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.