Value Investing Parallels: The Late 1990s And Now

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During his recent interview with Tobias, Eric Cinnamond of Palm Valley Capital discussed Value Investing Parallels: The Late 1990s And Now. Here’s an excerpt from the interview:

Tobias: What are the parallels and the differences between the late 1990s and now?

Eric: Well, I think the similarities are that value is very cheap relative to growth, very cheap. The biggest difference is the components of value. Now, in ‘99, I had– you look at the Russell 2000 value, there were some really high-quality small-cap value stocks in there. There was Church & Dwight, the market leader, or Armand Hammer, J & J Snack Foods, JJSF, Lancaster Colony, they do dressings and bread, Gorman-Rupp, one of my favorite pump companies, sewage pumps, the big blue pumps, you see at construction sites. Oil-Dri, the market leader in cat litter. God, there’s so many, [unintelligible [00:16:11], Scotts Miracle-Gro. I can go on and on.

Tobias: It’s so sexy.

Eric: [crosstalk] -everyone uses. 50, 60 times earnings– [crosstalk]

Tobias: Well, it’s not expensive.

Eric: At least Church & Dwight, they use Armand Hammer for almost everything. I don’t know if you can put WD-40 in toothpaste. [laughs] I think there is a limit there, but it is at 60 times earnings. All these traditionally small-cap value stocks back in the 90s and early 2000s, have had multiple expansions that have been unbelievable. You’ve gone from 10 to 15 times– Boston Beer’s another one. I bought Boston Beer at $9 in 2001, I believe, maybe 2000, it’s now at $900.

Tobias: I thought it got interesting a couple of years ago, I think it got cheap a couple of years ago, but then I didn’t buy it at the time, and I went back and looked at the chart, and I was stunned at how much it had gone up.

Eric: That’s probably the should have, could have, would have of my career. I did well on it, but if I held it–

Tobias: Yeah, you wouldn’t be doing this. [laughs]

Eric: Wouldn’t be doing this podcast with you.

[laughter]

Eric: The composition of value completely changed. Now, those kind of companies are huge premiums to book, huge P/Es, 30 to 60 times, price and sales three to six times, very expensive. That is partially because of the multiple expansion we have, which of course, any of these perpetual bond-type companies, which these, are very high quality, you’ve had low rates. But 10, 11 years of this rate environment has caused people to just– you can slap any multiple on these and it’s still better than zero. So, then what’s left in value?

Well, extremely cyclical companies generate trough results, energy, financials. Financials is a huge component now. I think the quality of value has gotten worse, even though value’s still cheap relative to growth. In 1999, it was high-quality value cheap to growth. It was just so much more comfortable for me to buy the market leader cat litter than a bank in Texas trading at 1.1 times book that may or may not have a pretty good commercial real estate loan portfolio. The financials now are very interesting. I think some are cheap and they’ve moved recently, but I think it’s harder to get a high degree of confidence in valuation than the stocks in 1999. So, that’s the big difference.

Tobias: I think that’s borne out statistically too. There’s a AQR research paper that shows one of the things that– I think it’s a Cliff Asness paper on his blog or something like that, but he looks at the return on assets of that value decile, and they were better companies than the expensive stocks in that early 2000s or late 1990s period even though they were trading much more cheaply.

This time around, you do have to take– They’re not as good companies, they’re still way too cheap for the quality that you’re getting, but they’re not as good as the expensive companies. You can make an argument that even if you’re overpaying for the more expensive companies, the market still has the sort kind of right if that makes sense.

Eric: Right. No, that doesn’t make sense. You’ve actually looked into this. See, I just make stuff up as I go.

Tobias: Well, I didn’t look at it, I’m just–

Eric: I just see if my buy lists, and I’m like these can’t be value stocks anymore. That’s interesting to know that.

Tobias: What’s causing all these?

Eric: These things go in cycles. I’m still a believer, these high-quality names are just so expensive if you’re growing 2% or 3%. What most of these do is grow at nominal GDP rates. It’s not exceptional growth. Organic growth is not there to support these valuations. We’ll just wait it out. You saw it in March, some of these names, like UniFirst, one of the market leaders in uniforms, another slow grower, but consistent. It got destroyed. Sykes is another one, public company market leader in call centers, that was another stock that got down to $24, 2.8 in free cash flow year, $2 in cash, no debt, just exceptional value. This again goes back to March.

What you had in March was the initial selloff. The high-quality value stocks or historically value stocks, they held up pretty well. It wasn’t till kind of mid-late March, where the bid disappeared, and that’s for us is like whoa. You had stocks down 5%, 10%, 15%, even 20% a day, where you could tell there was the bid was disappearing, liquidity was drying up. There was no one there on the bid. A few 100 shares will knock these stocks down. That’s when I said, finally, finally, passive is in trouble, because there were outflows, and you could tell the trading was so sloppy that they were selling into a market with no bid.

That’s when we got invested., and that’s when the higher-quality names got cheap. We bought Weis Markets, WMK. It had at the time $5 a share of cash, now has $8 a share in cash. It’s got down to 35, $3 a share and normalized free cash flow. This year, they’ll make $5 because of the pandemic, and $35. They own half their stores. We bought it below tangible book value, 4% dividend at the time, and it didn’t matter if people were selling. There was no bid. That’s what we do so well.

March was interesting with the high-quality. Talk about how expensive high quality is, they did get hit in March. That I think was a reflection of passive finally getting outflows. March was a test run. That wasn’t it. If anything, it’s caused people to believe, “You should buy every dip.” It has encouraged them. They didn’t really learn that lesson, but what we believe is that was a great test run, check everything you’ve done.

Look under the hood of your portfolios, how did these stocks perform, because that for a couple of weeks was what the end of the cycle we believe is what it’s going to look like when the bids disappear, and you can’t get out without moving the stock down significantly. Right now, I think, the liquidity in these illiquid names in small caps that we’ve been doing this for so long, it just feels like it’s always going to be there, but it’s not. Same with junk bond funds or corporate debt funds. It’ll be very interesting when the cycle ends to watch the passive investors try to all get out at once.

We’ve talked about this before, but that is going to be the great opportunity for patient disciplined investors, is when the passive funds have to sell because they don’t have cash. When they get outflows, they have to sell. We saw that in March, and it was glorious for disciplined value investors that had the capital to buy from them.

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