Our New Canadian Deep Value Stock Screener – (CAGR) 19.1% per year

Johnny HopkinsStock Screener Comments

Big news this week with the release of our new Canadian All TSX deep value stock screener, and the backtest results are astounding!

Backtesting Results Canada All TSX Stock Screen

We backtested the returns to a theoretical portfolio of stocks selected by The Acquirer’s Multiple® from the Canada All TSX stock screen. The backtest assumed the screen bought and held for a year 30 stocks selected from the All TSX universe (the largest 95 percent of all TSX stocks by market capitalization). The portfolios were rebalanced on the first day of the year using the most recent fundamental data. The backtest ran from January 2, 1999 to June 16, 2017.

Over the full eighteen-and-one-half year period, the Canada All TSX screen generated a total return of 2,536 percent, or a compound growth rate (CAGR) of 19.1 percent per year. This compared favorably with the S&P/TSX Composite TR, which returned a cumulative total of 232 percent, or 4.7 percent compound.

You can read more about the full backtesting results for the Canada All TSX stock screen here.

How does this compare with our U.S. Stock Screens?

Here’s how the Canada All TSX stock screen compares with our three U.S. deep value stock screens:

All Investable U.S. Stock Screener (CAGR 25.9%)

Over a full sixteen-and-one-half year period, the All Investable stock screen generated a total return of 5,705 percent, or a compound growth rate (CAGR) of 25.9 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Small & Micro Cap U.S. Stock Screener (CAGR 22%)

Over a full sixteen-and-a-half year period, the Small & Micro Cap stock screen generated a total return of 3,284 percent, or a compound growth rate (CAGR) of 22.0 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Large Cap 1000 Stock U.S. Stock Screener (CAGR 18.4%)

Over the full sixteen-and-a-half year period, the Large Cap 1000 stock screen generated a total return of 1,940 percent, or a compound growth rate (CAGR) of 18.4 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 259 percent, or 5.6 percent compound.

How do I get the Canada All TSX stock screen?

The Canada All TSX stock screen is included with our three other U.S. stock screens for paid subscribers here.

How To Develop A Superinvestor Mindset Like Buffett, Munger, Neff, Loeb, Lynch and Soros

Johnny HopkinsCharles Munger, Warren Buffett Comments

One of my favorite investing books is How To Think Like Benjamin Graham and Invest Like Warren Buffett, by Lawrence A Cunningham. One of the best pieces in the book looks at the principles applied by some of the greatest superinvestors of all time.

Here’s an excerpt from the book:

The best investors employ a mind-set that takes account of just a few things, but those things are indispensable. Every extraordinary investor follows Ben Graham’s first principle: The market does not perfectly price the business value of a stock. Warren Buffett takes that insight dead seriously by limiting his purchases to stocks that are way underpriced by the market. Both of these investment titans as well as Phil Carret emphasize the importance of avoiding bad deals, stocks that are way overpriced in the market.

These investors and other greats, such as Buffett’s partner Charlie Munger, always remember that there are tens of thousands of investment options available to just about anyone. To opt for one requires a strong belief that the market is giving the best deal available compared to all the others. And opportunity does knock. One way to test opportunity is to take Loeb’s approach: always ask whether you would be comfortable committing a large portion of your resources to a single stock you are considering.

Buffett and other outstanding investors, including Peter Lynch, know that an intelligent appraisal depends on your ability to understand a business. This gives you a basis for gauging points all these top investors consider crucial, such as a company’s competitive strength, brand power, and ability to develop new products profitably.

The investment giants (not monkeys) don’t worry much about whether their investments end up concentrated in certain companies. For example John Neff, the portfolio manager of the Windsor Fund from 1964 through 1995, generated returns exceeding the average by a steady 3% annually and did so while sometimes allocating as much as 40% of the fund into a single business sector. Buffett’s Berkshire Hathaway is a wonderfully diverse collection of outstanding businesses, but that diversity was an accidental by-product of the tremendous growth in the capital it deployed rather than a conscious effort to participate in lots of different businesses or sectors.

This cast of illustrious investors extends the commonsense understanding of markets and businesses to the analysis of business fundamentals. Chief among these factors are economic characteristics such as strong financial condition, earnings stability and growth, strong sales and profit margins, and large amounts of internally generated cash to fund growth as opposed to a continuing reliance on external financing sources.

These investors also pay attention to the quality and integrity of management, looking for companies which consistently maximize the full potential of a business, wisely allocate capital, and channel the rewards of this success to shareholders. They emphasize the importance of exceptionally competent managers who own substantial amounts of equity in their own companies and can rapidly adapt to dynamic business conditions. They also believe that managerial depth and integrity include assuring good relations with labor and promoting an entrepreneurial spirit.

The hedge fund master George Soros summed it up well by saying that “the prevailing wisdom is that markets are always right; I assume they are always wrong.” The prevailing wisdom of market efficiency is one way to view markets. In this view, price changes are due almost exclusively to changes in fundamental values. Therefore, a diversified selection of stocks with different pricing behaviors compared to the overall market makes the most sense.

The contrary view says that lots of price changes occur for nonfundamental reasons. The goal here is to identify those companies whose prices are below their business value. This perspective calls for thinking about individual businesses rather than the overall market.

Sam Zell – How To Find Great Investment Opportunities When Others See Distress

Johnny HopkinsSam Zell Comments

One of my favorite investors is Sam Zell.

According to Forbes, Zell is one of America’s most prolific real estate investors, Sam Zell is the son of a Polish grain merchant. His parents and sister escaped Poland by train hours before Hitler’s army bombed the tracks that ran through their town. The family reached the U.S. by way of Japan in 1941. Sam was born four months later. In October 2015, Zell agreed to sell 23,000 apartments — about 20% of his Equity Residential’s portfolio — to Barry Sternlicht’s Starwood Capital for $5.4 billion. His private equity firm Equity International, which invests in emerging markets, closed its first Asian fund in September 2016 with $205 million committed. It plans to invest in Japanese warehouses.

One of my favorite Zell interviews is one he did with the Graham and Doddsville Newsletter in the Winter of 2012 in which he spoke about his investing strategy and how he finds great investment opportunities when others see distress.

Here’s an excerpt from that interview:

G&D: How do you think about valuation, whether it‘s a real estate or a non-real estate asset, and could you perhaps give us an example of your approach?

SZ: I start by not paying much attention to the market. I think the Street reflects the value of the last share traded, but the true value of the asset may be more or less than what‘s indicated publicly. In the same manner, I don‘t make investments predicated on the assumption that there‘s a greater fool out there who‘s going to buy it from me for more than I paid for it. I look for situations that logically make sense to me.

As an example, in 1985 I took over Itel Corporation. At the time, Itel had been the largest bankruptcy in the history of the United States. Coming out of Chapter 11, the company still owned a subsidiary that leased 17,000 railcars. Business had been so terrible that utilization of the railcars was 32%. While others might have considered this a really horrible situation, I looked at it and said: ―These railcars are almost new because they haven‘t been used. By virtue of this fact, I bought them at dramatically less than their replacement cost. I then looked at the broader rail business and determined how many railcars there were, who had built them, when they had been built and what the general story of the business was.

It turned out that in 1979, the US government had changed the tax laws and created a special one year 100% tax deduction for heavy equipment. Furthermore, in 1979, the United States had built 120,000 boxcars. But between 1979 and 1985, the United States had built a total of only 20 boxcars.

