The Deep Value Cycle

[Guest hellsten]

The Brooklyn Investor writes about deep value investing and Richard Pzena's PZN:

http://brooklyninvestor.blogspot.com/2012/09/the-deep-value-cycle-and-case-for-value.html

http://brooklyninvestor.blogspot.com/2012/09/pzena-investment-management-pzn.html

 

He first described this deep value cycle in depth on the conference call held in February 2012.  This is what he said:

- Cycles are long, 10 years on average with deep value outperforming in 7 of those years.

- Over the past four value cycles, deep value outperformed by 480 bps/year.

- Recent experience is consistent with these past cycles.

- Last peak was 58 months ago (as of February 2012) and deep value is 11.8% behind the S&P 500 index, almost exactly the same as the average in past cycles.

- The recent deep value upcycle started in December 2008, but was interrupted for six months in 2011, but this too is consistent with past cycles.

- There is significant pent up opportunity in the value category due to flight-to-safety and across the board, indiscriminate selling of cyclical businesses.

 

I guess this might be good "news" for Francis Chou and Pzena.

 

The article includes Pzena's study on 10-year holding periods for bonds, stocks, commodities and hedge funds:

http://www.pzena.com/heading-our-research/pzena-white-paper.php

 

Personally, I like to invest in what I believe are high-quality companies. I still find basket cases such as RSH, SVU, NOK, and RIMM attractive. I'm just not able to buy them like e.g. Francis Chou.

 

BAC and AIG seem to be the favorites on this board. What other deep value stocks do you find attractive right now?

[Uccmal]

hellsten, You might also enjoy David Dreman "Contarian Investment Stategies for the next generation"; 1998.  Dreman has done alot of moderately robust research on low P/b, low p/cf, low pe, and low P/dividend stocks. 

 

I dont follow anything as a strict method, but these studies show that the 'return to normal' stategy works.  Dreman sums up the rationale of why value strategy works.  It is exactly like BAC and AIG are playing out.  Company gets in deep trouble, new management comes in, cleans up the mess, and as profitability returns, the stock price appreciates for years at an accelerated rate. 

[Kraven]

hellsten, You might also enjoy David Dreman "Contarian Investment Stategies for the next generation"; 1998.  Dreman has done alot of moderately robust research on low P/b, low p/cf, low pe, and low P/dividend stocks. 

 

I dont follow anything as a strict method, but these studies show that the 'return to normal' stategy works.  Dreman sums up the rationale of why value strategy works.  It is exactly like BAC and AIG are playing out.  Company gets in deep trouble, new management comes in, cleans up the mess, and as profitability returns, the stock price appreciates for years at an accelerated rate.

 

Dreman recently updated his book and it came out in the last year or so.  I am not sure all that much changed, but he does relate things to the financial crisis.

[Guest hellsten]

hellsten, You might also enjoy David Dreman "Contarian Investment Stategies for the next generation"; 1998.  Dreman has done alot of moderately robust research on low P/b, low p/cf, low pe, and low P/dividend stocks. 

 

Thanks. I have fond memories of reading Dreman's book on a beach chair a few years ago. It's one of the best books on value investing IMO.

 

Joel Greenblatt talks about overriding the formula in the latest Graham and Dodsville issue, which was posted in another thread here:

http://www.scribd.com/doc/109359209/Graham-Doddsville-Issue-16-Fall-2012-vFINAL2

 

There’s a certain medication on the market that’s made by a small pharmaceutical company. This company was considered a very attractive buy according to one of our screens. But I knew why it looked cheap - its key medication was coming off of patent the next year and the stock was priced accordingly. My inclination could have possibly been to override the formulaic recommendation because I knew exactly what was going on. It wasn’t like it was a big secret. I didn’t override anything, however, and the company subsequently figured out a way to extend the patent a little longer which then led to a doubling of the stock price over the next six months. I think that’s really been our experience. Part of the future is unknowable but there are some instances where you can take a calculated risk/reward bet.

