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Is Value Investing Dead?


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Jeff Matthews wrote the following about Mattress Firm (MFRM) just two months ago, I hope he does not mind me reproducing.

 

http://jeffmatthewsisnotmakingthisup.blogspot.com/2016/06/mattress-fire.html

Mattress Fire

 

Back in May—that’s less than two months ago—the Chief Marketing Officer of Mattress Firm (ticker: MFRM; Tangible Book Value Negative $30.32 Per Share if our Bloomberg is correct)—was asked how business had started the new year.

 

  “It continues to be a bit choppy…” he began—choppy being one of those euphemisms Wall Street hates to hear—before adding, in the true nature of a marketing guy, “…but we’re SUPER optimistic that we’re coming up on summer selling season, Memorial Day...”

 

Sure enough, Memorial Day did come—even if Mattress Firm appeared to begin the Memorial Day sales event a week or two before the actual weekend—giving the CEO something positive to talk about on the ensuing earnings call, when some of the more important numbers were otherwise going the wrong way.

 

Specifically, while MFRM showed 49% revenue growth in the first quarter, it was thanks mainly to the acquisition of Sleepy’s and other mattress retailers the previous twelve months.  What analysts call “organic” growth was somewhat less than 49%. 

 

Like, 5,000 basis points less.

 

Comp-store sales were down 1.1% in the quarter (despite a boost from the inclusion of e-commerce sales from the recently acquired 1,000-store Sleepy’s chain in those “comp-store sales,” for some weird reason).

 

For a clearer picture of the sales trend at what management itself likes to call “the first truly border-to-border, coast-to-coast multi-brand mattress retailer,” it’s worth noting that comp-store transactions—i.e. stripping out the effect of sales mix—were down 0.9%.

 

That decline in comp-store transactions at MFRM was not, however, a new phenomenon: MFRM has reported declining comp-store units in each of the last five quarters (except for one that was termed “roughly flat”).

 

The seemingly innocuous 0.9% comp-unit decline in the most recent quarter looks a little less innocuous when you consider it was up against a seemingly easy-to-beat 6.4% unit decline in the same quarter last year.

 

As usual with MFRM, however, things got better after the quarter ended, according to management on the call: “Since Memorial Day our trends have been positive and in line with our revised same-store sales guidance,” they said.

 

We’ve heard that kind of “things got better this week” from companies reporting otherwise dour news many times…in fact, we heard it from MFRM last year, when it reported that negative 6.4% unit comp quarter: “However, late in the quarter we implemented certain initiatives to drive units and we had subsequently seen positive results.”

 

Prosperity at Mattress Firm is always just around the corner.

 

Unfortunately, just around that corner is a new competitor: the internet.

 

Specifically, what are termed “Bed-in-a-Box” competitors (Tuft & Needle, Casper et al) that sell mattresses rolled up in boxes delivered straight to your door by UPS and therefore have no need for 3,500 stores like MFRM, or commissioned sales employees or delivery trucks.

 

Indeed, according to figures disclosed at a Furniture Today conference in May, the “Bed-in-a-Box” industry—and full disclosure, your editor is a happy repeat Casper customer—is running at a $900 million sales rate right now, from a standing start 4 years ago.

 

While $900 million might not sound like much in an industry reported to be worth $7 billion in total (mattresses, not all bedding-related products), it would be the equivalent of about 700 Mattress Firm stores by our math, or about 20% of those “boarder-to-boarder, coast-to-coast” stores.

 

Is it any wonder MFRM comp-store transactions have been flat-lining lately?

 

And while MFRM would probably note that many of the bed-in-a-box vendors are establishing show-rooms in major cities like Manhattan, we’d bet money that they won’t open anything close to 3,500 stores when it’s all over.

 

Why bother?  They’re already “boarder-to-boarder, coast-to-coast” mattress retailers, in the sense that they can ship anywhere a UPS truck can go, without the fixed cost structure.

