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The agony of the value investor


thekiefs
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https://www.economist.com/finance-and-economics/2018/10/27/the-agony-of-the-value-investor?fsrc=rss%7Cfec

 

Thoughts? The only hard-hitting quantitative analysis is the Russell 3000 index comparison. I, and maybe many of you, probably take issue with the categorized "value" stocks at a macro level, prompting many questions on defining that "value".

 

We need that analysis to draw generalized conclusions about the whole sector, but I think too many value investors retort by cherry-picking a few superstar returns over a long period of time as evidence of the efficacy of the approach. I see that bias in venture capital too; I don't like it. I also know declarations of value investing's death have a long history, one rife with bitter debate over the actual stocks at play versus the realization that the market is right a majority of the time (i.e. EMT kinda true).

 

As I pour more into the battered down names this week (TAP, FFH, AN, ADS, BRK) I can't help but think of the shift to the knowledge economy and how expensing R&D might actually provide more value over the long-run in growth-focused industries than the business moats we look for... businesses typically not associated with high R&D spend, a salient point about accounting made in the article.

 

How do you keep the faith?

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Value investing means two different things to two different sets of people

 

A) Value as defined by Low P/B and/or Low P/E stocks. This is the academic definition that is used.

 

B) Value investing as defined as paying low price in relation to intrinsic value. This is the Graham/Buffett.

 

Right now both A & B are under performing market but are due to different reasons.

 

As far as (A) is concerned, cycles come and go where growth leads for a while and value takes over for a while. That is likely to continue. The financial crisis impacted a lot of value firms more than growth and this probably contributed to some of the under performance.

 

As far as (B) is concerned, there are lots of reasons.

 

Value investing principles always work. Thinking of a stock as a part ownership of a business. Buying with a margin of safety. Mr. Market. None of these change. But how these are applied should keep evolving as markets evolve. The problem is many value investors refuse to evolve. There are many areas where economy has undergone huge changes and the techniques needed to be updated. A few examples:

 

1) Take Tech. It is almost with as much pride as revealing a Superman cape underneath their shirts, value investors are so damn proud of the fact that they don't invest in Tech. Well Tech now has many companies with as strong moats as any other industry. These investors have chosen to not to even look at it.

 

2) I think Internet is on the scale of the Industrial revolution. It changed so much of the economic drivers for so many industries. Many of the brands like Coke, PG, Kraft, etc. which dominate some value investors portfolios have seen their competitive advantages deteriorate significantly. Some of these value investors are blind to this which is probably due to the fact they dont even look at Tech to understand what is going on.

 

3) Low interest rates pushed discount rates to low levels probably for a very long time into the future as well. This resulting increase in asset prices, pushed prices to levels that many value investors feel there is not enough margin of safety when they use much higher discount rates. Some of them believe that 10% stock market returns or 6.5% real returns as a god given divine right of investors.

 

4) Macro. Some go further and think the 5.7% corporate margins also as some kind of mathematical certainty. The fact is we have less than 150 years of stock and economic data. That is about 5 sets of non-overlapping 30 year periods of stock and economic returns. Not enough to draw any reliable conclusions. Maybe in another 2000 years we would have enough data to draw some conclusions. But to draw strong conclusions from 5 sets?

 

I think value investing is working just fine. The fact is we as investors need to keep evolving. Buffett did. He did not use the same methods as Graham even though he worked closely with him. So many value investors just copy Buffett. Buffett took advantage of brands when they are just taking off. Media and Consumer staples, for example. You have to ask, what have current set of value investors built on top of Buffett? 

 

Vinod

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1) Take Tech. It is almost with as much pride as revealing a Superman cape underneath their shirts, value investors are so damn proud of the fact that they don't invest in Tech. Well Tech now has many companies with as strong moats as any other industry. These investors have chosen to not to even look at it.