[SharperDingaan]

You might want to re-think how you apply it.

 

'Return to normal' implies the future will resemble the past - the business model is still valid, & the environment hasn't changed that much. Back in the day that may have been reasonable; today - not so much.

 

Do you really think that when Europe finally recovers, Europe will still be doing business the same way it was done before the 'crisis'. Banking & investment regulation did not change? 'Too big to fail' remained only a banking concept, & did not spread to other industries? The 'Too big' would not become nationalized entities?

[Guest hellsten]

While looking at the major shareholders of RSH, I noticed Donald Smith & Co increased their ownership by 230% to just over 1% of their total portfolio:

http://investors.morningstar.com/ownership/shareholders-major.html?t=RSH&region=USA&culture=en-us

 

This is the first time I hear about Donald Smith & Co (that I can remember):

http://www.donaldsmithandco.com/

 

Google turned up some interesting details:

"The Man Who Outperformed Warren Buffett":

http://www.investmentu.com/2011/March/donald-g-smith-outperforms-warren-buffett.html

 

Holding an MBA from Harvard and a law degree from UCLA, Don uses a different approach. He specializes in finding “deep value” companies, whose fundamentals turn positive.

Among the many factors that stock analysts use – such as price-to-sales, price-to-earnings, price-to-dividends, return on equity, etc. – Don discovered that the price-to-book ratio offers the most opportunity to outperform. And especially stocks selling below their book value.

After going through an in-depth screening process, evaluating out-of-favor companies, Smith attempts to measure “tangible” book value using various factors. He adjusts for hidden assets, goodwill and dilution from options and convertible debt. His company spends time talking to company executives and conducts hands-on due diligence to determine the company’s future prospects.

Smith says, “We stress test. That’s the first of the value traps, buying something that ends up going bankrupt on you. The second trap is buying a cheap asset that stays cheap forever.”

Smith seeks to avoid both. And how have his investigative techniques worked out?

The “On Sale” Sign is Hanging Over These Three Sectors

In over 30 years since its inception, Donald Smith & Co. has earned a compounded annual return of 15.3%. And over the past 10 years, when the stock market has gone nowhere, his company’s annual return is 12.1%.

 

On their website they have some interesting facts about deep value investors:

Our approach is highly differentiated. Only 1/10 of 1% of all money managers focus on investing in the lowest decile of price-to-tangible book value stocks. Even fewer money managers perform detailed fundamental analysis when employing a low price-to-tangible book value strategy.

 

More links:

http://www.quotes.net/authors/Donald+G.+Smith

http://greenbackd.com/2010/10/29/donald-g-smith-in-the-fall-2010-graham-and-doddsville-newsletter/

 

Anyone have more information on Donald Smith & Co?

[writser]

You might want to re-think how you apply it.

 

'Return to normal' implies the future will resemble the past - the business model is still valid, & the environment hasn't changed that much. Back in the day that may have been reasonable; today - not so much.

 

Do you really think that when Europe finally recovers, Europe will still be doing business the same way it was done before the 'crisis'. Banking & investment regulation did not change? 'Too big to fail' remained only a banking concept, & did not spread to other industries? The 'Too big' would not become nationalized entities?

 

"The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton

[biaggio]

Hellsten, thanks for posting re Don Smith

 

 

Interesting read on his philosophy in 2010 interview here

 

http://www4.gsb.columbia.edu/filemgr?file_id=736835

[Guest hellsten]

Hellsten, thanks for posting re Don Smith

 

 

Interesting read on his philosophy in 2010 interview here

 

http://www4.gsb.columbia.edu/filemgr?file_id=736835

 

Thanks. I'm definitely putting Donald Smith on my list of gurus :)

[txitxo]

The Brooklyn Investor writes about deep value investing and Richard Pzena's PZN:

http://brooklyninvestor.blogspot.com/2012/09/the-deep-value-cycle-and-case-for-value.html

http://brooklyninvestor.blogspot.com/2012/09/pzena-investment-management-pzn.html

 

He first described this deep value cycle in depth on the conference call held in February 2012.  This is what he said:

- Cycles are long, 10 years on average with deep value outperforming in 7 of those years.