 

All this makes last night’s news that MFRM had disclosed a “material weakness” in its just-filed 10Q involving “controls relating to accounting for significant transactions” even more interesting than the usual “material weakness” disclosure in your average 10Q:

 

"Specifically, we did not design and maintain effective controls related to the recording of the expense for the flow through of the inventory step up fair value adjustment in the Sleepy's acquisition. We believe the financial statements included herein properly reflect the correct amount and proper classification of the flow through of the Sleepy's inventory step-up adjustment….”

 

You might think that a company with $1.1 million of cash and $1.6 billion of total intangible assets on its balance sheet (thanks to its “coast-to-coast” rollup of mattress retailers) against $1.45 billion of debt, negative $55.4 million of retained earnings and $477.4 million of total shareholder equity would have been on those issues before they cropped up, but apparently not.

 

Meanwhile, and unfortunately for MFRM, the Caspers of the world are not sitting still, and watching a reported $900 million worth of mattresses get siphoned off to direct-to-consumer competitors is exactly the thing Mattress Firm doesn’t need at this moment.

 

The company spent years steadily snapping up new geographies as part of its grand plan—Mattress Giant, Sleep Experts, Mattress Liquidators, Best Mattress, Sleep Train and, finally, Sleepy’s—at the very moment clever Millennials were figuring out how to design, manufacture and ship a mattress in a box so that they and their friends didn’t have to deal with the process of schlepping down to one of those stores Mattress Firm has been accumulating.

 

So when we hear the word “choppy” to describe the sales environment—as we did in May from MFRM’s own marketing man—our ears perk up. 

 

“Choppy” is one of those Wall Street euphemisms that can often mean a whole lot more than it looks on paper. 

 

It’s right up there with analysts who are “tweaking our estimates lower” (i.e. slashing them) and sales that have “come in a bit light” (i.e. not even close to plan).

 

Or, our favorite, management that is “laser-focused” on the company’s problems (i.e. playing solitaire on their iPhones).

 

  Unfortunately for MFRM, “material weakness” is not a euphemism.

Yesterday, Mattress Firm was offered an all cash buyout of $64 per share; a 100% on the share price as of when Jeff wrote his blog entry.

 

I am not having a go at Jeff (whose work is always illuminating) and I am not really suggesting value investing is actually dead.  But the current investment environment has become almost totally bifurcated towards growth rather than value. Even looking at the ideas on this forum, considerable bullish argument is made unicorn stocks with the most extended valuations. You look at the traditional value funds, performance has generally lagged badly. I won't name names, but plenty of people are badly under-performing the market, especially in the 10 year period following the financial crash.

 

With the S&P at all-time highs and the valuations of growth stocks certainly looking frothy at least. Are we finally reaching a stage where value could out-perform growth?

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I think most here are aware of underperformance of value for 2-3+ years, so I won't bother with that.  I just recently made a spreadsheet of all the ideas that I considered investing in for the last 3 years (many came from here).  83% of them are down, and many of them down significantly.  Obviously, that doesn't mean there is permanent loss, but it sure seems to indicate what kind of market we have been in.

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Maybe buying large cap stocks that have value characteristics is dead, but otherwise things seem fine and well.

 

I've noticed that value investing shifts, there is always some segment of the market that's cheap where traditional value metrics work.  I've had a lot of success looking for low P/B, P/E, low-IV bank stocks over the past few years.  Simply buying banks below book and selling them above is a simple and workable strategy.  The problem is most value investors will say "I don't do banks" or "I don't do oil" or "I'm not into transportation stocks" or whatever else.  And when you limit yourself you're blocking off whatever area of the market is cheap.

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But Nate, this is fuddy duddy value small cap stuff you keep talking about👍 Show me a 450b megacap ready to triple.

 

Ha! Yes.. let me get on my soap box for a minute here.

 

This is within the context of banking where I have the data to support this.  There are about 1,000 banks with tickers (some rarely trade).  One of the functions of our software is to build out valuations based on standard models for these banks.  Then banks are ranked "undervalued, moderately undervalued, fairly valued, slightly overvalued, overvalued" based on the delta between their pre-computed IV and their trading price.

