(Image Credit, twitter.com)
A lot of investors have never heard of Charles Mizrahi.
Hidden Values Alert has been named one of Marketwatch.com’s 10 Best Advisors from October 2007 to January 2015…a period that included the Financial Crisis of 2008 and the subsequent bull market that began March 2009.
The returns that Mazrahi has racked up are certified by Hulbert Financial Digest – the fiercely independent rating service that tracks the performance of financial newsletters.
Charles Mizrahi is also the author of the highly acclaimed book, Getting Started in Value Investing (Wiley).
As a value investor, I was particularly interested in his approach to finding investments and how he values these businesses.
I found an article on Mizrahi on ValueWalk that provides some great insight into his investment strategy.
Let’s take a look…
This is an excerpt from the article on ValueWalk here, Charles Mizrahi On Early Years And Hidden Values Alert.
Rupert Hargreaves: Could give our readers a bit of background about yourself and how you got into value investing?
Charles Mizrahi: I started trading on the New York Futures Exchange back in 1983 when I was about 22 as floor trader, trading stock index futures.
That was my first taste of the world of finance and I saw right there on the floor the amount of crazy emotion that was in swinging prices on a short-term basis. That was a real education for me. I learnt a lot about temperament and how markets react on a short-term basis. From there I became a money manager, trading S&P futures with a technical approach.
Then, I had an epiphany in 2000. I read Tweedy, Browne’s booklet, “What Has Worked In Investing”. The research kept coming back to valuation, this was back in the dot-com bubble. After that, I went out and bought about 50 books on value investing and anything to do with Warren Buffett and his shareholder letters.
I read them cover to cover. At that point, I realized that valuation and value investing makes the best sense in the world. Then I founded a financial publishing company and I now publish two financial newsletters, the Hidden Values Alert and the Inevitable Wealth Portfolio. Both of these newsletters have portfolios of stocks picked using a value approach.
RH: That’s a hell of a big jump from trading index futures to value investing, do you still use any of your trading disciplines today?
CM: No. The reason is because when I went into value investing, I quickly realized that when you use stop losses, trends or anything like that, you’re asking the market to tell you what to do. The stop loss, for example, is nothing but an arbitrary number based on what number you brought in at; it has nothing to do with fundamental value at all. So, I didn’t implement any of the floor trading strategies I used but, and this is a big but, floor trading did teach me about behavioral finance, and how markets and investors react. It also taught me that the most important thing in any market is temperament.
RH: Now you publish the Hidden Values Alert newsletter…
CM: Yes, I publish two newsletters, Hidden Values Alert newsletter and the Inevitable Wealth Portfolio newsletter. Hidden Values started around ten years ago in 2005 simply because I saw that there were no real value investing newsletters out there. I didn’t see any letters using Graham or Buffett to any great extent. So, I started the newsletter and created three portfolios, Prime Time Portfolio, Special Situation and Bargain Basement.
The Prime Time portfolio is focused on large cap stocks, Special Situation is focused on mid-caps, and Bargain Basement is focused on 25 stocks with valuations of about $1 billion or so.
All three portfolios are based on the same methodology of buying financially sound companies when they are trading at attractive prices. The portfolios have about a 10% overlap and the returns…well for Prime Time the portfolio has produced a return double the S&P 500 since inception, Special Situation is almost matching the S&P 500, and Bargain Basement is slightly underperforming, but that’s after the recent sell-off which has hammered value stocks.
The Inevitable Wealth Portfolio newsletter was created in Jan 2009, around six to eight weeks before the bottom of the Financial Crisis 2008 bear market. Here we take a Graham type approach, which he talked about before his death during 1976. The portfolio is made up of 30 stocks, each equally weighted with strong balance sheets and low trailing P/Es.
RH: Can you go into more detail?
CM: Well, the first thing we’re looking for in a potential stock for the portfolio is a clean a balance sheet; a balance sheet that is not leveraged, the total assets to shareholder equity ratio is not excessive. Once we’ve built a watch list of financially sound companies, we look at valuation. We’re looking for stocks that are trading for P/Es below a certain threshold. When we’ve got a list of companies that meet these criteria, we then roll up our sleeves and start to dig deeper, looking at things such as free cash flow, return on equity, management, net margins, etc…
RH: That’s a very simple strategy…
CM: I think it was Marty Whitman who said that there are only a couple of variables that one needs, and Graham said the same thing. You don’t need one hundred different variables when choosing stocks. There are usually two or three key variables that make up 90% of the decision-making process.
For example, in horse racing, it’s the speed of the horse. We’re looking for those metrics that tell us as much as we need to know about the company to pass the first hurdle — profits, which are shown in the P/E and the financial strength of the enterprise which can be seen on the balance sheet. These are the same two things you’d want to look at if you were thinking of buying a coffee shop or hardware store. You want to have a business that’s financially sound, and the owner is selling it at a discounted price. Everything after that is just there to support our decision.
RH: How do you arrive at your target price, do you calculate intrinsic value?
CM: We never really try to calculate intrinsic value, we just try to buy at a valuation where we feel comfortable.
We don’t want to pay a P/E of more than 12 on anything. If you think about it, if you were to buy the whole business at a trailing P/E of 12, you’d be getting a return of 8.5% on your money, with today’s interest rates that’s pretty good. If you bought the business at a P/E of 10, you’re effectively getting a 10% return on your money. At a P/E of 5, you’re getting a 20% return on your money, that’s assuming those earnings are sustainable.
RH: What makes you decide to sell a position then?
CM: For the Inevitable Wealth Portfolio, we have a fixed target price based on a certain percent above the price we paid. If we hold for a certain period, and it doesn’t hit our profit target, we sell out of the position. The reason we do that is because we only have a finite amount of capital and we don’t want to get stuck in value traps. So, we put a time limit on it.
One of the biggest lessons I learnt as a floor trader is that one of the hardest things to know is when to get out of a position. You build an emotional bond. When you have a stock that goes up 10%, 20%, 50% or 100% you start to get more lax and throw it to the side. Then all of a sudden, it drops by a third, and you lose out. So we wanted to take the human emotion out of it.
With the Hidden Values Portfolios, as long as the companies are still meeting our criteria, we’re happy to hold on to stocks, which is why we’re holding on to some stocks which have gains of 200%+ for us.
RH: I think you’ve already answered my next question on concentration…
CM: Let me just elaborate on that. With Inevitable Wealth Portfolio, we have 30 stocks at all times, all equally weighted. We’re not comfortable with a concentrated portfolio; there are just too many unknown unknowns out there that could wipe out returns. In the Hidden Values Portfolios, we have around 20 stocks or so in each portfolio.
RH: Do you have an idea you could share with us?
CM: Yes, there’s one small-cap that’s rather interesting. Hibbett Sports, Inc. (NASDAQ: HIBB, $30.05 1/26/16). It’s a $700 million company. They have sporting goods stores in small and midsized towns. There’s no debt, the balance sheet is clean, cash flow is robust, and management appears to be doing a good job. The stock recently came under pressure due to a whole bunch of factors but we think the current valuation (P/E of 9 or 10) is too low for this business, and the company will continue to grow over the next few years.
RH: Do you think the earnings are sustainable?
CM: We think so. We believe that Mr. Market has discounted this stock too much. The stock is down 40% over the past year, but we don’t think any of the factors weighing on the company are terminal. Remember this is just one stock out of a portfolio of 30. Even we’re wrong on this; the position isn’t going to hurt us.
We have 3% of the portfolio in each stock, even if it goes down by 50%, it’s not going to sink us.
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