be no different even if you started in 2008 and can muster the courage and patience to keep going. No one has a clue what the market performance over the next five and ten years will be. But everyone will agree that there will be many companies that will be bigger, better, and more profitable. And Mr. Market doesn’t care about fundamentals in 2008, businesses that continue to improve profit generation will ultimately be recognized.
History Doesn’t Repeat Itself...But It Does Rhyme
Knowing a little market history after the worst year since the Depression can be very instructive. The following chart shows how the Dow has fared during and after recessions.
Recessionary Period (Change in Dow during recession) (Change one year after)
Aug 1929 - March 1933 (-84.2%) (81.1% )
May 1937 - June 1938 (-23.2%) (-2.4%)
Feb 1945 - Oct 1945 (21.3%) (-9.4%)
Nov 1948 - Oct 1949 (-0.12%) (18.7%)
July 1953 - May 1954 (21.6%) (29.7%)
Aug 1957 - April 1958 (-9.9%) (36.8%)
April 1960 - Feb 1961 (7.5%) (6.9%)
Dec 1969 - Nov 1970 (-1.4%) (4.7%)
Nov 1973 - March 1975 (-19.0%) (30.1%)
Jan 1980 - July 1980 (11.5%) (1.9%)
July 1981 - Nov 1982 (7.4%) (22.8%)
July 1990 - March 1991 (1.2%) (11.0%)
Mar 2001 - Nov 2001 (-5.7%) (-9.7%)
The crucial part, of course, is how long our current recession will affect the market. No one truly knows. What we do know is that the market will have turned by the time we get the “official” word.
But another important chart to look at is below.
Company [2001 Price] [2003 Price] [2007 Price]
Apple [$7-$13] [$6 - $12] [$82 - $200]
Vulcan Materials [$37 - $55] [$29 -$49] [$77 - $129]
Tesoro Corp [$5 - $8] [$2 - $7] [$31 - $66]
Transocean [$23 - $57] [$18 -$26] [$73 - $150]
Fluor [$15 -$31] [$10 - $22] [$37 - $86]
Source: Value Line (note: prices reflected low’s and highs for the year are rounded to nearest dollar for illustrative purposes)
The sample above is instructive in showing us how markets behave. Many securities that were bought in 2001 - a year of double digit market declines - were deeply underwater at the end of the year. Two years later many investors were still down by over 50% on many holdings if they had held on. But by 2007, if you had invested in solid companies with great earnings power, you more than made up for it. Even with a 60% two year decline in share value for Fluor shares in the heavy construction firm more than rewarded long-term investors. Assuming you had bought at $25 in 2001, you were down over 50% by 2003. Assuming you had sold at $65 in 2007, your six year holding period return was $160%. I’ll take numbers like that all day.
This recession is vastly worse than the 2001 variety. But as a long-term investor, you should keep your focus on holding period returns and if you stick with businesses that will be doing well a couple of years from now, you’ll realize that stocks can still produce the best returns.
With 2008 finally over, many investors have equity portfolios that have shriveled by 30% to 70%. Simple arithmetic will tell you that if you're down 50% in 2008, you need a 100% return to get back to even. While possible, it will be a remote possibility for many to earn a triple digit return in 2009 considering that many consider it to be a healing year at best.
Whether we like it or not, investing is most beneficial and pays off when done for a period of many years. As such, investors holding securities are better off focusing on holding period returns, which is what really matters. The stock market swings wildly in the short run, but over time, stock prices have always caught up with the underlying fundamentals of the business. Skeptics will correctly argue that investing a dollar invested in the market over the past decade would be worth slightly less today. But I’m not talking about investing in the broad market, but instead individual securities.
One thousand dollars invested in steel producer Nucor would be worth about $20,000 at the end of 2008. The same $1,000 invested in UnitedHealth Group in 1998 would be worth over $15,000 today once you factor in three 2 for 1 stock splits that occurred in 2000, 2003, and 2005. Even boring old Wal-Mart shares would have been worth about $3,000 today in exchange for putting up $1,000 in 1998, and this is not including the dividend. And even and investment in 1998 in Whole Foods which today trades around $9 share, down from an all-time high of $80, would be up over twofold when accounting for the two stock splits.
The market is tough to beat, but you could have easily made satisfactory returns over the past ten years in which the market went nowhere. And these returns would have outperformed real estate, bonds, and just about any other asset class.
The next decade will be no different even if you started in 2008 and can muster the courage and patience to keep going. No one has a clue what the market performance over the next five and ten years will be. But everyone will agree that there will be many companies that will be bigger, better, and more profitable. And Mr. Market doesn’t care about fundamentals in 2008, businesses that continue to improve profit generation will ultimately be recognized.
History Doesn’t Repeat Itself...But It Does Rhyme
Knowing a little market history after the worst year since the Depression can be very instructive. The following chart shows how the Dow has fared during and after recessions.
Recessionary Period (Change in Dow during recession) (Change one year after)
Aug 1929 - March 1933 (-84.2%) (81.1% )
May 1937 - June 1938 (-23.2%) (-2.4%)
Feb 1945 - Oct 1945 (21.3%) (-9.4%)
Nov 1948 - Oct 1949 (-0.12%) (18.7%)
July 1953 - May 1954 (21.6%) (29.7%)
Aug 1957 - April 1958 (-9.9%) (36.8%)
April 1960 - Feb 1961 (7.5%) (6.9%)
Dec 1969 - Nov 1970 (-1.4%) (4.7%)
Nov 1973 - March 1975 (-19.0%) (30.1%)
Jan 1980 - July 1980 (11.5%) (1.9%)
July 1981 - Nov 1982 (7.4%) (22.8%)
July 1990 - March 1991 (1.2%) (11.0%)
Mar 2001 - Nov 2001 (-5.7%) (-9.7%)
The crucial part, of course, is how long our current recession will affect the market. No one truly knows. What we do know is that the market will have turned by the time we get the “official” word.
But another important chart to look at is below.
Company [2001 Price] [2003 Price] [2007 Price]
Apple [$7-$13] [$6 - $12] [$82 - $200]
Vulcan Materials [$37 - $55] [$29 -$49] [$77 - $129]
Tesoro Corp [$5 - $8] [$2 - $7] [$31 - $66]
Transocean [$23 - $57] [$18 -$26] [$73 - $150]
Fluor [$15 -$31] [$10 - $22] [$37 - $86]
Source: Value Line (note: prices reflected low’s and highs for the year are rounded to nearest dollar for illustrative purposes)
The sample above is instructive in showing us how markets behave. Many securities that were bought in 2001 - a year of double digit market declines - were deeply underwater at the end of the year. Two years later many investors were still down by over 50% on many holdings if they had held on. But by 2007, if you had invested in solid companies with great earnings power, you more than made up for it. Even with a 60% two year decline in share value for Fluor shares in the heavy construction firm more than rewarded long-term investors. Assuming you had bought at $25 in 2001, you were down over 50% by 2003. Assuming you had sold at $65 in 2007, your six year holding period return was $160%. I’ll take numbers like that all day.
This recession is vastly worse than the 2001 variety. But as a long-term investor, you should keep your focus on holding period returns and if you stick with businesses that will be doing well a couple of years from now, you’ll realize that stocks can still produce the best returns.
Subscribe to:
Posts (Atom)
