topofeaturellc

also I assume you guys know that just using EV/EBIT and throwing out the ROIC factor makes magic formula work better. Fun fact number 2 - People who self-select on the MF website tend to reject names that score low on the ROIC factor but high on the EV/EBIT and accept names where the opposite is true. And therefore in aggregate the self-selecting people underperform the model. I suspect the QMJ work that AQR does (which is great and you should read it) - if you disaggregated returns you see that its really giving you something that mostly loads on value but does a decent enough job of screen out a few of those cheapest quintile dogs (and it doesn't need to be many) to outperform a pure value factor. I.e. I suspect its not buying the absolute worst businesses that adds value, not buying the better businesses. But I don't have the underlying data to see if that's really true.

I'm reading a book by James Montier - he cites research that suggests that value managers have an average holding period of 4-5 years and that relative out performance for a position (as compared to an index) was the most in years 3-5. This suggests there is something to holding on BUT.... He also citrs research that splits the markets into quintiles by P/E and the bottom one nearly always out performed the second which out performed the third and so on. This suggests there is something to recycling to the cheapest every year. So there is two possibilities: 1) the years that value doesn't outperform absolutely kill returns enough to ruin years of out performance relative to slightly lesser value stocks 2) or there's something about the persistence/momentum of a stock that moves from 2x P/E to 4x P/E that's not shared by other 4x P/E stocks. My guess is on the later. Yeah. Also has to do with the dispersion of returns in the cheapest quintile. Fun fact - the worst 60% of performers in the cheapest quintile of P/B or EV/EBIT underperforms every other quintile. But what happens is that over time your portfolio becomes more focused on the 40% that work and that persists for several years.

also optimizing for Cash Flow vs P&L is a complicated topic and not every business is in a situation where they can do that. In a rational world the accrual accounting and the cash flow accounting eventually matchup so that the only benefit is the time value of money. that and there are in the long-term issues with optimizing for tax - especially for industries that sell to the public sector.

Let me caveat this by saying that I think many companies over distribute, that in the current market dividends are overvalued and many companies don't buy back when the should be buying back.. If the stock is overvalued by more than your 1/(1-marginal tax rate) you'd prefer a dividend. If the stock is undervalued but management and the board are inclined to reinvest the capital at a rate of return< tax adjusted cost of equity -you'd still prefer a dividend. And there is lots of evidence that management teams in aggregate are terrible at determining their own intrinsic value. It just simply isn't correct to say that dividends are always an inefficient way to return capital to shareholders. BRK doesn't pay a dividend because shareholders believe that management can reinvest their cash at greater than their CoE. That's rational. Most businesses can't do that.

I wouldn't say that growth investing doesn't work at all -- it can work so long as you're not paying for growth. If I buy a company for 10x FCF (hopefully less) with the knowledge that there is some growth defined by the function where growth_rate=min(0,X) then it can work quite well. It's only growth investing at 25x FCF that tends not to work out. (Google is a notable exception, though, it may have been possible at the time to realize that the amount of growth Google had in front of it was immense enough to make 25x FCF not a terrible idea.) I dont think buy a company that is trading on 10x FCF or even 10X some prior years CF w/some sort of optionality is really "growth investing"

I would suggest that by the time you identify great owner operators you are unlikely to make money investing along side them. Merely because unlike them you normally don't get the opportunity to invest at book.

this paradox is also sort of why its rational growth stories react to earnings the way they do (and why since in aggregate we have no skill at figuring out earnings forecasts growth investing doesn't work)

I think that's a pretty thoughtful way to do things, but I think if you believe that non-deposit banking is a CoC biz on marginal capital invested the spread of ROTE over your CoE is already including the value of that Basically I think you'd find that = adjusted book*market ROE = tangible book*historic company ROTE I wouldn't expect true deposit funded banks to have really different costs of funds over the long-term. Where there might be difference is in deposit growth rates - although I suspect the banks know that better for us and are more competitive with one another in markets with population growth vs markets that don't really grow - so it nets out wrt to valuing future growth. I'd generally say I'm a normal earnings power guy, but I think the case of banks the earnings power is derived from the balance sheet and especially the funding side of the balance sheet, so here I think Book is a pretty good way to think about valuation. I also think you need to underwrite the asset side of the balance sheet pretty thoroughly to figure out what magnitude of loss can permanently impair the equity. At the end of the day I think deposit banks have show a remarkable ability to reprice their assets and liabilities to earn a cost of capital return on marginal capital.