 

 

+1

 

I've met a young value investor who refuses to consider any tech stocks. He would often proudly say "Well, technology is not my strongest strength...", e.g., when he couldn't get a projector to work for presentation. I wanted to vomit...

 

I mean, there is no problem following the footsteps of Warren Buffett... but you don't have to blindly copy all his investing habits!

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I disagree with a lot of the tech stuff. I know lots of value investors that invest in tech and do it very smartly. They're not chasing FAANGS or anything like that. But a few years back (maybe like 5) companies like Google, Microsoft and Cisco were screaming value buys by almost any measure.

 

Now there are investors that style themselves as value that don't buy tech. They do that because Warren Buffett said something about tech 20 years ago. That may just mean they're not very good. Listening and emulating WB is not a bad place to start. But you're supposed to start from there, learn some more, evolve and do what works for you. WB himself is the great evolver. He is the great disciple of Ben Graham. But what he's built is not at all Graham-esque

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Value investing means two different things to two different sets of people

 

A) Value as defined by Low P/B and/or Low P/E stocks. This is the academic definition that is used.

 

B) Value investing as defined as paying low price in relation to intrinsic value. This is the Graham/Buffett.

 

Right now both A & B are under performing market but are due to different reasons.

 

 

How did you determine this? I know at least two investors of group A that outperformed the market over the last two years (using low P/NCAV) and i am sure there are more than enough that outperformed over that timeframe with B), too. If tech doesn`t belong into my circle of competence why should i bet there? (My problem there is always to determine the longevity of the cashflows, because of that i also don`t invest in biotech/pharma.)

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That's because value stocks tend to be good for a one time pop - or maybe until they're bought out - although they may be value stocks precisely because of some entrenched management preventing such a buyout. I think Fischer and Graham in his books wrote that sometimes being contrarian is right and sometimes it's wrong. There is no virtue in being with or against the crowd. sometimes the crowd is right

 

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Vinod had a great post. Here's just a few things that have resonated with me over in recent years. I like the way Howard Marks describes value investing, "Figure out what something is worth and buy it for less." Its kind of funny there has to be a debate over whether this kind of philosophy works.

 

Someone asked Marks a question recently about value being dead. He basically said, "Look, when the economy is hot and there is confidence in the markets, that typically creates a favorable environment for stocks who's prices mostly depend on the future. These companies tend to trade for rich premiums. Naturally, this isn't where you find a lot of value investors. But all this stuff cycles through."

 

Bill Nygren of the Oakmark Funds has also made the point that the distinction isn't value vs. growth. Its value vs. momentum. As Buffett and Munger have so effectively proven, high quality businesses are worth a lot more that crappy ones. A company can still be a bargain even if it doesn't trade at a low P/B or P/E ratio.

 

Those are just a few things that have stuck with me. 

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Tech is such a broad title that it has little meaning for me.  There are some commodity tech areas (memory chips, computer hardware) and some more moated areas (software, networked communities, transaction processors).  The former are what folks traditionally think of tech as & IMO are not very good LT value enhancers, the later are more of what I would consider growing value enhancers.  I think this is along the lines of Buffets thoughts also. 

 

Packer

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A few things to add to this.

 

Thinking as a business owner means knowing the value proposition of the business; the how it makes its money, why, who's buying the product, where are they, and when are they buying it. And not for every product, just the 20% that make 80% of the money. In a rapidly changing business world, basing decisions on just valuation ratios - makes very little sense.

 

WEB bought primarily 'brand' businesses (Coke, Sara Lee, etc.), and essentially substituted 'brand' for 'reputation'. Quality and brand went hand-in-hand, and a brand 'made the list' BECAUASE OF its reputation for quality (the moat). Cheap businesses with poor reputations didn't make the cut (better to buy the great business ...), and 'reputation' is not a line on either the P&L or BS. Yet we all know that the value of 'reputation' is repeat business, with/without current management.