In the meantime, demand for boxcars was as flat as a dead man‘s EKG. Therefore, nobody wanted to touch the business because there was no growth. During this same period, 65% of the boxcars in the country were scrapped. I reminded myself that everything is about supply and demand. I knew that when the supply and demand curves for boxcars met, I could make a fortune. So I went out and bought all of the used railcars in America.

By the time I was done, we owned 92,000 railcars and became the largest lessor of railcars in the United States. We did extraordinarily well because we had bought these railcars at significant discounts to replacement cost and yet rented them at market rates. Now, you tell me I‘m a genius but the truth of the matter is that the information I‘ve laid out was available to everybody. All anyone had to do put the pieces together. For some reason, that‘s what I do well. I see things differently.

G&D: Could you give us another example where you saw something that was obvious to you but not to others?

SZ: Another division of Itel was in the container leasing business. At the time, the container leasing industry was comprised of the seven sisters, which were seven container leasing companies that represented 95% of the world‘s container leasing business. The one I acquired through Itel was number four. This business had $100 million of revenue, $50 million of expenses, and $50 million of cash flow. Then I looked at the number three business in the industry, which had roughly $100 million of revenue and $50 million of cash flow. I considered what would happen if I put these two container leasing businesses together. All of a sudden, I would need only one shipyard in Hong Kong and only one shipyard at the other ports throughout the world, and I would need only one computer system.

I don‘t really believe in synergies, such as cross-selling and all the other elements they teach in business schools. The only thing that‘s relevant to me is redundancy. Everything else is if-come-maybe. So, I acquired the number three business in the industry, put the two companies together and the revenue was still $200 million but the expenses were now $85 million instead of $100 million. We picked up a 15% expense difference, which was all profit, and we became the low-cost producer. We then acquired the leasing company that was number seven in market share and became number one in the container leasing industry. By virtue of this, we had the lowest costs in the business and a real competitive advantage.

So that‘s the way I look at things. It isn‘t like there are six rules of investing or something like that – certainly there haven‘t been in my life. One of my criticisms of business schools is that the definition of an MBA graduate is someone who knows how to do the numbers; they just don‘t know what the numbers mean. This is the product of business schools emphasis on formulas. In other words, business schools teach how the pieces should be put together. But for me, there is no formula. Similarly, I‘m pretty agnostic about industries. We‘ve been in the container leasing business, the railcar leasing business, the insurance business, the real estate business, the agricultural chemicals business, the oil and gas business, and I could go on and on.

G&D: Do you have another example of a unique investment opportunity that presented itself due to a shift in an economic cycle?

SZ: As was true for my philosophy of being the first national real estate investor in second-tier cities, I‘ve always been willing to shift my ideas and criteria, but I‘ve also always believed in what I‘m trying to implement. In the early ‘70s, buying apartments became too expensive so I started financing builders to build apartments. By 1972, everyone believed the world was going to grow to the sky; there were cranes on every block. But I knew that supply and demand were out of balance, and I stopped backing developers. Then, seemingly overnight, market sentiment shifted, and in 1973, everyone seemed to believe there was no future. Asset prices plummeted, and I realized that this didn‘t make sense either. So, I began aggressively acquiring property, financed very cheaply, to take advantage of what I thought was a once-in-alifetime distressed opportunity.

Between ‘73 and ‘77, I acquired $3 billion worth of real estate. The banks had a problem carrying a large amount of distressed real estate with so many properties in foreclosure. They weren‘t looking to make money. They were just trying to mitigate the losses their real estate loan portfolios were expected to generate. In those days, institutions didn‘t have to mark-to-market, so I tried to figure out ways to preserve the principal of the asset for the seller and still make the deal work. It basically amounted to lowering interest rates on the debt to the point where you could almost carry it or you had a defined carry. We realized that if we could accumulate assets – particularly in an inflationary time – with cheap fixed rate debt, it was hard not to make a fortune.

When people looked at our performance during the ‘70s, they always asked, ―How did you pick all those ripe projects? But the truth of the matter was that I created $3 billion worth of 5% fixed rate debt in an inflationary environment of 10, 12 or 13%. In this situation, it was hard for it not to work. And yet, like many others in my career, most people thought I was crazy. I‘ve spent my whole life listening to people explain to me that I just don‘t understand, but it didn‘t change my view.

Many times, however, having a totally independent view of conventional wisdom is a very lonely game. In the early 1990s, when I was again buying up all of the distressed real estate I could in the US, I kept looking over my shoulder asking myself, ―Where is everyone else? It‘s not that I like competition, but you do start to wonder why you continue to be the only game in town. And I was for roughly three years, from ‘88 to ‘91. I would buy a building from a bank and they‘d ask, How about three more? At some point I stopped to question my thesis, but I went through my whole thought process once again and remained confident that I was right.

G&D: Are there any other key tenets of your investment process?

SZ: I philosophically believe that if you can‘t delineate your idea in one or two sentences, it‘s not worth doing. I‘m the Chairman of everything and the CEO of nothing, which means that the people who work for me come to see me with ideas all day long. My criterion is if they can‘t concisely explain their idea, then I throw them out of my office and tell them to come back when they can. Simplicity is critical. Additionally, one of the greatest risks of any investment is execution risk, and I think it is highly overlooked. I have great respect for execution risk and am always sensitive to people coming up with ideas that don‘t have all of the t‘s crossed and i‘s dotted with respect to how the plan is actually going to be executed.

G&D: How do you or your team typically generate investment ideas?

SZ: I have a pretty good address book and a lot of people call me with ideas. We‘ve done hundreds of transactions and I take great pride in the fact that people are willing to do repeat deals with me. It‘s very common for us to get phone calls from previous partners who want to introduce us to new opportunities. Then, of course, there are about 30 or 40 managing directors who work in my office, and they in turn have contacts and those connections generate ideas.

We‘re very opportunistic and we‘re very comfortable looking into new ideas. We have resources in a wide variety of industries so we can learn a lot about a business pretty quickly. We‘ve also been in many industries, so a lot of what we know or have learned in the past is transferrable.

G&D: What is it about your personality or process that has allowed you to be so successful?

SZ: Number one, I always seemed to have a lot of selfconfidence so I didn‘t pay attention to conventional wisdom.

Number two – you may have heard the quote, – common sense isn‘t so common – I‘ve always been a great believer in logic. I have a lot of common sense and I see things differently. Many people see problems, but entrepreneurs see solutions, and that‘s really what I do. I recognize differences that other people don‘t seem to see.

Third, and most importantly, what I have been able to do is to assess risk and reward accurately throughout my career. The definition of a great investor is someone who starts by understanding the downside. You must make the judgment in advance as to how much downside risk you are willing to take. I knew that I could always survive the good days, but the critical element is to be able to survive when the market isn‘t doing well or the investment isn‘t performing. I always focus on how much exposure I am taking.

Investors stumble when they take risk and don‘t receive commensurate reward. Investors stumble when they get bull-headed or when they shift to doing something that is outside of their core competencies. My success has been related to being a very good observer, having opinions and being willing to implement them, and understanding and believing in the Bernard Baruch saying nobody ever went broke taking a profit.

Lastly, in the simplest philosophical phrase, I‘ve always believed in going for greatness. I‘m highly motivated and I‘ve always been highly motivated, not necessarily because it translates into dollars, but because there‘s a great satisfaction in achievement. I think, more than anything else, that is what has always driven me and been a major contributor to my success.