MLP/REIT/YieldCo madness is going to be looked back fondly by bankers for many a year.

Great question. In theory it's supposed to be implemented, but I'm still seeing news releases about standardizing things like asset quality. If this is going to be implemented by Oct then that doesn't give much time for the submitters to adjust their systems to whatever has yet to be determined. An EU implementation slipping. Why I never...

It will be standardized or implemented?

Some other things to think about - what does return on tangible cap look like? What does it look like through a cycle? Is the low IC because of bad deals? If not who or why are there people in the industry willing to take such lower returns? Is there a participant with a low cost of capital? What is the shape of the cost curve? Are there sunk assets that are still cash breakeven on a marginal costs basis? What needs to happen for those bad assets to close? Unless there is a path and a clear economic rational for this to be come a CoC ROTC business (and actually it needs to be much more to justify the current valuation) then its def not worth almost 2x tang book. Actually if its less than CoC the only reason to own it is because it trades at a big enough discount to book that you can liquidate it slowly and earn a decent return. Otherwise you are in for a life of slowly getting diluted and levering the Balance Sheet. Another thought is that they've mismarked their assets, but that just means its still expensive Would also add - I don't generally find it that useful to think much about why the market values something where it does.

One other thing about banks is the the quality and granularity of data collected by the databases in the US is much much better than it is in Europe. I've not used SNL, but CapitalIQ and Factset capture the regulatory data in the US, but they don't ex-US. Bloomberg doesn't either.

A few points I'm a Dev World guy - so my responses are biased towards that: -There just aren't many professional international small cap managers - especially long-only. A lot of this has to do with liquidity. If you offer people daily liquidity then the most you can run in a reasonably concentrated-ish portfolio (say 40 names) is about 500 mil. Its hard to make that work with the required infrastructure - even tucked into a bigger firms where you've got the operational stuff covered its hard to make it work. You basically need to charge hedge fund fees for it, and even then you are size limited. Its a major inefficiency BTW - why its worth your time to focus there. -A lot of guys have some language skills. I'm extremely comfortable reading annual reports in French and Spanish, less so Italian. In undergrad I actually took Business French, and the terminology is pretty similar in all of the romance languages with respect to Financial Statements. -Japan - other than some guys who just look for decent ROE businesses trading at crazy cheap P/B (which I think is great, and is probably how I would approach Japan if I had to - so I don't mean that as a pejorative) - pretty much everyone I've met who is a fundamental investor in Japan has significant Japanese speaking staff - usually the analysts, occasionally the PM. Its also the norm to bring a translator to meetings. I've done meetings in translation and it sucks. I suspect Korea is the same way. - The adoption of IAS makes life so so much easier so that you can be much more confident using the databases to find names, and then try to figure out the language problem when you do your research. Again - I've not run across too many N. European companies (I actually can't think of any off the top of my head) that didn't publish an English language annual. But god it used to suck back in the day with crazy German depreciation rules and what not. - One area where I think language is a real issue is regulated industries. I usually find that regulators don't consistently translate their documents into English. Anecdotally it seems to me like the Banking Regulators are the worst. This is a problem. I'm not really a banks guy so I don't have a solution But this is a problem even in Large Cap land. I spent hours trying to learn about Italian banking rules on credit before I just gave up. If I was running a product that just did non-US small cap I'm pretty sure I'd need a guy who just did banks and nothing else. - When all is said and done, yeah - you hire a translator. I remember having to hire a guy to translate Romanian for me once - not because I was investing in Romania, but because of something involving a sub that was hairy. - The guys I know who do Frontier stuff rely on the databases and then spend a bunch of time vetting management as being trustworthy and then buy on crazy cheap multiples of what ever they favor. I don't actually know any true deep-value frontier guys. - Most the big EM shops have speakers of the languages in their analyst pools. There are actually a decent number of small cap EM managers - I think because its much easier to charge 2% fees. By my way of thinking the language issue is much much bigger for you if your investment strategy is short-term/sell-side driven/earnings focused or scuttlebutt focused. But for classic value guys, the cheapness of things eliminates a decent part of the risk. Just some thoughts. I'd be interested to hear what others think.

