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Does Value Investing "still" work?


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Much discussion as to why results from Value Investing have been poor for > a decade. Covid and 2020 has further highlighted the gap between value & growth investing (mostly tech).

 

In Francis Chou's 2020 semi-annual letter, he argues that value investing works but he his valuations have been wrong - gave too much emphasis to assets and not enough to operating side of business for companies in trouble - mistakes of commission.

 

On the other hand, mistakes of omission were undervaluing profitable companies and potential for growth. Not sure how he would change the valuation for growing companies - accept a different P/E?

 

The following is Francis' write up on Does Value Investing Work? :

"With the lackluster returns by value funds in recent years compared to growth and index funds, there is some doubt as to whether value investing can still work in the current market. We hold the view that value investing certainly works, but only when executed properly. Sometimes it is easier to blame the market environment than to admit our own faults. Although factors such as low interest rates, the popularity of passive investing and elevated market valuations played a role in blunting returns for value investors, we also accentuated the problem. The key to value investing is appraisal. If that is not precise enough, everything falls apart. We tend to fish in troubled waters, and what caused the biggest problem in recent years was that our appraisal of troubled companies was off the mark.

When we thought a company was worth 100 cents, it was actually worth closer to 60 cents. We tended to give much higher weight to asset values and not enough weight to the value of the operating company. We used the asset value as a huge security blanket and became blind to the deterioration of the worth of the operating company.

That was a mistake of commission. We also made a bundle of mistakes of omission.

Over the last 30 years, roughly half our portfolio was in troubled companies and the other half was in good companies. So, we are well acquainted with investing in both types of companies. But what happened over the last few years was that we spent most of the time undervaluing the good companies. When our assessment showed that the investments were worth 100 cents, they were more accurately close to 150 cents, thus causing us to miss most of those opportunities. These “omissions”, though they are unseen mistakes, are nevertheless as real as mistakes of commission. In summary, although the markets have been less kind to value investing, we exacerbated the problem as practitioners."

 

The full letter is publicly available at http://choufunds.com/pdf/SEMI-AR%202020%20%28English%29.pdf

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You are laying out cash to buy a business to get more cash from business in future.

 

If you get  the second part right and buy at a decent discount, I don't see how investment( or call it value investment) won't work. 

 

Trying to assign value based on P/B or P/E can be indication of value sometime, but not really a value other times. But if you can figure out owners earning with high degree of certainty and buy at a discount, it's extremely hard to not make money over time.

 

 

 

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You are laying out cash to buy a business to get more cash from business in future.

 

If you get  the second part right and buy at a decent discount, I don't see how investment( or call it value investment) won't work. 

 

Trying to assign value based on P/B or P/E can be indication of value sometime, but not really a value other times. But if you can figure out owners earning with high degree of certainty and buy at a discount, it's extremely hard to not make money over time.

 

rranjan, Yes makes sense. How then do you explain Chou Associates 15 yr compound return of 1.6%? Are you saying that value investing community is not able to fairly assess how much cash the business will generate in future.

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You are laying out cash to buy a business to get more cash from business in future.

 

If you get  the second part right and buy at a decent discount, I don't see how investment( or call it value investment) won't work. 

 

Trying to assign value based on P/B or P/E can be indication of value sometime, but not really a value other times. But if you can figure out owners earning with high degree of certainty and buy at a discount, it's extremely hard to not make money over time.

 

rranjan, Yes makes sense. How then do you explain Chou Associates 15 yr compound return of 1.6%? Are you saying that value investing community is not able to fairly assess how much cash the business will generate in future.

 

I have not followed Chou to really comment on what he is doing. Market may not price properly for couple of years, but in most instances market will push asset price closer to true worth in 4-5 years. Often it will overshoot as well.

 

In general, if you do poorly for 15 years then it means simply one thing, you are making mistakes in figuring out how much cash business will produce for owners.

 

Recently, we have seen articles like value investment being dead or value investors not doing well. Some time it could the case of growing companies getting higher multiple due to very low interest rates. I meant, cash coming after 10-15 years becomes a lot more valuable for investors if they think that interest rate(proxy for inflation) will remain low for entire time. It may create a situation where investors starts overpaying for such companies and underpaying for decent cash but not growing that much. But even if you own second group, it's hard to only make 1.6% for 15 years unless you are making mistakes in evaluating what cash business will generate over time for owners.

 

But when all said and one, investment is all about how much cash you get in future, how quickly you get it and how certain you are about getting it.  Growth is simply  a component in figuring out how much cash will come to owners in future. These tags about value investment, growth investment etc does not make too much sense to me.