 

Inability to evolve is perhaps THE greatest impediment to value investing, and it is in many ways directly comparable to the evangelical in the 'bible belt'. I'll read another book, when the good lord writes one!  The options are pretty limited  :D

 

The masters are very good at what they do, but the world has moved on. Obviously some things are just 'same old' in a new wrapper, but too many things are truly new (tech), and we all progressively 'stale date' as we age. Even the very good!

 

Different strokes.

 

SD

 

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Some very good posts above. 

 

One thing I would add to complement Vinod’s point about cycles is the following:

 

Roughly speaking, you can think of any given company’s value as consisting of two parts: the value of profits now and the value of expected profits in the future.  Stable companies have a decent amount of both, fast growing companies often have little of the former but (hopefully) a lot of the latter, and declining companies may have some of the former but usually little of the latter. 

 

The way the DCF math works is that when long term interest rates go down, it not only makes all companies more valuable but it also makes the value of future expected profits rise in relation to the value of current profits.  So “growth companies” tend to benefit the most from it, stable companies benefit too but not as much, and declining companies benefit very little.

 

Also, generally speaking, static valuation metrics like P/E and P/B tend to be positively correlated with future growth prospects (as they should). 

 

So if you put these pieces together it’s not hard to see how this could cause something like a purely mechanical quantitative value fund to underperform a broad market index when long term interest rates decline in a big way like they have post crisis.  The “problem” with the value fund here is not that it is following an unsound strategy; rather it is that it doesn’t capture the full benefits of reduced interest rates that the index enjoys.  And this is something that may well work in reverse when interest rates start to rise again.

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Vinod had a great post. Here's just a few things that have resonated with me over in recent years. I like the way Howard Marks describes value investing, "Figure out what something is worth and buy it for less." Its kind of funny there has to be a debate over whether this kind of philosophy works.

 

Someone asked Marks a question recently about value being dead. He basically said, "Look, when the economy is hot and there is confidence in the markets, that typically creates a favorable environment for stocks who's prices mostly depend on the future. These companies tend to trade for rich premiums. Naturally, this isn't where you find a lot of value investors. But all this stuff cycles through."

 

Bill Nygren of the Oakmark Funds has also made the point that the distinction isn't value vs. growth. Its value vs. momentum. As Buffett and Munger have so effectively proven, high quality businesses are worth a lot more that crappy ones. A company can still be a bargain even if it doesn't trade at a low P/B or P/E ratio.

 

Those are just a few things that have stuck with me.

 

Nice!

 

I like Marks too.

 

Not saying that I'm able to do what he says, but I'm trying.

 

I also like that "value vs momentum" statement (a lot.)

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Value investing means two different things to two different sets of people

 

A) Value as defined by Low P/B and/or Low P/E stocks. This is the academic definition that is used.

 

B) Value investing as defined as paying low price in relation to intrinsic value. This is the Graham/Buffett.

 

Right now both A & B are under performing market but are due to different reasons.

 

 

How did you determine this? I know at least two investors of group A that outperformed the market over the last two years (using low P/NCAV) and i am sure there are more than enough that outperformed over that timeframe with B), too. If tech doesn`t belong into my circle of competence why should i bet there? (My problem there is always to determine the longevity of the cashflows, because of that i also don`t invest in biotech/pharma.)

 

How did you determine this?

 

A is pretty simple. Value indexes are underperforming market and growth indexes.

 

B is a bit more anecdotal. We see how many well known investors are underperforming the benchmarks.

 

If tech doesn`t belong into my circle of competence why should i bet there?

 

Fair point. What I am trying to point out is that studying Tech is important because it is impacting so many industries. Unless you study Google and Facebook, you would have no idea why the moats of Coke, Kraft & PG for example are being weakened. That is just scratching the surface. And if you study Tech, maybe it might slowly come into your CoC?

