value investing

Extreme Discounts

© Can Stock Photo / konephoto

One of the basic distinctions made in the stock market is between growth and value. Growth stocks offer the potential or history of above-average growth in revenues and earnings. Investors are buying a brighter future.

Value stocks present a low cost in terms of price for a current dollar of earnings, or price/earnings (P/E) ratio. In the late 1990’s growth stock boom, value stocks were derided as “old economy” stocks. The exciting “new economy stocks,” computer chip and internet and fiber optic companies, were all firmly in the growth camp.

Investing in growth worked well until it didn’t. Value stocks went nowhere until the Tech Wreck, when growth stocks peaked and then fell a long way. The stock market often experiences periods where one of these factors outperforms, and the other one lags.

A recent article at MarketWatch.com1 detailed the work of a Wall Street analyst who claims that value stocks are at their biggest discount relative to growth in many years. The charts show that valuation differences generated by a decade of strong growth stock returns put value stocks at perhaps the biggest discount in history relative to growth.

In plain language, the bargain stocks have generally become bigger bargains.
When there are sound reasons for expecting better stock prices at some point in the future, we may own companies that are underwater, or down from what we paid for them, for an extended period.

We strive to own the best bargains. It is hard to watch as bargains become even better bargains while more expensive stocks do better. But we know how this works. We believe that sooner or later the bargains will produce gains.

If the differences in valuations are at extreme levels, perhaps the trend change is coming sooner rather than later.

Clients, if you would like to talk about this or anything else, please email us or call.

Notes & References

1. MarketWatch, “Value Stocks are Trading at the Steepest Discount in History”. https://www.marketwatch.com/story/value-stocks-are-trading-at-the-steepest-discount-in-history-2019-06-06. Accessed June 14th, 2019


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Rule #2

© Can Stock Photo / ragsac

We often talk about our three fundamental principles of investing. Rule #2 is ‘Buy the best bargains.’ This is our intent, but we must act on what we know, which is incomplete. Our crystal ball does not actually work; we do not know the future. No guarantees.

The best bargain is likely to be unpopular – or else it might not be a bargain. We often buy into sectors that are down sharply from much higher levels, years before. The crowd is almost never rushing into shares that have declined 50 or 80% over a period of years.

This matches up nicely with our contrarian philosophy, doing our own thinking, going our own way. In fact, we believe that profit potential lives in the gap between the consensus expectation and the unfolding reality. We think there is an edge in finding a lonely, but correct, position.

There are different categories of bargains. The best bargain might be a cyclical investment at the low point in its cycle – homebuilders in recession, for example. Or a wonderful, durable blue chip company available at a temporarily low price because of some short-term issue. Or a deeply discounted bond in a stressed company that we figure is trading below liquidation value. No guarantees, as we said!

Our approach is not the only one. Some believe in buying only when an investment is already in a clear up-trend. Others want to own the things that are on the magazine covers, the ones everyone is talking about. For better or worse, we do our best to stick to our convictions. (And sometimes they are better, and sometimes they are worse.)

The value style, our philosophy, is right for us. Clients, if you would like to talk about this or anything else, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

A Better Topic Than “The Market”

© Can Stock Photo / Pedxer

Everybody talks about it; it raises a lot of questions. Is the market too high? Where will it go next? Is it due for a fall? How will the economy affect it? (Or politics, or world affairs, or astrology?)

Many people seem to be referring to a major market average or index when they talk about the market. But the investment universe is far broader than those. The individual pieces may have little to do with what is happening with the major averages.

  • For example, even when the averages are near all time highs, stocks in some industries or companies may be half or less of their own highs from years ago.
  • The United States is not the only advanced economy in the world with a stock market. Some overseas markets have done very little for a decade, and are not close to high points.
  • Certain holdings have shown a tendency to go the opposite direction from the major averages.
  • Even with in the US stock market, some holdings appear to be bargains even when highflyers have gone off the charts.

Instead of asking those questions about “the market,” we think it makes more sense to always be asking these questions:

  • Where are the best bargains in the investment universe? We should be looking at them.
  • Where are the stampedes? We should avoid them.
  • Is there a way to secure reliable income in today’s environment?

This is a way to bring the focus to something useful, in our opinion. Clients, if you would like to talk about this or anything else, please email us or call.© Can Stock Photo / Pedxer

Stocks Have No Memory

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Clients sometimes bring up their own history with a particular investment in
trying to assess it. We sometimes hear things like this:

• “It’s done nothing but go down since we bought it.”
• “This is the most boring stock ever! It just lays there.”
• “At what point do you give up on waiting for it to turn around?”

As investors, our challenge is to form an opinion about the future value of prospective investments. Broad economic trends, industry developments, and company evolution may go into the mix. Reading annual and quarterly reports, checking our research sources, and looking at pertinent news are part of our routine. We frequently have to do some arithmetic, too.

Notice something missing from our recipe? Investment price performance does not go into the stew. Track record is not a factor for us personally. If you believe in buying low, you sometimes buy things with terrible recent performance. Conversely, some of the best track records in history belong to bubbles at their peak.