 

 

 

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Guest cherzeca

how many "filters" do you want to apply? like Buffett, you can first find a great business. then you try to buy right (cheap). if you can't buy right, you don't buy.  if your holding horizon is long (as Buffett) then you might focus on the former rather than the latter, since over time what looks like an expensive entry point may look cheap down the road.  you can over think all of this, but usually a long investment horizon smooths out a lot of entry indiscretion as long as you buy into a great business.

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I don’t know if one can have a proper discussion about this issue without drilling down to specific investments    Otherwise we are just speaking in generalities and it’s not useful.

 

So too answer does value investing work we should break down the companies he invested in that lead to the 1.5% returns over 15 years......

 

Why did sears not work ??  Massive Real estate assets  But poor operating business.....  but isn’t this the typical value investment playbook.  The concept that assets are safer than operations is a critical value investment concept.  Throwing out this idea is just admitting that value investing does NOT work.

 

So why did sears not turn out to be a great investment?  I think if you can do a post mortem on Sears you can answer the question

 

One issue that will come up is are you really the owner as a equity investor in the same way you were 30 years ago.  The concept of stakeholders is stronger now than it was 30 years ago.  You can’t go in and wack management and close down all these sears stores overnight.  You would be attacked by politicians and the media and brought before Congress.    So this is just one issue that has changed.  You are no longer the “owner “ in the same way you were 30 years ago.  I think there are more lessons to be learned in such an exercise and if done well we may discover that at least in the way it was practiced by Ben Graham and early Warren Buffett value investing does not work - maybe

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Yes value investing beautifully works - for the owners of the value funds.

 

Chou associates USD returned 0.9% compounded for last 15 years. Yet investors have $133MM in assets in this fund.

The fund collected $1,345,763 in fees.

Who are these dumb people?

 

Quit being a value investor, become a owner of a value themed fund. That’s where the money is.

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So why did sears not turn out to be a great investment? 

 

35% gross margins in retailer won't work when other retailer can operate at 11% gross margin. Department stores fell behind and it's very hard to make math work for customers if your gross margin is drastically higher than others. Department stores needed high gross margin to operate because they had much higher expense. Old customers kept going for a while due to habit , but you can not attract new customers. Eventually you die if you are not providing value to your customers.s

 

Now there was hypothetical value in asset, but it could not be converted to cash. If you can not take out cash then investment will not work.

 

 

 

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I believe that Value Investing Still works.  Very well in fact.  The problem i see for many value investors is:

 

1.  Many are formulaic thinkers who never advance beyond a simple desire to repeat what worked in the past without realizing the market is a dynamic competition that requires adaptation

2.  Many value investors, particularly sophisticated ones, shoot themselves in the foot over and over and fail to learn from their own mistakes, as well as the mistakes of others.  This is particularly true for long/short managers who keep impailing themselves on bubble stocks for no reason

3.  Many value investors take pride in having zero market or trading acumen

4. Many talented analysts are put into portfolio management roles with little to any knowledge on how to run a portfolio, manage risk, and "step on the gas" at the right time.  They are like the guy who studied boxing for years in books, then step in the ring expecting to be competent. 

 

All of these issues are encapsulated by the lazy desire to blame "value investing not working" for crummy results.  And if one wants to define "value investing" as some statistical factor (or collection of them) you have been made obsolete, indeed quite a few years ago. 

 

 

 

 

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Now there was hypothetical value in asset, but it could not be converted to cash. If you can not take out cash then investment will not work.

 

 

 

Yes but WHY can you not convert this to cash.

The thesis for all the value guys in sears wasn’t based on the operating business.  It was based on the assets

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Now there was hypothetical value in asset, but it could not be converted to cash. If you can not take out cash then investment will not work.

 

 

 

Yes but WHY can you not convert this to cash.

The thesis for all the value guys in sears wasn’t based on the operating business.  It was based on the assets

 

 

Deadspace, you may have struck a chord when you say that traditional value investing focused on assets but not possibility of generating cash from the assets. Some of the error was in expecting that assets to be re-valued but not understanding the inflection point that will cause the re-valuation. Some have simply believed that over time "value will out".

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In general, if you do poorly for 15 years then it means simply one thing, you are making mistakes in figuring out how much cash business will produce for owners.

 

 

 

Agree. However, plethora of value investors have not done as well as expected for past 10-15 years including Prem Watsa and FFH whom this board is v. familiar with. Thus, there have been a group of v. intelligent, astute and respected deep value managers that have not performed as well as expected over a relatively long time frame of 10-15 years. Changing understanding of future cash flow generation likely required to change outcomes going forward.