 

Among value investors there is almost a sort of Techno Racism, for lack of a better word. It is as if investing in Tech threatens their value investing manhood. I used to be one of them. :)

 

Vinod

 

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Fair point. What I am trying to point out is that studying Tech is important because it is impacting so many industries. Unless you study Google and Facebook, you would have no idea why the moats of Coke, Kraft & PG for example are being weakened. That is just scratching the surface. And if you study Tech, maybe it might slowly come into your CoC?

 

Among value investors there is almost a sort of Techno Racism, for lack of a better word. It is as if investing in Tech threatens their value investing manhood. I used to be one of them. :)

 

Vinod

 

We can agree that studying FB and GOOG makes sense for anybody, because the economy of the advertising systems they use is just amazing (at least as long as demand for digital ads is growing, should this turn it can result in a double whammy). But i disagree that KO,KHC and PG struggled because of them, they just had problems with a strong USD and falling demand for unhealthy products over the last 10 years. I wouldn`t even call Google or Facebook Tech companies, in my mind they are just advertising spaces. But since they were overpriced for much of the last years they have together only performed in line with the market over the past two years, so there was nothing that a value investor has missed. MSFT is also interesting, but much too expensive right now.

For other tech stocks like NVDA or TXN i would argue that you are looking at a cyclical industry just at the top. This is a dangerous place to be. And AMZN, NFLX or TSLA are not really investable for me at the current point in time. AAPL can be seen as a consumer products company. I agree with packer here, the tech sector is wide spread and you can`t brush them all together.

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But i disagree that KO, KHC and PG struggled because of them, they just had problems with a strong USD and falling demand for unhealthy products over the last 10 years.

 

They struggled for a lots of reasons. But I think the street narrative about USD, struggling middle class and unhealthy products, misses more important structural long term factors. Google and Facebook is only scratching the surface. You can look at data not just by these three but many other branded consumer products companies and more importantly by individual markets where currency is not an issue and in emerging markets where the focus is still not yet on healthy stuff. You see they are struggling in many of these markets as well.

 

Vinod

 

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“Price is what you pay...value is what you get” that’s it.

Mr. Buffett

 

The value guys all know what it is like to buy momo, growth and popular stocks because we all got smoked when they fell out of their ass at some point (hopefully early in our lives)! We learned the hard way of the folly of growth that looked like it would never stop or the moat that could never be broken etc. We had our blood spilled and learned by fire...we try to pass on this horrible experience to those that believe the hype. We look stupid to the young Wall Street gurus and day traders that rule the world in the high multiple growth oriented stock market. We miss the rise and fall of the crypto’s and the pot stocks...the 150PE tech companies that can’t ever be beaten. Our stories are boring at cocktail parties...as we get rich slowly over time. We sleep well and from what I see (hoping) we live longer as we nurture our craft until late in life.

 

a quick story...that won’t make any headlines...was having a beer with a friend on a dock where I fielded the question of the time....how high would Amazon go? There was “nothing that can stop it”

was every headline and my friend could not help but think there was more upside. This was the first week of September....I was studying an arbitrage opportunity on a tender offer from Thomson Reuters. It was like talking about a snail on the beach compared to a new Tesla powered jet boat that

might spray us on the way by!

I explained my snail project (TRI) I figured that I could make between 0 and 9% in the next 3 weeks but the kicker was (at least to me) that I thought there was 0 downside or I would break even in a

worse case scenario.

Of course the response was...Amazon could do that in a day or two!!!i am not sure but it may have done that! I explained that I had the conviction to bet a lot of money on TRI because I did not see any

downside as my shares would be bought out at least what I paid for them on Sept 30. If $9b in shares were not tendered all would be paid for at the high end of the tender or $47 USD. I determined that there is no way that they will have that many shares tendered as it was a third of the outstanding shares. That is exactly what happened and I made my 9%. My friend followed...today the difference between Amazon and the TRI arbitrage is above 30%...Amazon is down 20% plus since then and I have the 9% return in the bank to continue to buy more value in this sell off.