Mildly off topic here. Does Canada, or any other nation for that matter, placing sanctions on Russia matter to Russia? Does it affect them or do they even care? I can't help but think as the Harper/Baird duo sanction Russia that if Putin even notices, must just be shrugging his shoulders. Surely Russia has its own maple syrup. ;D The only sanctions that will actually hurt the economy are those which impact trade with W. Europe, and Nat Gas specifically. That's really the only think Russia exports that isn't a fungible commodity. The sanctions can make life for Putin's buddies less fun but who knows if that matters.

That's what you get if you started investing after 2008... Nope, you're not the only one. I'm moderately amused with the influx of (predominately new) people on the forum that think 40% and 50% returns are somehow easy to achieve and/or the norm for investors. This seems to dovetail coincidentally with the amount of people looking to start funds because they're sure that they can continue (begin?) to outperform. Well to begin with its a little silly to assume that because someone is new they are new to investing. But also its not correct that someone who is looking for something trading at half of intrinsic value is expecting to earn some insane return. Don't forget a double over five years is "only" a 15% return - and inevitably you'll have things you are wrong about. But for me there are a few reasons why I want to be buying things at huge discounts 1) Margin of Safety - the cheaper something is to what I think its worth the more I can be wrong without incurring a permanent impairment. The confidence interval surrounding IV is probably bigger than I think. 2) Time - the bigger the discount the longer I can wait for it to narrow 3) Need my winners to be big enough to subsidize my losers. For me, personally I hope to earn a premium over a dumb value strategy. A little bit from liquidity risk, a little bit more from stock selection. If I can't beat that I should just be buying a value factor ETF or something.

Right - exactly. Figuring out how and when that improvement could happen is a big part of the investment process. And your willingness to participate in that idea should be a function of the IRR for the shares assuming earnings/CF mean revert on some confidence interval surrounding that time frame. Figuring out timing on the way in is hard enough when you know you are willing to wait it out. But its even harder when you say you'll throw in the towel at some date in the future. The reality is that most research above say the $100 Mil Market Cap in the Developed markets is something like a commodity. It's really having a process that uses that information correctly and the patience and temperament to implement that process which matter. When you set a two year time horizon you are giving up on a lot of that for no good reason. Peter Lynch was doing something that is different from how I define value investing - and in the context of what he was doing, sure I can see why you'd want to operate on a shorter time frame. Buying Cigar Butts is a different thing - they have to work on a shorter time frame because the IV is shrinking over time.

There is a difference between buy and hold and having a longer-term horizon to realize intrinsic value. And trading out of something with a 30% return to intrinsic value for something with a 100% return to intrinsic value isn't counter to having a longer horizon either.

That's a sunk cost fallacy. You don't have a choice between accepting a 13% or selling and looking for something else. If the research is still in your opinion correct, its still a 25% return idea. You might have other 25% return ideas - and it would be rational to view those as interchangeable, but just because they are new 25% return ideas doesn't mean they are better. Actually assuming you are investing in businesses that accrete book value or grow cash flows over time you'd normally think your estimate of intrinsic value should have increased over five years - so it you earned 0% on it, it should be an even better idea today.

no - that's really what I meant. A portfolio is an accumulation of single security ideas if you are a bottoms up investor - which I presume most of us are. Sure - you may end up expressing some macro view - but that's something more to worry about from a risk perspective than anything else. and this doesn't mean that buying something where you know you'll know if you are right in two years is wrong, but to only look at it on that short of a time horizon is doing yourself a disservice. The flip side of that is that you need to be prepared to admit you are wrong at any time as well. Turnover isn't the same thing as what your investing horizon is. If you were buying things in fall of '08 there was a decent chance you didn't hold them even a year in order for them to hit your original assessment of intrinsic value. But you bought them because you knew that if it took five or ten years for the business to mean revert and for the market to revalue the business the IRR was going to be pretty good. Shorter time frames imply smoother returns, but the evidence is that the returns to value investing are very lumpy. Indeed. That's why it works.