 

I talk a lot about undervalued banks, but not all banks are undervalued, not even a majority, maybe 10-15% are undervalued.  The rest are fairly or slightly overvalued.  There are a few very overvalued outliers as well.  Our model values banks in a way that bank investors value banks, so in some senses it's not surprising that banks are trading at fair value.  But what's surprising is that the market is so efficient.  For say 85% of bank stocks investors get it right.  That means the question you need to ask of the other 15% is why isn't the market getting it right?  Often the easiest answer is the stocks are too small and too illiquid to get right.  Other times they're cleaning up old issues that investors don't believe will happen.  Or my favorite, investors are burnt out with mediocre performance and are tired of waiting for the land of milk and honey.

 

Investing is about two things, odds and expectations.  It's the odds that a situation corrects itself or the odds that something happens.  Hanover Foods at 30% of book value is cheap, but what are the odds it ever re-rates?  The second factor on this is expectations.  Hanover is at 30% of book because nearly 100% of the market is saying "I view the odds of Hanover re-rating to be 0%"  In this way odds and expectations are intertwined and investing is simply finding situations where the odds are wrong.  In large caps it's very unusual to find situations where the market has the odds wrong.  In small caps there are a lot more opportunities to do so.  If one isn't lugging around billions in AUM (and if you are why care about performance? You can write yourself a nice check and if you match the market live like a king) when it seems like common sense to find areas where the odds are egregiously wrong and just sit there and make money.

 

I have a book on my bookshelf "Options as a Strategic Investment"  The book details every option type and strategies to employ when trading options.  In each section the author details how to find misplaced options, essentially spots where the odds are wrong.  In my view buying mispriced odds on options is no different than value investing.  The same could be said for real estate, for paintings, for oil stocks, for whatever.

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Whats alive?

 

- mean regression is very much alive

- i see many small guys are on the bank consolidation theme ( see oddball and Tim Melvin) this seems like a rational theme

- not giving a shit about liquidity investor

 

Whats (soon) to shift

 

- more advanced software used for micro/nano caps. This makes qualitative investing more towards 80 percent of judgement making process.

 

- I dont have the data but with the rise of great micro cap content blogs and companies like  the micro cap club. More funds are started in this space and more AUM. This space is more efficient and competitive than historically speaking.

 

- micro/nano is being framed as public market venture capital. Anything called venture capital has investors foaming hoping to slay there public future unicorn.

 

Overweight Qualitative and underweight classic data.

 

Nothing dies it just shifts and morphs to the context of the enivornment.

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I am not having a go at Jeff (whose work is always illuminating) and I am not really suggesting value investing is actually dead.  But the current investment environment has become almost totally bifurcated towards growth rather than value. Even looking at the ideas on this forum, considerable bullish argument is made unicorn stocks with the most extended valuations. You look at the traditional value funds, performance has generally lagged badly. I won't name names, but plenty of people are badly under-performing the market, especially in the 10 year period following the financial crash.

 

With the S&P at all-time highs and the valuations of growth stocks certainly looking frothy at least. Are we finally reaching a stage where value could out-perform growth?

 

"Most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth." Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

 

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive."

 

W.E.B.

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Most folks just don't 'get' value investing ....

 

You are not doing 1-year, or a 'forever' investments; you are also looking at 'lumpy' returns, & extended holding periods - assessing return based on monthly/annual/compound return is just BS measurement. If your intent is fashionable 'talking points' to use on the cocktail circuit, there are many cheaper ways of doing it.   

 

You are also not applying 'magic' formula. An established firm that is growing rapidly - is just as much a 'value' investment, as buying cheap & hoping for mean reversion to produce a price increase. Just because 'growth' doesn't have a 'magic' formula, does not make it a 'not value investment'.

 

If you just want to be fashionable ... you really shouldn't be value investing.

 

SD

 

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I don't think value investing was ever alive.

Growth is a component of value, a very important one. A value stock in my definition is one that has growth which is mispriced. With tech/biotech stocks you often have growth that is overpriced.

If you can get growth and something like trading at NAV (good luck, but possible in the odd case) you are in investing heaven.

 

 

 

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Most folks just don't 'get' value investing ....