Undervalued InterDigital Inc FCF/EV Yield 16% – All Investable Stock Screener

Johnny HopkinsStocks Comments

One of the most undervalued stocks in our U.S. All Investable stock screener is InterDigital Inc (NASDAQ:IDCC).

InterDigital, Inc. (InterDigital) designs and develops technologies for wireless communications. The company is focused on three technology areas: cellular wireless technology, Internet of things (IoT) technology, and, through its Hillcrest Laboratories, Inc. (Hillcrest Labs) subsidiary, sensor and sensor fusion technology.

A quick look at the company’s share price history (below) shows that the company has had a great run over the past twelve month, up 49.85%, but InterDigital still remains undervalued.

(Source: Google Finance)

To get an idea of why the company remains undervalued lets start with its latest balance sheet dated March 2017.

InterDigital currently has cash and cash equivalents of $886 million, which is made up of $139 million in cash and $747 million in short term investments. The company also has $275 million in long term debt. If we subtract the total debt $275 million from its cash and cash equivalents $886 million, that means InterDigital has a net cash position of $611 million.

Now, if we have a look at the company’s current market value, it’s currently trading at $2.82 Billion. When we subtract the net cash of $611 million, that means InterDigital has an Enterprise Value of $2.21 Billion. A quick look at the company’s trailing twelve month income statement shows that InterDigital generated $423 million in operating earnings. Therefore the company is currently trading on an Acquirer’s Multiple of 5.22 times operating earnings (EV $2.21 Billion divided by operating earnings $423 million).

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

Moreover, when we take a look at the company’s latest cashflow statement, InterDigital generated $348 million in free cashflow over the trailing twelve months which means the company has a FCF/EV yield of 16%. In addition to its strong balance sheet, other financial strength indicators are also solid with a Piotroski F-Score of 7, a Altman Z-Score of 4.07, and a Beneish M-Score of -1.11. The company has also maintained solid gross margins and operating margins of 69% and 36% respectively. Finally, the company has a buyback yield of 1% and a dividend yield of 1%, giving it a total shareholder yield of 2%.

To summarize, InterDigital has a strong balance sheet and solid free cashflows. It’s currently trading at 5.22 times operating earnings and a FCF/EV yield of 16%, plus it has a 2% total shareholder yield. With solid gross and operating margins InterDigital remains undervalued in spite of its 49.85% share price gain over the past twelve months. For more undervalued stocks like InterDigital, subscriber to our U.S. and Canadian deep value stock screener.

Mohnish Pabrai Says An Investment Opportunity Should Hit You Over The Head Immediately Otherwise Move On

Johnny HopkinsMohnish Pabrai Comments

Great video with Mohnish Pabrai speaking with the folks at Google. This whole presentation can be summed up at 27:05 when Pabrai says, “Spending time on [researching] companies is likely to make me bias”.

In other words when you’re looking for investment opportunities they should hit you over the head immediately. If they do not don’t spend enormous amounts of unnecessary time researching them. This will lead you to become bias towards the investment. Instead, move on and find another opportunity that does hit you over the head immediately.

He also provides some useful hacks that will help overcome some of our inherent biases.

Charlie Munger Says The Investment Management System Is Bonkers – Here’s Why

Johnny HopkinsCharles Munger Comments

One of my favorite investing tomes is Poor Charlie’s Almanack by Charles Munger. As an investor, it’s the one book you need to read on ‘rational’ investing strategy. A quick look on Amazon shows that there are fourteen used copies selling for $162.01 and one new copy for $50,000. That can’t be right, can it!

One of my favorite parts of the book is Charlie’s discussion on the investment management business and why Berkshire Hathaway is able to do things that other investment managers cannot or will not. Here’s an excerpt from the book:

Most investment managers are in a game where the clients expect them to know a lot about a lot of things. We didn’t have any clients who could fire is at Berkshire Hathaway. So we didn’t have to governed by any such construct. And, we came to this notion of finding a mispriced bet and loading up when we were very confident that we’re right. So we’re way less diversified. And I think our system is miles better.

However. in all fairness. I don’t think a lot of money managers could successfully sell their services if they used our system. But if you’re investing for forty years in some pension fund, what difference does it make if the path from start to finish is a little more lumpy or a little different than everybody else’s. So long as it’s all going to work out well in the end? So what if there’s a little extra volatility.

In investment management today. Everybody wants not only to win but to have the path never diverge very much from a standard path except on the upside. Well that is a very artificial, crazy construct. That’s the equivalent in investment management to the custom of binding the feet of the Chinese women. It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of ìt.

That is really hobbling yourself. Now. investment managers would say,” We have to be that way. That’s how we’re measured”. And they may be right in terms of the way the business is now constructed. But from the viewpoint of a rational consumer, the whole system’s “bonkers” and draws a lot of talented people into socially useless activity.

And the Berkshire system is not “bonkers.” It’s so damned elementary even bright people are going to have limited, really valuable insights in a very competitive world when they’re fighting against other very bright, hardworking people.

And it makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times. You’re much more likely to do well if you start out to do something feasible instead of something that isn’t feasible. Isn’t that perfectly obvious?

How many of you have fifty—six brilliant insights in which you have equal confidence? Raise your hands, please. How many of you have two or three insights that you have some confidence in? I rest my case.

I’d say that Berkshire Hathaway’s system is adapting to the nature of the investment problem as it really is.

This Week’s Best Investing Reads From Our Top 50 Investing Blogs 2017

Johnny HopkinsValue Investing News Comments

Each week Tobias and I pick out the best investing reads from our Top 50 Investing Blogs 2017.

Here’s what we’ve been reading:

  1. Acquirer’s Multiple & the Quest for Value (Old School Value)
  2. How to Invest in an Overvalued Market (A Wealth of Common Sense)
  3. Factor Investing: Evidence Based Insights (Alpha Architect)
  4. The Jeff Bezos Empire in One Giant Chart (Visual Capitalist)
  5. Investor Returns Hurt by Attempts to Time the Market (Validea’s Guru Investor Blog)
  6. This Is What The Blowoff Stage Of A Stock Market Bubble Looks Like (The Felder Report)
  7. Vintage Value Investing Named One of the Top 50 Best Investing Blogs on the Planet! (Vintage Value Investing)
  8. “It’s Actually a Good Thing” (The Reformed Broker)
  9. TIP143: Mastermind Discussion 2nd Quarter 2017 (Featuring Tobias Carlisle) (We Study Billionaires)
  10. What Is Your Belief System? (Enterprising Investor)
  11. Finding High-Quality Companies Today (Vitaliy Katsenelson Contrarian Edge)
  12. Still (Not) Crazy After All These Years (Cliff’s Perspective)
  13. All Models Are Wrong (Farnam Street)
  14. What’s This Business Worth? (Hurricane Capital)
  15. Escaping the Magnetic Pull of a Bubble (Jason Zweig)
  16. Uber’s bad week: Doomsday Scenario or Business Reset? (Musings On Markets)
  17. Why I Don’t Talk About My Stocks Publicly, And Why You Shouldn’t Either (Safal Niveshak)

Just How Did Walter Schloss Achieve a 21.3% CAGR From 1956 to 1984

Johnny HopkinsWalter J. Schloss Comments

Walter Schloss was one of Buffett’s Superinvestors of Graham-and-Doddsville. He had an incredible track record of returns over his investing career, achieving a 21.3% CAGR over the period of 28 and a quarter years from 1956 to Q1 1984. And, he did it while keeping his own expenses to a minimum.