Time is the biggest structural advantage you have as someone with permanent capital. Especially if you are buying really cheap businesses that have issues. How 95% of professional managers have to think about return horizons is part of why you should be able to outperform over time. You don't ever have to worry about "well we got downgraded to two morningstar stars, so now we can't sell retail, and the consultants hate us because our 1 and 3 suck relative to the universe". Brandes has a great piece on their website that shows that managers with great 10 year+ numbers usually have significant periods of underperformance. Look at how long it took some really smart value guys to get paid on housing stocks. Personally I tell people 5, but I think 10 is a better number

There are pluses and minuses to everything. The RIA route is a really good option if you are starting a long-only biz and you are funding with Friends and Family. At a certain point you can move to a more traditional sep account setup pretty easily. But if you want to be long-short or do anything "exotic" or you want to solicit larger pools of capital you really need to go the fund route. You could start out as a sep account biz and do anything you want, but the fixed costs are much higher. You can also find mutual fund in a box setups as well. And USCITS. Higher fixed cost than an RIA but lower than a Sep Account biz. The USCITS in a box solution is a pretty good one if you think you can solicit funds from the EU. I think that if you think your core client base is going to be retail folks the mutual fund in a box solution is a pretty good one. I think break even on it is like in the 10's of millions. But I'm not really sure to be honest.

There have been points in his career when he had really good numbers. Not to mention the stickiness of assets and just the benefits of starting out at a different time - 56 years ago. Path Dependency matters a lot for firms. Once you get to a certain size not blowing up becomes more important economically than generating returns. When Sarofim started this business was barely professional. Its just a totally different world. But I agree - lots of folks don't appreciate how big a role being an effective marketer plays in asset gathering. Its probably easier to get rich as an average investor with a great marketing approach than as a very good investor with an indifferent marketing approach.

Yes - absolutely. But that number is going to be pretty high or you'll need to think a lot about how to make the argument that your strategy will scale. Especially if you are doing anything esoteric.

I think you need to think about your personal situation. If you can sit back 3-5 years with a small pool of capital you have personally or FNF , not take a draw from the business, and someone like IBKR fits your needs on the PB side - then yes - just go for it. If five years from now you have good (audited and custodied) numbers then it'll all work. You can build the business side of your firm when you are ready to start marketing. And the vendors will be jumping over themselves trying to help you out with the business side if you have years of good audited numbers and a mainstream enough strategy. That's probably not the best way to do the biz thing, but its easy. If you need to be able to sell yourself to folks right out of the gate the game is very different. In that case, yeah - figure out your niche, find the folks who want it, and figure out who is going to turn the lights on for you. Your short-term performance won't matter to the kind of folks you want as LPs to do this kind of launch. Its really really hard to do. A fund like that will require a CFO, a name auditor and a real PB right out of the gate. The cost of starting up and running that biz will probably run a few hundred K before you pay yourself- mostly based on your occupancy costs (Can't be a dude with a BBerg if you want that biz), market data, travel, marketing, and your CFO - who you'll have to pay in cash and some form of profit participation. Compliance is a non-issue at launch - although you need a plan. Backoffice is why you have your CFO supported by your Admin and the PB. Legal will be a big start-up expense as well. And that assumes you find someone who wants to put you in biz. My impression is that you can tranche the investor world into a few pools Day 0- Folks who will help you turn the lights on in exchange for meaningful economics Day 1 - Folks who will come in once the lights are on and there is a business they can underwrite but you've basically sold them your story investing wise - no results. Usually want a fee break and capacity Day 180 - Day 1 guys who want to see you clear a trade, settle the books and write a letter. Probably also want to see you can construct a portfolio that doesn't blow up on sight. Again - want fees, probably capacity Day 365 - Day 1 guys who care more about #'s than they want to admit 100 mil AUM - Institutional guys - care about #'s. By the time you care about them - you've got a viable biz. Etc, and each tier on the pyramid grows exponentially. But yeah - if you are in that second camp - fund raising is the only thing that matters. Figure out if you can come up with a big list of Day 0 and Day 1 guys and go from there. But let me repeat - this is really really hard.