 

You are not doing 1-year, or a 'forever' investments; you are also looking at 'lumpy' returns, & extended holding periods - assessing return based on monthly/annual/compound return is just BS measurement. If your intent is fashionable 'talking points' to use on the cocktail circuit, there are many cheaper ways of doing it.   

 

You are also not applying 'magic' formula. An established firm that is growing rapidly - is just as much a 'value' investment, as buying cheap & hoping for mean reversion to produce a price increase. Just because 'growth' doesn't have a 'magic' formula, does not make it a 'not value investment'.

 

If you just want to be fashionable ... you really shouldn't be value investing.

 

SD

 

Value investing is not hard science my friend. Its subjective and hence most people are not going to "get it". I love picasso more than warhol. Does it mean " i dont get art". Repeat value investing is not hard science.

 

+1

 

That's why we don't use either the 1 year, or compound return;

Its also why we buy cyclicals - at their lows, & sell near their highs. We let the commodity price do the 're-rating' for us;

And, why we hold both long & short term views on any given cyclical. Gains on the way down, AND on the way up. 

 

If we tried to use 'hard science' most of this wouldn't work. But  it means that we periodically consult the academic literature, & apply whatever is new.

No 'one' formula, or 'technique'.

 

SD

 

 

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It is not the strongest species that survive, nor the most intelligent, but the ones most responsive to change. -Charles Darwin

 

IMO, investing nowadays takes more imagination/insight. The influx of new talents well versed in value investing tenets have largely eliminated obvious opportunities - ones that are obvious from financials/screens. The ability to imagine how a business and its financials may evolve over time is a much harder skill to hone/teach.

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It is not the strongest species that survive, nor the most intelligent, but the ones most responsive to change. -Charles Darwin

 

IMO, investing nowadays takes more imagination/insight. The influx of new talents well versed in value investing tenets have largely eliminated obvious opportunities - ones that are obvious from financials/screens. The ability to imagine how a business and its financials may evolve over time is a much harder skill to hone/teach.

 

This man has got it. +1

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There was an article recently by a guy named Jason Voss saying basically that most investors don't do research.

 

https://blogs.cfainstitute.org/investor/2016/06/07/alpha-wounds-lack-of-independent-judgment/

 

If that's true, and a lot of banks that used to provide small cap research are no longer in business, then is there reason to believe that small caps are better researched now? I've never visited small cap club, but I have trouble believing it's filling the gap.

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Nothing has changed under the sun.  How many have invested in oil related companies this year?

 

Canadian stocks?  The whole cdn. market was in a bear this year, and has rebounded in less than 6 months. 

 

Its all about temperment.  Blainehodder can stick to the magic formula.  SD and I are in oil related stuff, Oddball is in banks.  Somewhere soon something else will go on sale but most people will be debating who should be president, or whether Apple is a value play, or not. 

 

My observation is that most cant pull the trigger.  Its a temperment thing.  The process of buying undervalued stocks is very hard.  The easy part is reading the numbers. 

 

Right now, the big money is being made in oil.  But one had to invest when things were real bad.  It was the same with BAC at $5.00, everything in 2009, Fairfax in 2004/05, etc. 

 

 

 

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There was an article recently by a guy named Jason Voss saying basically that most investors don't do research.

 

https://blogs.cfainstitute.org/investor/2016/06/07/alpha-wounds-lack-of-independent-judgment/

 

If that's true, and a lot of banks that used to provide small cap research are no longer in business, then is there reason to believe that small caps are better researched now? I've never visited small cap club, but I have trouble believing it's filling the gap.

 

I also think this is true based on hearing PMs talk about stocks I know a bit about, but that's what happens when you're in a 100 stocks, you'll never even understand one of them well.

 

Also, interesting quote from Graham and Doddsville newsletter:

 

Let me correct a misperception. Most funds don't author many of their own ideas, and we’re one of them. We have an idea or two that we generate ourselves, especially in credit, but most are in The Wall Street Journal, or they come up in discussions at dinner with friends of mine. The idea that we’re sitting in a room, and then are suddenly all like “I got it! Let's buy XYZ.” That's not how it works. Bill Ackman is a different guy. Bill does do that and he's unique. John Griffin does that as well, especially in Japan. Generally, though, we all talk to each other and share ideas. Ideas are not generated out of thin air. They come to me from Barron’s, The Wall Street Journal, Financial Times, idea dinners, brokers, etc. That's how they come.