In Buffett’s 1994 shareholder letter he wrote about Schloss: “Please note that Walter’s total office expense is about $11,000 as compared to net income of $19 million. Meanwhile, Walter continues to outperform managers who work in temples filled with paintings, staff and computers.”

One of my favorite articles on Schloss that describes his investing strategy was a 1973 Forbes article which illustrated how he consistently identified undervalued companies. One of his best picks was Boston & Providence Railroad. Schloss started buying B&P in the early 60’s for $96 per share, and bought it all the way up to $240. Penn Central wanted B&P’s real estate, but it could only get it if the shareholders were paid off. Eventually, a portion of B&P’s real estate was sold for $110 a share to the Penn Central Railroad, another portion of property was sold for $277 per share and there was still some Rhode Island property to be sold off. Schloss and his partners owned over 1,800 shares of B&P at that time. Their check was for $500,000.

Here’s an excerpt from the Forbes article:

Making Money Out of Junk

Walter Schloss, 57, is kind of a junk collector among stock market players. He is not much interested in earnings growth or in management or in other things that concern most analysts. He’s only interested in cheap stocks.

Now, as any reader of Benjamin Graham knows—and Walter Schloss is both a former student and ex-employee of Graham—a cheap stock is not necessarily low priced. That is, a $5 stock may not be cheap. And a $50 stock need not be dear. To these people, cheap means cheap in relation to a company’s assets or its value as a going business.

Schloss went into money management on his own after Ben Graham retired in 1955. In his early days in business, Schloss used to look for what he calls “working capital stocks.” That is, situations where the market price per share was less than working capital per share—after deducting all debt and preferred stock. You got all of the physical plant and equipment for nothing. You couldn’t get cheaper stocks than this.

“Back in the 1930s and 1940s there were lots of stocks, like Easy Washing Machine and Diamond T Motor, that used to sell below working capital value,” he explains. “You used to be able to tell when the market was too high by the fact that the working capital stocks disappeared. “But for the last 15 years or so there haven’t been any working capital stocks.

On the other hand, when stocks of fairly good companies sell at one-third of book value, you can have some really interesting situations.” Book value? we asked. Aren’t earnings what count? “I really have nothing against earnings,” he retorted, “except that in the first place earnings have a way of changing. Second, your earnings projections may be right, but people’s idea of the multiple has changed. So I find it more comfortable and satisfying to look at book value.

“But there are two things about book values. I think they are understated on today’s figures. Republic Steel, for example, has a book value of $65 a share. I don’t think you could replace it at $130 a share. No one is going into the steel business in the U.S. today except the Japanese with a scrap plant. Or take cement. A new company can’t go into the business unless somebody comes up with a revolutionary new process.

“At such a time these companies and industries get into disrepute and nobody wants them, partly because they need a lot of capital investment and partly because they don’t make much money. Since the market is aimed for earnings, who wants a company that doesn’t earn much?

“So,” Schloss went on, “if you buy companies that are depressed because people don’t like them for various reasons, and things turn a little in your favor, you get a good deal of leverage. “Look at Marquette Cement. It used to sell in the 50s; it has a book value of $28 a share, this year it sold at 6, about a fourth of book value. Everyone says cement is going to be in big demand for construction. The industry isn’t building any more plants because it is uneconomic.

“If Marquette ever develops some decent earning power, which it hasn’t in the last few years, I could see it earning $1.50 a share and in decent markets selling at $15 a share. Also, the Europeans, with their 20% devaluation of the dollar, might come in and buy control. “Or take Keystone Consolidated, a steel company that used to have fairly decent earnings. It has a book value of $49 a share and was recommended by some fellows last year at $25. Now it’s selling at around $14. The company is having a terrible time because it has to buy scrap for its furnaces on the open market, and the Japanese have pushed the scrap market way up.

“So here is another company selling at less than one-third book. It stopped paying a dividend for a year. Some one could come in with a tender offer. Maybe going from 24 to 14 doesn’t prove anything, because Levitz went down too. But Levitz didn’t have the book value these companies have. All it had was earnings projections. “Not only do you get my companies at a discount, but most of them pay you while you wait for appreciation.

Would you rather own a 7½% bond that guarantees you 7½% until it matures, or a stock that yields 5% and, with a break, could end up selling at $35 instead of $14?” That’s assuming, we said, that the company can make a comeback. Supposing it can’t? “Historically, many companies that have had terrible times have come back, or many of them do, A decline doesn’t mean it’s the end.”

Schloss’ greatest investment coup came in the death throes of the Boston & Providence Railroad—”a company in bankruptcy longer than any company in the history of railroads,” says Schloss with a hint of pride. He originally bought its guaranteed stock for 96 a share and kept on buying up to 240. “The old New Haven Railroad had guaranteed the original lease of 85 a share. But the New Haven went bankrupt in 1933 or so. It came out of bankruptcy in something like 1946 and went back in the early 1960s.

Then the New Haven merged into Penn Central, and I thought, ‘Great, maybe everything will work out.’ Then the Penn Central went bankrupt, and it looked like curtains. “But the Penn Central wanted the B&P’s real estate, only it couldn’t get it unless the stockholders were paid off. So they were, at $110 a share. Last year the Massachusetts property was sold off, paying the stockholders an other $277 a share. It still owns some Rhode Island property. I don’t know how much more we will get for that.” Schloss and his partners owned over 1,800 shares of the Boston & Providence. Their check was for $500,000.

Bargain hunters are drawn irresistibly to railroads because of the huge gaps between book value and market value that are so common in railroads. This can be a snare, though. Schloss lost badly on The Milwaukee Road when he took at face value an offer by Ben Heineman’s North west Industries to buy it for a minimum of $80 a share in NI stock: “I paid $50 a share for it because I was going to get $80. Well, that was 1969, the market went down and the deal didn’t go through. You have to be very careful when people say they are going to do something.”

Does Schloss have a favorite stock now? He is reluctant to reveal the contents of his portfolio, but he says, “I’ll give you an example of the kind of stock I would own. Hudson Pulp has a very small floating supply,but among other things it owns over 300,000 acres of Florida timberland worth $250 an acre—$60 a share on stock that sells for around $25. Yet its earnings have not been very good, and the company really hasn’t done a darn thing for 20 years. So you hope maybe the fellows who run it will decide someone else could do a better job.”

Finding companies like this isn’t hard, he says. “Over the years I’ve developed a few friends who think the same way. In fact, in Forbes there is a feature you call Loaded Laggards, companies that have taken a market beating and are selling at a discount from their book values.”

No Xeroxes

Schloss recognizes that he won’t find any Xeroxes on his bargain counter—but no Levìtzes either. “I just want to grow 15% to 20% a year, and my average is 17%. I’ll take my profit when it comes. I do think there are people who psychologically like to lose money. But I think people who are reasonable in their investments do all right.”

Is today’s market reasonable? “It would be fairer to say I have no opinion about the market, but I think there are some interesting stocks there. The thing about buying depressed stocks is that you really have three strings to your bow: 1) earnings will improve and the stocks will go up; 2) someone will come in and buy control of the company; or 3) the company will start buying its own stock and ask for tenders.

“Take Lowenstein. This year it sold at $16 a share, paid a 90-cent dividend, and you got 5%% on your money. It has a book value of $43. Or look at National Detroit Corp., which owns the National Bank of Detroit. It has a book value close to $60 a share and sold at $41 this year. It’s a good company, maybe better than some of the ones I have.