- Over the past four value cycles, deep value outperformed by 480 bps/year.

- Recent experience is consistent with these past cycles.

- Last peak was 58 months ago (as of February 2012) and deep value is 11.8% behind the S&P 500 index, almost exactly the same as the average in past cycles.

- The recent deep value upcycle started in December 2008, but was interrupted for six months in 2011, but this too is consistent with past cycles.

- There is significant pent up opportunity in the value category due to flight-to-safety and across the board, indiscriminate selling of cyclical businesses.

 

I guess this might be good "news" for Francis Chou and Pzena.

 

The article includes Pzena's study on 10-year holding periods for bonds, stocks, commodities and hedge funds:

http://www.pzena.com/heading-our-research/pzena-white-paper.php

 

Personally, I like to invest in what I believe are high-quality companies. I still find basket cases such as RSH, SVU, NOK, and RIMM attractive. I'm just not able to buy them like e.g. Francis Chou.

 

BAC and AIG seem to be the favorites on this board. What other deep value stocks do you find attractive right now?

 

  Very interesting reading. As they say, just buying a basket of stocks in the lower 20% in terms of P/B will beat the indexes by a few percent over the cycle. Guaranteed. Dreman showed that it worked many decades ago, then Eugene Fama published a paper as if he was making a big discovery with the same result, and as Pzena shows, it keeps happening. That anomaly does not go away. What value investors do is exploit the same effect in a more convolved way.

 

 

 

 

[SharperDingaan]

"The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton

 

Keep in mind that most often - this type of investment is not ‘passive’. The main risk is that the target bankrupts, so the focus is short-term. Is it worth more broken up, ‘green-mailed’, or privatized via a creeping takeover &/or as a debt for equity swap with a later IPO? Is it worth the effort to correct? (ie: RIM) - the names change, but the game remains the same.

 

The medium-term risk is the business model. Is it good enough to tweak/save? or better to just keep the brand & distribute differently? - the IPO buyer is buying the model & the earning power. You get the most if the ‘refreshed’ business model is sexy, & ‘with the times’. A Facebook.

 

ING proved you do not need Bricks & Mortar to have a bank – you need brand, & technology. Amazon proved you need brand – and distribution. Apple/RIM/Samsung proved you need brand - & rapid product development. Sell less product at higher margins, do it directly, on-line, more nimbly, & with better risk control.

 

Applied: Is a far smaller - but entirely virtual - lean, mean, AIG machine worth more than the current version? Is it worth the effort to get there?

 

[SharperDingaan]

The long kept sales force secret is that most traditional business models, disproportionately benefit the sales force over the actual business owners.

 

To increase sales requires additional investment (fresher product, aggressive pricing, new/improved distribution, promotion); all of which the firm pays for. The sales force is typically paid on the additional sales they produce (as a result of the investment) + a commission bonus on their total sales year-to-date. The higher the total sales the higher the commission rate; & the higher you are in the sales force food chain, the more the benefit.

 

If the investment works a (5%) increase in sales will produce additional margin, but there will be no benefit to the business owner until the business has paid off the additional investment. The sales force benefits immediately. If the investment fails, sales are unlikely to fall to what they would have otherwise been; & the sales force still benefits. Asymmetric sales force payoffs

 

The on-line model doesn't just pay no/less sales commission, it also removes most of the asymmetric sales force payoffs, & a large chunk of the agency bias (the 'slow the process, & lets milk this thing'), to the benefit of the business owners actually taking the risk. Quicker & fact based decisions, faster pivots, .... improved nimbleness.

 

Needless to say the sales-force will disagree, & advocate for status-quo ....