 

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Nothing has changed under the sun.  How many have invested in oil related companies this year?

 

Canadian stocks?  The whole cdn. market was in a bear this year, and has rebounded in kes than 6 months. 

 

Its all about temperament.  Blainehodder can stick to the magic formula.  SD and I are in oil related stuff, Oddball is in banks.  Somewhere soon something else will go on sale.

 

I agree that the small cap end of the market remains generally inefficient and poorly followed. Proliferation of ETF's, brokers putting all of their clients money into WRAP accounts and other  structured products, the decline in the number of small cap funds and assets under management (at least in Canada) have all seen money move away from this space. Also the overall mantra in the markets and investing nowadays is overwhelmingly "liquidity". How many times do I mention a stock to your mainstream investor and many other managers of money and the question or refrain is "is it liquid"?

 

 

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My old relatives used to love talking stocks. They would watch Louis Rukeyser and brag about how great their Coca Cola and McDonalds was doing. This was in the days of the Beardstown Ladies. Internet investing and the wide swings have cleared most of those investors out, plus the indexing mantra. The same thing happened in poker, huge rush of people entered and lost money and never came back.

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I think the old Ben Graham/Walter Schloss/Buffett Partners version of value investing is basically dead. On life support, anyway. Trying to sell the idea of buying ultra-cheap companies with very visible problems to the masses was never going to be popular, but I'm even seeing the idea of it die out even among value investors.

 

It has evolved into a flight to quality. Everybody thinks paying a reasonable valuation for compounders is the new definition of value investing. That's certainly one way to go about it, but I'm not sure that's value investing. I consider it more just "investing."

 

 

 

 

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Interesting TED talk posted on valueinvestingworld.com. I found it to be relevant to a post earlier in this thread:

 

 

Pretty basic thesis, but it reminded me of a poster's comment that value investing requires more imagination/insight/novel ideas. It isn't as simple as "low P/E ratio" anymore with the introduction and greater adoption of computing.

 

Net-nets were quite novel ideas during BG's time, but are much easier to pick out with screeners or quant algorithms now days

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I think the old Ben Graham/Walter Schloss/Buffett Partners version of value investing is basically dead. On life support, anyway. Trying to sell the idea of buying ultra-cheap companies with very visible problems to the masses was never going to be popular, but I'm even seeing the idea of it die out even among value investors.

Sorry to pick you out, but that statement actually gives me hope that value investing has a future if anything. I think so many folks have been so badly stung by value (whether it's through permanent capital loss or awful performance) that they're now increasingly embracing growth. It seems to me that the growth story is now so ingrained into investors, that their expectations have become detached from reality. I actually read an article a few days ago that suggested that stocks were actually cheap as their returns were favourable when measured against long term bond yields. It's like no one can conceive interest rates ever going up ever again.

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IMO, investing nowadays takes more imagination/insight.

If you're looking for spectacular returns, I agree.

 

Speaking of imagination/insight, I am reminded on Buffett's purchase of Coca Cola 30 years ago. It was already a large, well followed company with scores of analysts. Yet Buffett was able to make a simple extrapolation that vast untapped markets outside of the US could be opened up to Coke's products. It was a simple deduction that a ham sandwich could have made, yet Buffett was the only one to do so.

 

Anyone care to speculate what in plain site opportunity like KO exists today? My thought would be Bank Of America. You have a CEO that is telling you that the company has $35-$40bn in normalized earnings. you have all the wreckage of the financial crisis now firmly in the rear view mirror, you have a stock that's priced well under book value. I don't think it'll be a 20 bagger like KO, but in 5 years time, I simply cannot see how it will not double from today's price.

 

Incidentally, it ticks the value investing criteria ;D single digit PE, priced under book, in a sector that is hated.

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