“The thing about my companies is that they are all depressed, they all have problems and there’s no guarantee that any one will be a winner. But if you buy 15 or 20 of them. .. .“

Walter Schloss is not a big-scale player, just a consistent player; he manages only about $4 million. But he claims to have averaged 17% a year on his money for 17 years. On $4 million, 17% comes to nearly $700,000 a year before taxes. With that kind of return, who needs an other Xerox?

You can read the original article here.

Seth Klarman – The Definitive Guide On Why Bottom-Up Investing Trounces Top-Down Investing

Johnny HopkinsSeth Klarman Comments

There’s a lot of discussion on which is the better investing strategy, bottom-up investing or top-down investing. The definitive guide can be found in Chapter 7 of Seth Klarman’s book, Margin of Safety.

Here’s an excerpt from that book:

There is no margin of safety in top-down investing. Topdown investors are not buying based on value; they are buying based on a concept, theme, or trend. There is no definable limit to the price they should pay, since value is not part of their purchase decision. It is not even clear whether top-down-oriented buyers are investors or speculators. If they buy shares in businesses that they truly believe will do well in the future, they are investing. If they buy what they believe others will soon be buying, they may actually be speculating. Another difficulty with a top-down approach is gauging the level of expectations already reflected in a company’s current share price.

If you expect a business to grow 10 percent a year based on your top-down forecast and buy its stock betting on that growth, you could lose money if the market price reflects investor expectations of 15 percent growth but a lower rate is achieved. The expectations of others must therefore be considered as part of any top-down investment decision. (See the discussion of torpedo stocks in chapter 6.)

By contrast, value investing employs a bottom-up strategy by which individual investment opportunities are identified one at a time through fundamental analysis. Value investors search for bargains security by security, analyzing each situation on its own merits. An investor’s top-down views are considered only insofar as they affect the valuation of securities. Paradoxically a bottom-up strategy is in many ways simpler to implement than a top down one. While a top-down investor must make several accurate predictions in a row, a bottom-up investor is not in the forecasting business at all. The entire strategy can be concisely described as “buy a bargain and wait.”

Investors must learn to assess value in order to know a bargain when they see one. Then they must exhibit the patience and discipline to wait until a bargain emerges from their searches and buy it, regardless of the prevailing direction of the market or their own views about the economy at large. One significant and not necessarily obvious difference between a bottom-up and top-down strategy is the reason for maintaining cash balances at times. Bottom up investors hold cash when they are unable to find attractive investment opportunities and put cash to work when such opportunities appear.

A bottom-up investor chooses to be fully invested only when a diversified portfolio of attractive investments is available. Topdown investors, by contrast, may attempt to time the market, something bottom-up investors do not do. Market timing involves making a judgment about the overall market direction; when top-down investors believe the market will decline, they sell stocks to hold cash, awaiting a more bullish opinion. Another difference between the two approaches is that bottom-up investors are able to identify simply and precisely what they are betting on.

The uncertainties they face are limited: what is the underlying business worth; will that underlying value endure until shareholders can benefit from its realization; what is the likelihood that the gap between price and value will narrow; and, given the current market price, what is the potential risk and reward?

Bottom-up investors can easily determine when the original reason for making an investment ceases to be valid. When the underlying value changes, when management reveals itself to be incompetent or corrupt, or when the price appreciates to more fully reflect underlying business value, a disciplined investor can reevaluate the situation and, if appropriate, sell the investment. Huge sums have been lost by investors who have held on to securities after the reason for owning them is no longer valid. In investing it is never wrong to change your mind. It is only wrong to change your mind and do nothing about it.

Top-down investors, by contrast, may find it difficult to know when their bet is no longer valid. If you invest based on a judgment that interest rates will decline but they rise instead, how and when do you decide that you were wrong? Your bet may eventually prove correct, but then again it may not. Unlike judgments about value that can easily be reaffirmed, the possible grounds for reversing an investment decision that was made based upon a top-down prediction of the future are simply not clear.

John Rogers Says Contrarian Investing Gives You The Confidence To Buy When Others Are Selling

Johnny HopkinsJohn Rogers Comments

Here’s a great interview with contrarian value manager John Rogers on WealthTrack who says if you don’t follow the crowd you’ll be a better investor. “Value investing is a contrarian approach. You’re going to be buying when others are selling. When there’s a lot of fear out there you’re going to be the one feeling confident going in buying those stocks at bargain prices.”

On how to keep shareholder during periods of underperformance Rogers says it’s important to stay in touch with your investors and keep them focused on the long term. “People are more likely to stick with us during those inevitable downturns because we’ve been able to make the case that if you think long term you’re going to outperform and by communicating that strategy consistently and executing it consistently I think it builds confidence in customers.”

On lessons he’s learned from Buffett and Munger he says:

  • Stay within your circle of competence
  • Invest in what you understand
  • Wait for the perfect pitch

On what type of companies to look for he says:

  • Strong brand
  • Strong franchise
  • How are companies going to maintain their moat over the next 5 to 7 to 10 years
  • Balance sheet strength is critical

How To Invest Like Sir John Templeton In 2017

Johnny HopkinsJohn Templeton Comments

One of the most famous contrarian investors of all time was Sir John Templeton. Templeton was remembered for a number of famous quotes including:

“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest of fortitude and pays the ultimate greatest reward.”

In the book, The Power of Failure: 27 Ways to Turn Life’s Setbacks Into Success, Charles Manz wrote a great piece on some of Templeton’s contrarian investments:

Some of the notable examples of Templeton’s against-the-tide investments include Japan in the 1960s when people thought the Japanese market was a mess and it would be crazy to invest there, Ford Motor Company in the late 1970s when the future looked very bleak for the auto giant, and Peru in the mid-1980s when political tension gripped the country and money and the middle class were fleeing. He committed significant sums in each of these cases and just a few years later earned millions on these investments.

Templeton saw significant stock market drops, which sent others into panic selling, as golden opportunities to invest. The best time to buy is when everyone is selling, the price is low, and there is almost nowhere to go but up, was the logic he espoused. This perspective extends to many other difficulties beyond financial investing. When things have hit bottom in some aspect of our lives, we have an opportunity to rebuild, to try something new and fundamentally different, to make an investment when there is little left to lose and a lot to gain.

So how to you invest like Sir John Templeton in 2017?

Templeton was very gracious with sharing his investing strategy, he provided 16 Rules for Investment Success, the rules of which still apply in 2017:

1. Invest for Maximum Total Real Return

This means the return on invested dollars after taxes and after inflation. This is the only rational objective for most long-term investors. Any investment strategy that fails to recognize the insidious effect of taxes and inflation fails to recognize the true nature of the investment environment and thus is severely handicapped.

2. Invest—Don’t Trade or Speculate

The stock market is not a casino, but if you move in and out of stocks every time they move a point or two, or if you continually sell short…or deal only in options…or trade in futures…the market will be your casino. And, like most gamblers, you may lose eventually—or frequently.

3. Remain Flexible and Open-Minded about Types of Investment

There are times to buy blue chip stocks, cyclical stocks, corporate bonds, U.S. Treasury instruments, and so on. And there are times to sit on cash, because sometimes cash enables you to take advantage of investment opportunities.

The fact is there is no one kind of investment that is always best. If a particular industry or type of security becomes popular with investors, that popularity will always prove temporary and—when lost—may not return for many years.