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Guest cherzeca

have you ever bought a cheap device on sale? and found out you get what you pay for? similar with value investing. you might minimize your downside by buying cheap, but perhaps also your upside.  it's a fine balance. buy quality, try not to pay up too much, hold on to it. 

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Now there was hypothetical value in asset, but it could not be converted to cash. If you can not take out cash then investment will not work.

 

 

Yes but WHY can you not convert this to cash.

The thesis for all the value guys in sears wasn’t based on the operating business.  It was based on the assets

 

Ceratainly of asset getting converted to cash was not too high. When you have to fire  people to liquidate asset, it's not easy to do so quickly.

 

There is time value of money when liquidating. Liquidating within a year is totally different than liquidating within 20 years. Illiquid real estate assets are not worth the claims made by many investors. If assets are liquid and can be converted to cash quickly then situation will be different.

 

I personally put these cases in too hard pile.

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If I can find a business throwing 10% of FCF with very little growth and FCF is not wasted then by owning it I can expect to make 10%.

 

If my investment returns depends on liquidating to produce cash then time line for liquidation matters a lot.

 

If you buy 1 dollar of asset by paying 50 cents then you will do fine if asset can be liquidated quickly. If it takes 10 years and meanwhile business also requires more cash to keep running then it's not going to work nicely.

 

I find it too hard. Even lampert admitted it that it was not a one foot hurdle.

 

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Lampert. "We'd rather jump over a one-foot hurdle too. But it's difficult to find the opportunity. So I'm willing to engage more in underperforming companies."

 

https://money.cnn.com/2006/02/03/news/companies/investorsguide_lampert_stockpicking/

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If I can find a business throwing 10% of FCF with very little growth and FCF is not wasted then by owning it I can expect to make 10%.

 

If my investment returns depends on liquidating to produce cash then time line for liquidation matters a lot.

 

If you buy 1 dollar of asset by paying 50 cents then you will do fine if asset can be liquidated quickly. If it takes 10 years and meanwhile business also requires more cash to keep running then it's not going to work nicely.

 

I find it too hard. Even lampert admitted it that it was not a one foot hurdle.

 

-----------

Lampert. "We'd rather jump over a one-foot hurdle too. But it's difficult to find the opportunity. So I'm willing to engage more in underperforming companies."

 

https://money.cnn.com/2006/02/03/news/companies/investorsguide_lampert_stockpicking/

-------

 

Agree. What I'm learning is that perhaps driver for value inflection point should be clear at time of purchase. Concept of "value will out over time" is not good enough.

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The big question with Sears was, "who the hell wants these crap properties? And they were mostly crap. So who is going to pay 100% on the dollar for them? Are you??

 

In terms of value investing in general; of course it works - but you need to adjust to the world around you at some point, and stop waiting for the world to adjust to you (it's a balance). Low interest rates have made things difficult - we have boosted terminal values at the expense of near-term cash flows. Much harder to estimate at time zero.

 

If your definition of value investing is buying under 5x ebitda or 10x PE or 1x book, well unfortunately you are fishing in a cesspool of mediocrity.

 

So I definitely agree it is harder. Life is easy when you only need to estimate a few years of cash flows to earn your keep. 

 

With rates so low, now you have to estimate out 7, 10, or more years. This is a much more difficult task!

 

 

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Value investing is maligned because of the many "value investors" who do it wrong and poorly.

 

A major of self-identified "value investors" either think it means buying turnarounds, low quality businesses (at perceived low prices), and/or extremely contrarian stocks. This leads to portfolios with companies with tons of debt where management must truly thread a needle to stem the tide or avoid bankruptcy. Moreover, these folks significantly underestimate (1) what they don't know, or (2) the numerous contingencies that could appear and derail things. This leads to positions in Sears, JC Penneys, GM, Howard Hughes, etc.without even the acknowledgement that there is a good chance each can (or deserve) to trade lower or even go bust.

 

Just as many dumb businesses justify folly with spreadsheets, value investors often do with specious fundamentals and stats: low P/E, P/B, etc. Or my favorite: EV to adjusted Ebitda.

 

I'm a value investor, but in most conversations with other value investors, I find myself first challenging their "It's only 8x earnings" assertions. I almost never get a good answer when I ask someone "Why does this business deserve to thrive or exist?"

 

 

 

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have you ever bought a cheap device on sale? and found out you get what you pay for? similar with value investing. you might minimize your downside by buying cheap, but perhaps also your upside.  it's a fine balance. buy quality, try not to pay up too much, hold on to it.