We aren’t saying our approach is the right approach. There is a whole school of thought that says you should only invest in things that are already going up—trend followers. But our approach is our approach, and we are unlikely to change.

Market values depend on the consensus opinion of the rest of the world. As contrarians, we look for potential gaps between the consensus and how we believe the future may unfold. No guarantees, of course—but we aren’t going to base investment decisions on a consensus that may be flawed.

Your stocks do not know how much you paid for them, or when you purchased them. We look at companies, not stocks—and make decisions in line with what we see. Opinions change, the consensus shifts, and we wait. Sometimes we look out of step for a time, perhaps years. That’s part of being contrarian.

Clients, if you would like to talk about this or anything else, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

Stock investing involves risk including loss of principal.

Buy Low, Sell High

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If you watch a lot of sports journalism, sooner or later you will see someone deliver some variation on this nugget of wisdom: “If we want to win, we just have to score more points than the other team.”

In investing terms, the equivalent is “If we want to make money, we just have to buy low and sell high.” This is just math: if you sell something at a higher price than what you paid for it, you make a profit.

The “sell high” part is usually easy for most people to grasp. Sometimes someone in a hot rally may get wrapped up in watching their gains go up and up and forget to cash out before things inevitably come crashing back down. But generally taking profits is fun and comes naturally to people.

It is the “buy low” part of the equation that people tend to struggle with more. Something in the news for being popular and making money is probably not trading at a low price. Buying low often means a metaphorical dumpster dive to find the unwanted dregs of the market. It is often not pleasant or easy to put your money in something that has a reputation as an unattractive investment. But if you want to buy low, that is where you frequently need to go.

The upshot is that this makes it a lot easier to get excited about a down market. It feels good to participate in a rising market, but it can be difficult to find spots to buy in when markets are up. For a value investor, market selloffs may lead to buying opportunities.

Clients, many of you already know what we are talking about. We are in business with you for a reason—we think you are the best clients in the world. We know it is not always easy to make disciplined investing decisions. But we think you have what it takes.

If you have questions about this or any other topic, please call or email us.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Four Trends for Fall, 2018

© Can Stock Photo / Elenathewise

The gap between consensus expectations and reality as it unfolds is where we think profit potential lives. This is why we put so much effort into studying trends, and the ramifications for investors.

One year ago, we wrote about four trends. The next energy revolution (solar + batteries), long range prospects for the world’s most populous democracy, the airline industry, and rising interest rates continue to play roles in our thoughts and portfolios.

Other ideas are also in play.

1. Thinking about the next few years, our highest conviction idea is inflation will exceed consensus expectations. Some of the ways we act on this belief may provide some counterweight to other portfolio holdings, since inflation hurts some industries while it helps others.

2. As the economic expansion lengthens toward record territory, the desire to extend our lifespan tends to be insensitive to the business cycle. Biopharmaceutical companies, working on cures for everything from Alzheimers to various forms of cancer, seem attractively priced.

3. The trend toward rising interest rates, noted last year, may have an effect on weaker and more leveraged companies. We are looking to avoid the second-order and third-order effects that higher rates may have on some borrowers.

4. US stocks have become popular relative to international equities, with dramatic outperformance over the past decade. At some point the trend changes, and better value usually wins out.

One of the difficult things about being contrarian–going against the crowd–is that we sometimes look silly. When everybody else is having more success in the short run while we search for bargains, it can be tough. But that is what we do. We’re excited about the continuing evolution of your holdings as the future unfolds.

We can offer no guarantees except that we will continue to put our best effort into the endeavor. Clients, if you have any questions or comments or insights to add, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

 

YOU Haven’t Missed Out

© Can Stock Photo / rustyphil

The Wall Street Journal recently highlighted “one of the biggest surprises of the US stock market’s relentless rally…how many individual investors have run away from it.” This is from the January 4, 2018 article “Individual Investors Sit it Out.”

The article cites industry sources about where people have been putting their money the last several years. While nearly $1 trillion got pulled out of investment products that target US stocks since 2012, almost the same amount has gone into bond investment products.

Clients, would you trade your results over the past three or five or seven years for bonds with low potential interest and growth?

Our fundamental rules have guided us. Avoid stampedes—and the stampede into the supposed safety of bonds may be one of the biggest in history. Seek the best bargains—interest rates near the lowest levels in four decades1 hardly seemed like a bargain to us.

A strong contrarian streak encourages us to think about doing the opposite of what everybody else seems to be doing. We’ve been buying stocks when others were selling.

We’re focused now on getting the next big thing right. If we seek to avoid stampedes, we need to be careful if the stampede joins us. What we now own may become too popular and get over-priced. A 30% or 40% gain from current levels might put us in risky territory.

By continuously seeking better bargains in other sectors and trimming back holdings that are no longer cheap, we seek to reduce the potential for loss. No guarantees, of course: the next poor year is out there somewhere.

On investment advisory accounts managed through LPL Financial, our revenues are a function of your account value. When you capture an opportunity or avoid a loss, we are better off. This focuses our attention wonderfully.

Clients, if you would like to discuss how this applies to your circumstances, please email us or call.