4. Buy Low

Of course, you say, that’s obvious. Well, it may be, but that isn’t the way the market works. When prices are high, a lot of investors are buying a lot of stocks. Prices are low when demand is low. Investors have pulled back, people are discouraged and pessimistic.

5. When Buying Stocks, Search for Bargains Among Quality Stocks

Quality is a company strongly entrenched as the sales leader in a growing market. Quality is a company that’s the technological leader in a field that depends on technical innovation. Quality is a strong management team with a proven track record. Quality is a well-capitalized company that is among the first into a new market. Quality is a well known trusted brand for a high profit-margin consumer product.

6. Buy Value, Not Market Trends or The Economic Outlook

A wise investor knows that the stock market is really a market of stocks. While individual stocks may be pulled along momentarily by a strong bull market, ultimately it is the individual stocks that determine the market, not vice versa. All too many investors focus on the market trend or economic outlook. But individual stocks can rise in a bear market and fall in a bull market.

7. Diversify. In Stocks and Bonds, as in Much Else, There is Safety in Numbers

No matter how careful you are, you can neither predict nor control the future. A hurricane or earthquake, a strike at a supplier, an unexpected technological advance by a competitor, or a government-ordered product recall—any one of these can cost a company millions of dollars. Then, too, what looked like such a well-managed company may turn out to have serious internal problems that weren’t apparent when you bought the stock.

8. Do Your Homework or Hire Wise Experts to Help You

People will tell you: Investigate before you invest. Listen to them. Study companies to learn what makes them successful. Remember, in most instances, you are buying either earnings or assets. In free-enterprise nations, earnings and assets together are major influences on the price of most stocks. The earnings on stock market indexes—the fabled Dow Jones Industrials, for example—fluctuate around the replacement book value of the shares of the index. (That’s the money it would take to replace the assets of the companies making up the index at today’s costs.)

9. Aggressively Monitor Your Investments

Expect and react to change. No bull market is permanent. No bear market is permanent. And there are no stocks that you can buy and forget. The pace of change is too great. Being relaxed, as Hooper advised, doesn’t mean being complacent.

10. Don’t Panic

Sometimes you won’t have sold when everyone else is buying, and you’ll be caught in a market crash such as we had in 1987. There you are, facing a 15% loss in a single day. Maybe more.

Don’t rush to sell the next day. The time to sell is before the crash, not after. Instead, study your portfolio. If you didn’t own these stocks now, would you buy them after the market crash? Chances are you would. So the only reason to sell them now is to buy other, more attractive stocks. If you can’t find more attractive stocks, hold on to what you have.

11. Learn From Your Mistakes

The only way to avoid mistakes is not to invest—which is the biggest mistake of all. So forgive yourself for your errors. Don’t become discouraged, and certainly don’t try to recoup your losses by taking bigger risks. Instead, turn each mistake into a learning experience. Determine exactly what went wrong and how you can avoid the same mistake in the future.

12. Begin With a Prayer

If you begin with a prayer, you can think more clearly and make fewer mistakes.

13. Outperforming the Market is a Difficult Task

The challenge is not simply making better investment decisions than the average investor. The real challenge is making investment decisions that are better than those of the professionals who manage the big institutions.

14. An Investor Who Has All the Answers Doesn’t Even Understand All the Questions

A cocksure approach to investing will lead, probably sooner than later, to disappointment if not outright disaster. Even if we can identify an unchanging handful of investing principles, we cannot apply these rules to an unchanging universe of investments—or an unchanging economic and political environment. Everything is in a constant state of change, and the wise investor recognizes that success is a process of continually seeking answers to new questions.

15. There’s No Free Lunch

This principle covers an endless list of admonitions. Never invest on sentiment. The company that gave you your first job, or built the first car you ever owned, or sponsored a favorite television show of long ago may be a fine company. But that doesn’t mean its stock is a fine investment. Even if the corporation is truly excellent, prices of its shares may be too high.

16. Do Not Be Fearful or Negative Too Often

And now the last principle. Do not be fearful or negative too often. For 100 years optimists have carried the day in U.S. stocks. Even in the dark ’70s, many professional money managers—and many individual investors too—made money in stocks, especially those of smaller companies.

Mohnish Pabrai – How To Calculate Intrinsic Value

Johnny HopkinsMohnish Pabrai Comments

I’ve just been re-reading one of my favorite investing books of all time, The Dhando Investor, written by Mohnish Pabrai. In Chapter 7, Dhandho 102: Invest in Simple Businesses, Pabrai provides a very simple example of how to calculate intrinsic value using the real life example of Bed Bath & Beyond Inc (NASDAQ:BBBY).

It’s a great illustration of how intrinsic value is not an exact figure but a range that you can compare to the company’s current market value to determine whether you want to dig further into the company.

Here’s an excerpt from The Dhando Investor:

When we see a huge gap between the price and intrinsic value of a given business—and that gap is in our favor—we can act and buy that business. Let’s take the example of a well-known retail business, Bed Bath and Beyond (BBBY).

I have to admit that I have never analyzed BBBY before. I have been to its stores a few times over the years, and it has been a pleasant experience. As I write this, BBBY has a quoted stock price of $36 per share and a market cap of $10.7 billion. We know BBBY is being offered on sale for $10.7 billion. What is BBBY’s intrinsic value?

Let’s take a look at a few BBBY statistics on Yahoo Finance.

BBBY had $505 million in net income for the year ended February 28, 2005. Capital expenditures for the year were $191 million and depreciation was $99 million. The “back of the envelope” net free cash flow was about $408 million.

It looks like BBBY is growing revenues 15 percent to 20 percent and net income by 25 percent to 30 percent a year. It also looks like it stepped up capital expenditure (capex) spending in 2005. Let’s assume that free cash flow grows by 30 percent a year for the next three years; then grows 15 percent a year for the following three years, and then 10 percent a year thereafter. Further, let’s assume that the business is sold at the end of that year for 10 to 15 times free cash flow plus any excess capital in the business. BBBY has about $850 million in cash in the business presently (see
Table 7.3).

So, the intrinsic value of BBBY is about $19 billion, and it can be bought at $10.7 billion. I’d say that’s a pretty good deal, but look at my assumptions—they appear to be pretty aggressive. I’m assuming no hiccups in its execution, no change in consumer behavior, and the ability to grow revenues and cash flows pretty dramatically over the years. What if we made some more conservative assumptions? We can run the numbers with any assumptions.

The company has not yet released numbers for the year ended February 28, 2006, but we do have nine months of data (through November 2005). We can compare November 2005 data to November 2004 data. Nine month revenues increased from $3.7 billion to $4.1 billion from November 2004 to November 2005. And earnings increased from $324 million to $375 million.

It looks like the top line is growing at only 10 percent annually and the bottom line by about 15 percent to 16 percent. If we assume that the bottom line growth rate declines by 1 percent a year—going from 15 percent to 5 percent and its final sale price is 10 times 2015 free cash flow, the BBBY’s intrinsic value looks like Table 7.4. Now we end up with an intrinsic value of $9.6 billion.

BBBY’s current market cap is $10.7 billion. If we made the investment, we would end up with an annualized return of a little under 10 percent. If we have good low-risk alternatives where we can earn 10 percent, then BBBY does not look like a good investment at all.So what is BBBY’s real intrinsic value?

My best guess is that it lies somewhere between $8 to $18 billion. And in these calculations, I’ve assumed no dilution of stock via option grants, which might reduce intrinsic value further. With a present price tag of around $11 billion and an intrinsic value range of $8 to $18 billion, I’d not be especially enthused about this investment. There isn’t that much upside and a fairly decent chance of delivering under 10 percent a year.