 

You only hear of value investors after the tide has turned everyone wishes they were value investors when growth ends but like lemmings they are incapable of ignoring the supposed easy profits that their neighbors are making in straight up markets. I don’t feel any better because Amazon dropped I am indifferent. It is a great business however, I don’t know what it is worth...but I knew the deck was stacked in my favor at TRI and that is how value investors think. There is no one that wants t hear that story other than value hunters.

It’s lonely but rewarding....for some reason the investing world has decided to pretend that Mr.Buffett was not a stock market operator. He made 25% a year pre tax from Arb’s like TRI. There is more than one way to get to heaven so don’t get pigeon holed on what value is....it’s there or it’s not.

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“Price is what you pay...value is what you get” that’s it.

Mr. Buffett

 

The value guys all know what it is like to buy momo, growth and popular stocks because we all got smoked when they fell out of their ass at some point (hopefully early in our lives)! We learned the hard way of the folly of growth that looked like it would never stop or the moat that could never be broken etc. We had our blood spilled and learned by fire...we try to pass on this horrible experience to those that believe the hype. We look stupid to the young Wall Street gurus and day traders that rule the world in the high multiple growth oriented stock market. We miss the rise and fall of the crypto’s and the pot stocks...the 150PE tech companies that can’t ever be beaten. Our stories are boring at cocktail parties...as we get rich slowly over time. We sleep well and from what I see (hoping) we live longer as we nurture our craft until late in life.

 

a quick story...that won’t make any headlines...was having a beer with a friend on a dock where I fielded the question of the time....how high would Amazon go? There was “nothing that can stop it”

was every headline and my friend could not help but think there was more upside. This was the first week of September....I was studying an arbitrage opportunity on a tender offer from Thomson Reuters. It was like talking about a snail on the beach compared to a new Tesla powered jet boat that

might spray us on the way by!

I explained my snail project (TRI) I figured that I could make between 0 and 9% in the next 3 weeks but the kicker was (at least to me) that I thought there was 0 downside or I would break even in a

worse case scenario.

Of course the response was...Amazon could do that in a day or two!!!i am not sure but it may have done that! I explained that I had the conviction to bet a lot of money on TRI because I did not see any

downside as my shares would be bought out at least what I paid for them on Sept 30. If $9b in shares were not tendered all would be paid for at the high end of the tender or $47 USD. I determined that there is no way that they will have that many shares tendered as it was a third of the outstanding shares. That is exactly what happened and I made my 9%. My friend followed...today the difference between Amazon and the TRI arbitrage is above 30%...Amazon is down 20% plus since then and I have the 9% return in the bank to continue to buy more value in this sell off.

 

You only hear of value investors after the tide has turned everyone wishes they were value investors when growth ends but like lemmings they are incapable of ignoring the supposed easy profits that their neighbors are making in straight up markets. I don’t feel any better because Amazon dropped I am indifferent. It is a great business however, I don’t know what it is worth...but I knew the deck was stacked in my favor at TRI and that is how value investors think. There is no one that wants t hear that story other than value hunters.

It’s lonely but rewarding....for some reason the investing world has decided to pretend that Mr.Buffett was not a stock market operator. He made 25% a year pre tax from Arb’s like TRI. There is more than one way to get to heaven so don’t get pigeon holed on what value is....it’s there or it’s not.

 

Another very nice reinforcement of these ideas.

 

Sounds like Marks again, "protect yourself from downside & the upside should take care of itself."

 

I hear Tesla & $hitcoin fairytales from these young kids at school on a regular basis & I try to describe these ideas to them.

 

I feel like an idiot when one of them tells me how their 1 share of OUAT (Once Upon a Time) rips up for a TEMPORARY happy ending.

It's hard to argue with an immediate gain like that without LOOKING like an idiot too, so I congratulate them & ask if they've booked the profit.

 

However, they never say anything when OUAT tanks & none of them can tell me what's actually going on at the company.

 

I still have hopes, & will continue to repeat to any of them who ask "know what you OWN, OWN what you know", and "day trading is for suckers."

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