1Interest rate data from Federal Reserve Economic Data, Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/FEDFUNDS (as of January 2018.)


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing, including stocks, involves risk including loss of principal. No strategy assures success or protects against loss.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Backward Measures of Risk

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Our investing experience over the last two years vividly demonstrates the problem with confusing volatility and risk.

After years of relative stability, a certain security plunged by more than 80% in a few months. The standard model of risk would have you believe that the security was relatively safer at the high price level. And the more the price declined, the riskier it became—according to the standard methods.

Value investors seek the bargains. To them, the lower the price, the better the deal. This is exactly the opposite of the standard model of risk.

The rest of the story is that the security turned on a dime at the low point, and rose back to its original level in the following months. At the very point the standard model of risk viewed this investment in the worst light, it was preparing to embark on a rise of more than 400%.

There is a good reason why people (including professionals) confuse volatility with risk. In the short term, volatility IS risk. If you have wealth to pay the bills due within a few days, you cannot afford to have the value bouncing around from day to day. If it goes the wrong direction, you might not have enough money to pay the bills.

Therefore, whether volatility is risk depends on the time horizon. In the short term, volatility is risk. In the long term, perhaps volatility is opportunity, not risk. We work hard to understand your time horizon so we can get this right for you.

Clients, if you would like to talk about this in more detail, or have other things on your agenda, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

A Share of What?

© Can Stock Photo / tvirbickis

Some people invest in common stock without even knowing what the company does. To them, a stock is price on a screen that can be bought and sold minute by minute—day-trading, they call it. Those people study price charts, not financial statements.

At the other end of the spectrum, investor Warren Buffett understands that a share of stock is a piece of a business—a share in an enterprise. He once said it would not bother him if they closed the stock market for ten years: he is happy to own percentages of businesses.

We suspect that many of you have an understanding that is somewhere in between these two views. We would like to offer you a little more perspective on what ownership is, and what it means.

Recently, in analyzing a company many of you own, we broke it down to what $1 invested represents. We’ll call it Company X, the leader in its industry, a blue chip company.

$1 invested today, whether you just bought in or paid half that amount some years ago, represents a certain amount of revenues—sales of goods by the company. It also represents a share of income and dividends (cash paid to shareholders).

Each dollar of ownership value in Company X represents 32 cents worth of revenues this year. After expenses, the company’s net income for the year will be between seven and eight cents per dollar of today’s stock value. If the Board of Directors continues to approve quarterly dividends at the recent rate, each dollar of stock value will get close to 3 cents in cash dividends.

For long term owners, this year’s results are of interest but the outlook for the future has a large impact on how the stock price will change. For this reason, we seek to understand the relative value today, but also the potential for the company to reap its share of future growth in the American or global economy—to increase its revenues, income, and dividends.

This work is totally captivating, if you are us. Clients, many of you have told us this is why you hire us—your interests lie elsewhere. They say it takes all kinds to make a world; we’re glad to know your kind. If you’d like to talk about this or anything else, please call or email us.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk including loss of principal.

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Classical Language, Mostly Classic Ideas

© Can Stock Photo / franckito

A surprising number of Latin phrases are woven into modern society, considering the language has not been widely used for centuries. From simple truisms like tempus fugit (time flies) to mottos like e pluribus unum (from many, one), the wisdom and ideas of a civilization lost to antiquity survive.

The Roman historian Tacitus wrote “experientia docet,” experience teaches. We must take issue with this one. Investors make a critical mistake in learning from experience, in our view. They often learn the wrong lesson.

People sometimes adopt tactics and strategies that would have worked great in the last cycle. Unfortunately, times change and the outdated strategies usually fail to perform like they did before.

In the year 2000, following the stock market bust stocks fell—but home values rose. This taught people the wrong idea that “you can’t lose money in real estate”, which caused a lot of damage during the 2007 financial crisis. Then, by 2009, lenders learned the wrong lesson again—because auto loans outperformed in the downturn. Today they may be setting up future losses by putting too much money into substandard auto loans.

A related problem is best illustrated by a product pitch we recently received from an investment sponsor. Their latest offering is based on “the top performing asset class of the last decade!”

Clients, you know what our issue is with this. We love to buy bargains. The best performer over the past decade is, by definition, no bargain. Piling in after a big runup may be jumping on the bandwagon right before it goes off a cliff. However, the experience of the last decade evidently taught many that the specific sector was the one to buy now. Wrong lesson, again.

One interesting facet of all this is that experience actually can teach us. We just need to be certain we are learning the right lesson.

There were useful and profitable lessons in the tech wreck of 2000 and the real estate bust that began in 2007. In our view, those lessons are that it is dangerous to invest in over-priced assets—and it doesn’t pay to join a stampede in the market. Those lessons help us live with attractively priced stocks, and avoid the flight to safety that made historically more stable assets overpriced (in our opinion.)

So let us leave you with a little Latin of our own devising: cognitio ad felicitatem. (Knowledge leads to prosperity.) Clients, if you have any questions, comments or insights please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

No strategy assures success or protects against loss.

Stock investing involves risk including loss of principal.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.