 

Agree.  And one way to think about this is that the market has become more efficient and hence value investing does not work because you get what you pay for whereas in the past you could more easily find valuable assets that were simply being ignored but in the last 15 years these assets that seemed just out of favour were being properly valued in the market.  It was the value investor that was missing the boat and falling into a value trap without knowing it.

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Feel like this topic comes up every 3 months or so. Value investing works if you do it correctly. Nothing in investing is stationary. You need to be flexible in thought and disciplined in application. Buying a textile company at 4x just because Buffett did doesnt mean you'll become rich.

 

Also worth pointing out that with money to be had this cheap, your 5x FCF isn't as valuable as you think it is. And if time isn't on your side, its even less so. Myself Ive gotten into trouble buying on the "discount to assets" strategy, as its easy to ignore the operational side because of "half NAV" or whatever. Where will your business be in 5-10 years is probably the most important question an investor can ask themselves. Sears didnt work for this reason. The properties weren't crap. They just had to continuously liquidate assets to keep burning all that cash on the biz...in which case the longer it goes on the higher the likelihood you are left with nothing. Trading at 50% of a $10B NAV with a $2B annual burn leaves you with nil after 4-5 years. Which is what happened.

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Feel like this topic comes up every 3 months or so. Value investing works if you do it correctly. Nothing in investing is stationary. You need to be flexible in thought and disciplined in application. Buying a textile company at 4x just because Buffett did doesnt mean you'll become rich.

 

Also worth pointing out that with money to be had this cheap, your 5x FCF isn't as valuable as you think it is. And if time isn't on your side, its even less so. Myself Ive gotten into trouble buying on the "discount to assets" strategy, as its easy to ignore the operational side because of "half NAV" or whatever. Where will your business be in 5-10 years is probably the most important question an investor can ask themselves. Sears didnt work for this reason. The properties weren't crap. They just had to continuously liquidate assets to keep burning all that cash on the biz...in which case the longer it goes on the higher the likelihood you are left with nothing. Trading at 50% of a $10B NAV with a $2B annual burn leaves you with nil after 4-5 years. Which is what happened.

 

 

Agree.  That is a good encapsulated summary of what happened.    But to the investors that purchased the equity what was supposed to happen was that the cash burn would be stopped by quickly closing and selling poorly performing stores.  The famous line by Bruce Berkowitz one of the value investors involved at the time was that sears losses were optional.    It’s easy in retrospect to summarize what happened here as obvious but this gets to the heart of a common value thesis that there is safety in the assets and that assets like real estate that have knowable market values and are fungible need to be given greater weight than unknowable cash flows at year 6 etc.  These assets were not safe because in essence they belonged to society NOT to the investors.  The concept of multiple stake holders makes it impossible to liquidate large assets and shut down large poorly operating businesses.    This is just one of the perhaps many lessons new age value investors need to learn to avoid the value traps that lead to these brutal results

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https://www.institutionalinvestor.com/article/b1n5nhk92q3g62/I-Can-t-Believe-I-m-Saying-This-But-I-m-Passing-on-Seth-Klarman

 

 

If value investing is merely being poorly practiced by some poor practitioners someone better tell this guy called Seth Klarman that he is just a poor practitioner of the art

 

I think part of the problem with guys like Klarman is that they are already rich, and did it their way. Type A, especially, forgive the language, nerdy intellects, are some of the most stubborn people on Earth. So yea, for a decade nothing some of these guys has done has worked...but they got rich doing it their way and they'll be damned if they ever listen to someone else who knows better. This is part of what is so admirable about David Tepper. He just kind of goes with what is working and is mentally able to change strategies on a dime.

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In terms of value investing in general; of course it works - but you need to adjust to the world around you at some point, and stop waiting for the world to adjust to you (it's a balance). Low interest rates have made things difficult - we have boosted terminal values at the expense of near-term cash flows. Much harder to estimate at time zero.

 

If your definition of value investing is buying under 5x ebitda or 10x PE or 1x book, well unfortunately you are fishing in a cesspool of mediocrity.

 

To double click on the idea of "adjust to the world around you" and metric of value, I've been thinking of this idea that in tech with proven earnings a P/E of 30 might be the equivalent of P/E of 10 in traditional industries. Reason: In proven tech companies with earnings, the total addressable market (TAM) is unknown because they open new markets. This does not happen with traditional commodities & industries - ie a pulp producer is unlike to evolve to clothing apparel retailer. With tech, a computer company (like Aapl) can become a music company and then a services company and then may become a health company. 

 

So if Aapl, Goog, FB are ever trading at a PE of <30, could be the equivalent of traditionally buying at PE of 10. Does that make some sense??

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