For me, it’s an easy pass.

Howard Marks Says You Can Invest In The Worst Companies In America And Have A Good Experience

Johnny HopkinsHoward Marks Comments

As a value investor it’s important that you always assess the downside risk of your investments, prior to purchase. Famed investors Buffett and Klarman are always speaking about the ‘margin of safety’ espoused by the grandfather of value investing, Benjamin Graham. One of the best articles on assessing the risk of an investment in the stock market comes from Howard Marks in his 2013 memo.

Here’s an excerpt from that memo:

Much (perhaps most) of the risk in investing comes not from the companies., institutions or securities involved. It comes from the behavior of investors. Back in the dark ages of investing, people connected investment safety with high-quality assets and risk with low-quality assets. Bonds were assumed to be safer than stocks. Stocks of leading companies were considered safer than stocks of lesser companies. Gilt-edge or investment grade bonds were considered safe and speculative grade bonds were considered risky. I’ll never forget Moody’s definition of a B-rated bond: “fails to possess the characteristics of a desirable investment.”

When I joined First National City Bank in the late 1960s, the bank built its investment approach around the “Nifty Fifty.” These were considered to be the fifty best and fastest growing companies in America. Most of them turned out to be great companies.. . just not great investments. In the early 1970s their p/e ratios went from 80 or 90 to 8 or 9, and investors in these top-quality companies lost roughly 90% of their money.

Then, in 1978, 1 was asked to start a fund to invest in high yield bonds. They were commonly called “junk bonds,” but a few investors invested nevertheless, lured by their high interest rates. Anyone who put $1 into the high yield bond index at the end of 1979 would have more than $23 today, and they were never in the red.

Let’s think about that. You can invest in the best companies in America and have a bad experience. or you can invest in the worst companies in America and have a good experience. So the lesson is clear: it’s not asset quality that determines investment risk.

The precariousness of the Nifty Fifty in 1969 — and the safety of high yield bonds in 1978 — stemmed from how they were priced. A too-high price can make something risky, whereas a too-low price can make it safe. Price isn’t the only factor in play, of course. Deterioration of an asset can cause a loss, as can its failure to produce profits as expected. But, all other things being equal, the price of an asset is the principal determinant of its riskiness.

The bottom line on this is simple. No asset is so good that it can’t be bid up to the point where it’s overpriced and thus dangerous. And few assets are so bad that they can’t become underpriced and thus safe (not to mention potentially lucrative).

Since participants set security prices, it’s their behavior that creates most of the risk in investing. This is true in many other activities as well, the common thread being the involvement of humans.

  • Jill Fredston, an expert on avalanches, has observed that “better safer gear can entice climbers to take more risk — making them in fact less safe.” (Pensions & Investments)
  • When all traffic controls were removed from the town of Drachten, Holland, traffic flow doubled and fatal accidents fell to zero, presumably because people drove more carefully. (Dylan Grice, Societe Generale)

So improvements in safety equipment can be neutralized by human behavior, and driving can become safer despite the removal of safety equipment. It all depends on how the participants behave.

James Montier – There Are No Silver Bullets In Investing (Just Old Snake Oil In New Bottles)

Johnny HopkinsJames Montier Comments

According to the Cambridge dictionary a snake oil salesman is:

someone who deceives people in order to get money from them:
He was dubbed a “modern day snake oil salesman” after he ripped off thousands of internet customers.

So why is it that so many investors are continually happy to part with millions of dollars to the latest snake oil salesman guaranteeing 20%+ returns. The answer(s) are quite simple:

1. A lot of investors want to take shortcuts when it comes to getting outsized returns and they’ll do anything to get the latest ‘silver bullet’ investment opportunity.

2. Greed.

But, as Charlie Munger warned, The Investing World Is Just A Morass Of Wrong Incentives, Crazy Reporting, And A Fair Amount Of Delusion.

One of my favorite articles on the subject of investment managers spruiking outsized returns was written by James Montier who said:

“Modern day investment management resembles, sadly, another old profession – and I’m not thinking of the oldest one, although there may be parallels there as well. Rather, I’m thinking of ancient alchemy with its near constant promises to turn lead into gold, just as investment managers repeatedly offer to transform low returns into high returns.”

Montier provides a great example of investors chasing the holy grail with his Sorry Tale of Sir Roger. Here’s an excerpt from that article:

The Sorry Tale of Sir Roger

I think one can gain some insight into the reason people constantly fall for such stories by examining the sorry tale of Sir Roger Tichborne. Like many a well-heeled young Victorian Englishman, Sir Roger went gallivanting around South America. Eventually he boarded the Bella in Brazil. Four days later, wreckage of the Bella was recovered, and all souls were declared lost. Lady Tichborne (Sir Roger’s mother) refused to believe that he had perished.

Encouraged in her beliefs by a medium who kept telling her that she couldn’t find Sir Roger in the afterlife, Lady Tichborne posted regular advertisements in newspapers around the world offering a reward for information about her lost son.

Some 10 years after Sir Roger’s disappearance, Lady Tichborne received word from an Australian solicitor claiming that her son was alive and well and living in Wagga Wagga, working as a butcher. Lady Tichborne was ecstatic, and sent funds to cover her “son’s” repatriation to the U.K. Upon his arrival, Lady Tichborne declared the man to be her son and instigated a £1000 stipend.

Not everyone was quite so convinced that the new arrival was in fact Sir Roger (see Exhibit 1).

Now it is perfectly possible for a man’s weight to change over the years (trust me, I know). However, Sir Roger spoke both Greek and Latin, the claimant spoke neither. Sir Roger had a working knowledge of chemistry, the new arrival couldn’t tell his sodium chloride from his calcium carbonate.

It is, of course, possible to forget things over time; perhaps a bump on the head during the wrecking of the Bella resulted in memory loss. However, it is rare that tattoos disappear of their own accord, even in the extreme sun of Australia. Sir Roger had some, yet these had mysteriously disappeared from the new arrival. It is even rarer that a person’s eyes change colour. Sir Roger had blue eyes, the new arrival had brown eyes! It was only after Lady Tichborne’s death that the rest of the family exposed the Australian import as an imposter.

The moral of this story? Never underestimate the willingness of people to believe in the most outlandish of things if it suits them. Just in case you think this example has no relevance for the world of investing, consider the returns of the mystery fund shown in Exhibit 2.

Investors are always looking for the Holy Grail of investing, a strategy that generates good returns and doesn’t have major drawdowns – something akin to the mystery fund. (As one of my colleagues put it, investors often behave like Lady Tichborne except in their adverts they disclose the details of their desires, i.e., smooth returns, high Sharpe Ratio, etc., and so the “claimants” [aka investment managers] are happy to create such illusions.)

Unfortunately, the exhibit presents none other than the fund returns of one Bernard Madoff! The obvious lesson from the Madoff affair is that if something looks too good to be true it probably is. Yet, just like Lady Tichborne, investors appear vulnerable to seeing exactly what they would like to believe.

The rest of this paper is about innovation in our industry. Now, innovation sounds like it should be exciting but, sadly, I share the perspective of J.K. Galbraith and Paul Volcker when it comes to innovation. Galbraith observed,

“The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.”

Paul Volcker has opined that the ATM is the only useful financial innovation in the last 30 years. The rest of this paper tries to examine some of the “innovations” put forward by investment managers, and concludes (spoiler alert) they are nothing more than old snake oil in new bottles.

You can read the entire paper here.

Bruce Berkowitz Says I’m Investing In That Which Is Hated Or Deemed To Fail And That’s Where I Like To Be

Johnny HopkinsBruce Berkowitz Comments

Here’s a great interview on Bloomberg with Bruce Berkowitz.

In terms of being a contrarian Berkowitz says, “The markets are not cheap, the markets are being driven by a handful of companies. As usual I’m investing in that which is hated or deemed to fail and that’s where I like to be.”

On his investing strategy he says, “I’ve always been value based and I’ve always been a balance sheet buyer. I’ve always bought assets at a significant discount to I believe the value and usually you can only do that when companies have issues but you have to determine if those issues are fixable. Then you have a situation where you have a price and you have a value and you know that over time either the price is going to go to the value or the value is going to come down to the price or most likely they meet somewhere in the middle. And, if your’re really good at what you do the value will increase as the price catches up with the value. But currently I don’t think many people think I have that ability.”



How Warren Buffett Turned $10.6 Million Into $221 Million While Others Were Embracing The EMT

Johnny HopkinsStocks, Warren Buffett Comments

As a value investor it is important that you read every word of every letter ever written by Warren Buffett in his Berkshire Hathaway Shareholder Letters.

One great example of what you can learn comes from his 1985 Chairman’s letter in which he discusses his intrinsic value calculation of The Washington Post and how he turned $10.6 million into $221 million while others were following the herd and embracing the efficient market theory. It’s also important to note that the year after Buffett’s investment, the market value of The Washington Post sank to $8 million, but Buffet remained unperturbed.

Here’s an excerpt from that letter:

We mentioned earlier that in the past decade the investment environment has changed from one in which great businesses were totally unappreciated to one in which they are appropriately recognized. The Washington Post Company (“WPC”) provides an excellent example.

We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise. Calculating the price/value ratio required no unusual insights. Most security analysts, media brokers, and media executives would have estimated WPC’s intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market valuation was published daily for all to see. Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.

Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value – and even thought, itself – were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest – whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)

Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by year end 1974 our WPC holding showed a loss of about 25%, with market value at $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents on the dollar of intrinsic value.

You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the exceptional economics of the business and the stock price moved closer to underlying value. Thus, we experienced a triple dip: the company’s business value soared upward, per-share business value increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value.

We hold all of the WPC shares we bought in 1973, except for those sold back to the company in 1985’s proportionate redemption. Proceeds from the redemption plus year end market value of our holdings total $221 million.

If we had invested our $10.6 million in any of a half-dozen media companies that were investment favorites in mid-1973, the value of our holdings at year end would have been in the area of $40 – $60 million. Our gain would have far exceeded the gain in the general market, an outcome reflecting the exceptional economics of the media business. The extra $160 million or so we gained through ownership of WPC came, in very large part, from the superior nature of the managerial decisions made by Kay as compared to those made by managers of most media companies. Her stunning business success has in large part gone unreported but among Berkshire shareholders it should not go unappreciated.

Our Capital Cities purchase, described in the next section, required me to leave the WPC Board early in 1986. But we intend to hold indefinitely whatever WPC stock FCC rules allow us to.

We expect WPC’s business values to grow at a reasonable rate, and we know that management is both able and shareholder-oriented. However, the market now values the company at over $1.8 billion, and there is no way that the value can progress from that level at a rate anywhere close to the rate possible when the company’s valuation was only $100 million. Because market prices have also been bid up for our other holdings, we face the same vastly reduced potential throughout our portfolio.

Investors Shouldn’t Compare Their Performance To Others – Here’s Why

Johnny HopkinsInvesting Strategy Comments

Great article by Ian Cassell at MicroCapClub titled, Don’t Compare Yourself To Others.

Ian covers two important issues that all investors can relate to. The first is how to sit still while others are making money, because you can’t find stocks that fit your strategy. The second is how to live through a drawdown when your portfolio is underperforming.

Here’s a small excerpt from that article:

To be a successful investor you have to have a philosophy and a process you believe in and you can stick to even when the times get tough. This is very important. If you don’t have a courage of your convictions and patience and toughness, you can’t be an investor. Because you’ll constantly be driven to fall in line with the consensus by buying at the top and selling at the bottom.

Every investment approach, even if skillfully applied, will run into environments for which it is ill suited. By and hold. Growth stocks. Value stocks. Small stocks. Large stocks. Foreign. Domestic. And that means that even the best of investors will have periods of poor performance. Nobody performs great all the time. Buffett was considered over with. Now, even if you are correct in identifying a divergence of popular opinion from eventual reality, that varying perception that I mentioned, it can take a long time for the price to converge with value and it can require something that acts as the catalyst. Underpriced does not mean “Going up tomorrow.”. Overpriced does not being “Going down tomorrow.”. And we, everybody has to know that. And in order to be able to stick with an approach or decision until it proves out, which can be a long time, investors have to be able to weather periods when the results are embarrassing. This can be very difficult.

You can read the complete article here.

The Acquirer’s Multiple® Canada All TSX Stock Screen Backtest

Tobias CarlisleStudy Comments

Chart 1. Returns from January 2, 1999 to June 16, 2017 (Log.)

We backtested the returns to a theoretical portfolio of stocks selected by The Acquirer’s Multiple® from the Canada All TSX stock screen. The backtest assumed the screen bought and held for a year 30 stocks selected from the All TSX universe (the largest 95 percent of all TSX stocks by market capitalization). The portfolios were rebalanced on the first day of the year using the most recent fundamental data. The backtest ran from January 2, 1999 to June 16, 2017.

Over the full eighteen-and-one-half year period, the screen generated a total return of 2,536 percent, or a compound growth rate (CAGR) of 19.1 percent per year. This compared favorably with the S&P/TSX Composite TR, which returned a cumulative total of 232 percent, or 4.7 percent compound.

Chart 2. Yearly Returns from January 2, 1999 to June 16, 2017

On an yearly basis, the model portfolios selected by The Acquirer’s Multiple® outperformed 13 1/2 of 18 1/2 years, although underperformed in 1999 (-6 percent), 2000 (-17.1%), 2008 (-4.8 percent), 2014 (-10.2 percent), and 2015 (-13.3 percent).

Chart 3. Rolling Yearly Returns from January 2, 1999 to June 16, 2017

The average twelve-month return for any stock selected by The Acquirer’s Multiple® Canada All TSX screen was 22.2 percent, beating out the S&P / TSX Composite TR’s average stock at 6.6 percent by 16.1 percent.

Chart 4. Drawdowns from January 2, 1999 to June 16, 2017

The worst drawdown for The Acquirer’s Multiple® Canada All TSX Stock screen was -63 percent, which occurred between July 2007 and March 2009. Over the same period, the S&P / TSX Composite TR drew down -50 percent.

The 30-stock portfolios selected by The Acquirer’s Multiple® from the Canada All TSX universe consistently outperformed the broader S&P / TSX Composite TR. The trade off is periodic underperformance–approximately one in four years–and a deeper drawdown in 2007 to 2009.

Click here to see the top 30 names in The Acquirer’s Multiple® Canada All TSX Stock Screener (must have a registered and paid subscription to The Acquirer’s Multiple®).

Disclaimer: Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance may be materially lower than that of the backtested portfolios. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investor’s decision-making process if the investor was actually managing money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios (in this case, The Acquirer’s Multiple®) designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable.