New book out now! The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market

Tobias CarlisleAmazon, Tobias Carlisle1 Comment

From Amazon

The Acquirer’s Multiple is an easy-to-read account of deep value investing. The book shows how investors Warren Buffett, Carl Icahn, David Einhorn and Dan Loeb got started and how they do it. It combines engaging stories with research and data to show how you can do it too. Written by an active value investor, The Acquirer’s Multiple provides an insider’s view on deep value investing.

The Acquirer’s Multiple covers:

  • How the billionaire contrarians invest
  • How Warren Buffett got started
  • The history of activist hedge funds
  • How to Beat the Little Book That Beats the Market
  • A simple way to value stocks: The Acquirer’s Multiple
  • The secret to beating the market
  • How Carl Icahn got started
  • How David Einhorn and Dan Loeb got started
  • The 8 rules of deep value

The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market provides a simple summary of the way deep value investors find stocks that beat the market.

Excerpt

Media

(If you’d like to schedule an interview, please shoot me an email at tobias@acquirersmultiple.com)

Buy The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market is out now on Kindle, paperback, and Audible.

Other Books

Fiat Chrysler Automobiles NV (NYSE:FCAU) Up 214%

Johnny HopkinsStocksLeave a Comment

On December 1st, 2016 we wrote this article titled – The One Automobile Stock That Value Investors Should Own Right Now – Fiat Chrysler Automobiles NV (FCAU), here at The Acquirer’s Multiple.

At the time the article was written, Fiat Chrysler was one of the cheapest stocks in our All Investable Stock Screener, trading on an Acquirer’s Multiple of 4.22. It’s share price was $7.70, down 46.75% from its previous twelve month high of $14.46 on December 29, 2015. Here’s what the price chart looked like then:

(Source: Google Finance)

Source: Google Finance

In the article we also reported that Bill Nygren of the Oakmark Funds and Mohnish Pabrai of the Pabrai Investment Funds both owned shares in Fiat Chrysler, 24,400,000 and 13,771,930 respectively.

As of today this same stock has risen a staggering 214% to $24.19 since the time the article was written. Here’s a look at the price chart for the past twelve months:

Source: Google Finance

After all that time and a rise of 214% Fiat Chrysler still remains undervalued, sitting in the 30th position in our All Investable Stock Screener with an Acquirer’s Multiple of 7.27 and a P/E of 10.7.

Joel Greenblatt – The 3 Golden Rules Of Successful Value Investing

Johnny HopkinsJoel GreenblattLeave a Comment

Here’s a great article published at Forbes recently regarding one of our favorite value investors, Joel Greenblatt. The article is written by Jack Schwager, author of the Market Wizards series, in which he recounts his interview with Joel Greenblatt for one of his books. Schwager recalls some of the insightful parts of the interview included Greenblatt’s successful investing strategy and his three golden rules of value investing.

Here is an excerpt from the Forbes article:

Is “value investing” correct? originally appeared on Quorathe place to gain and share knowledge, empowering people to learn from others and better understand the world.

Answer by Jack Schwager, author of Market Wizards series, Co-founder of FundSeeder, FundSeeder Summit, on Quora:

To answer this question I will invoke the wisdom of Joel Greenblatt, one of the foremost experts on value investing. I interviewed Greenblatt in my book Hedge Fund Market Wizards. Joel Greenblatt is currently Managing Principal and Co-Chief Investment Officer of Gotham Funds and previously was the portfolio manager for Gotham Capital, which in the course of its 10-year track record achieved an average annualized compounded return of exactly 50.0% (before incentive fees). The outperformance was remarkably consistent: The lowest annual return during the entire period was positive 28.5%.

In our interview, Greenblatt said, “The power of value investing flies in the face of anything taught in academics. Value is the way stocks are eventually priced. It requires the perspective of patience because the market will eventually gravitate toward value.”

He then went on to explain research he conducted on a value formula he used.

“We also divided the formula rankings into deciles with 250 stocks in each decile. Then we held those stocks for a year and looked at how each of the deciles did. We repeated this process each month, stepping through time. Each month, we had a new set of rankings, and we assumed we held those portfolios (one for each decile) for one year. We did that for every month in the last 23 years, beginning with the first month of the Compustat Point-in-Time database. It turned out that Decile 1 beat Decile 2, 2 beat 3, 3 beat 4, and so on all the way down through Decile 10, which consisted of bad businesses that were nonetheless expensive. There was a huge spread between Decile 1 and Decile 10: Decile 1 averaged more than 15% a year, while Decile 10 lost an average of 0.2% per year.”

In response, I had what seemed to me to be an obvious question: “Since there is such consistency in the relative performance between deciles, wouldn’t buying Decile 1 stocks and selling Decile 10 stocks provide an even a better return/risk strategy than simply buying Decile 1 stocks?”

I thought I was being perceptive. Greenblatt quickly disabused me of that notion.

“My students and hundreds of e-mails asked the exact same question you just did. The typical comment was, ‘I have a great idea Joel. Why don’t you simply buy Decile 1 and short Decile 10? You’ll make more than 15% a year, and you won’t have any market risk.’ There’s just one problem with this strategy: Sometime in the year 2000, your shorts would have gone up so much more than your longs that you would have lost 100% of your money.”

This observation illustrates a very important point. If I wrote a book about a strategy that worked every month, or even every year, everyone would start using it, and it would stop working. Value investing doesn’t always work. The market doesn’t always agree with you. Over time, value is roughly the way the market prices stocks, but over the short term, which sometimes can be as long as two or three years, there are periods when it doesn’t work. And that is a very good thing. The fact that our value approach doesn’t work over periods of time is precisely the reason why it continues to work over the long term. Our formula forces you to buy out-of-favor companies, stocks that no one who reads a newspaper would think of buying, and hold a portfolio consisting of these stocks that, at times, may underperform the market for as long as two or three years. Most people can’t stick with a strategy like that. After one or two years of underperformance, and usually less, they will abandon the strategy, probably switching to a strategy that has done well in recent years.

It is very difficult to follow a value approach unless you have sufficient confidence in it. In my books and in my classes, I spend a lot of time trying to get people to understand that in aggregate we are buying above-average companies at below-average prices. If that approach makes sense to you, then you will have the confidence to stick with the strategy over the long-term, even when it’s not working. You will give it a chance to work. But the only way you will stick with something that is not working is by understanding what you are doing.”

Greenblatt’s narrative can be boiled down to what I term Greenblatt’s three rules of value investing:

1. Value investing works.

2. Value investing doesn’t work all the time.

3. Item 2 is one of the reasons why Item 1 is true.

Investing in good businesses that are priced cheap—Greenblatt’s approach modeled after Buffett—will outperform the market over the longer term. This value edge does not go away because the periods of underperformance using a value approach can be long enough (a few years) and severe enough, to discourage investors from sticking with the approach. Although many managers may realize the merit of value investing, they too will have trouble using such an approach because of the shortening of investor time horizons in tolerating subpar performance. The fact that institutions have become increasingly likely to redeem investments from managers who turn in below-average performance for periods as short as one year, let alone two years, means that managers who stick to a value approach risk losing substantial assets at some point. The inability of so many investors and managers to invest with a long-term horizon creates the opportunity for time arbitrage—an edge in an investing approach that requires the commitment to long-term holding periods.

You can read the original article at Forbes here.

Seth Klarman – Value Opportunities Still Exist In Firms Being Attacked By The Likes Of Amazon

Johnny HopkinsSeth KlarmanLeave a Comment

Good news for value investors as the WSJ reports that Seth Klarman at Baupost is still finding value opportunities in firms being attacked by the likes of Amazon, saying:

“Increasing technological disruption is already pushing some securities well below our assessment of underlying value,” writes Mr. Klarman, “as legitimate concerns are, in some cases, carried to excess.”

Klarman also sees potential value in so-called unicorns, private companies with billion-dollar-plus valuations, that collapse on disappointment. In the thin markets for such private companies, it may be possible for Baupost to step in on preferential terms when promising companies stumble, says the letter.

Here is an excerpt from the WSJ:

How can value investors, who seek to buy stocks at depressed prices, prevail in a financial world dominated by market-matching index funds?

That’s the main question posed by Seth Klarman, chief executive of the Baupost Group, the $32 billion hedge-fund group, in his 2017 year-end letter to shareholders.

“Could Baupost itself be disrupted?” asks Mr. Klarman in a copy of the letter reviewed by The Wall Street Journal.

He cites companies like Amazon posing an existential threat to existing businesses. “Today, taxi medallion owners, traditional newspapers, shopping malls and department-store chains are gravely threatened,” he writes.

“Discussions in the Baupost conference rooms are increasingly likely to include an assessment of what Amazon executives are discussing in their conference rooms.”

He suggests that Baupost, which historically has shied away from most rapidly-growing industries, could venture into investing in “the new firms that are seeking to displace the older incumbents.” The firm is exploring ways to put a value on raw data, researching top technology firms and attending more tech conferences, writes Mr. Klarman.

“Disruptive change is already driving differences in the assumptions we are comfortable making and the cash flow projections that underpin our financial models,” he says in the letter.

Mr. Klarman also sees potential value in so-called unicorns, private companies with billion-dollar-plus valuations, that collapse on disappointment. In the thin markets for such private companies, it may be possible for Baupost to step in on preferential terms when promising companies stumble, says the letter.

Mr. Klarman warns that “while companies such as Amazon and Facebook are driving enormous change and have themselves been growing rapidly, they are not necessarily great investments going forward…many of these companies seem very fully valued.”

On the other hand, Baupost is finding value among some firms attacked by the likes of Amazon. “Increasing technological disruption is already pushing some securities well below our assessment of underlying value,” writes

Mr. Klarman, “as legitimate concerns are, in some cases, carried to excess.”

As an example, he cites department stores: “Even for Macy’s, the correct price today is not zero,” says the letter.

“Macy’s owns valuable real-estate assets, and there may be ways to navigate through the current environment while salvaging some value for shareholders.”

The report doesn’t mention Baupost’s investments in distressed Puerto Rican bonds, which attracted criticism last year.

You can read the original letter at the WSJ here.

The Acquirer’s Multiple Gazette – (Investing Reads, Podcasts, Tweets, Superinvestor News)

Johnny HopkinsValue Investing NewsLeave a Comment

The Acquirer’s Multiple Gazette is a roundup of this week’s best investing reads, podcasts, tweets and superinvestor news:

Investing Reads

Buffett on Start-Up Investing (csinvesting)

Poker, Speeding Tickets, and Expected Value: Making Decisions in an Uncertain World (Farnam Street)

According To These 3 Measures The Stock Market Is Now Literally Off The Charts (The Felder Report)

Breaking Up Tech: Indexes doing what the economy won’t (The Reformed Broker)

As Good As it Gets? (The Irrelevant Investor)

The Lifecycle of an Investment Idea (A Wealth of Common Sense)

Changing Your Mind (MicroCapClub)

Future U.S. Equity Returns: A Best-Case Upper Limit (Phliosophical Economics)

How to Lose 93% of Your Money… And Be Happy About It (Jason Zweig)

Taxing Questions on Value (Musings on Markets)


Superinvestors holding positions in some of our Acquirer’s Multiple Stocks

Superinvestors who hold the #3 pick in our Small & Micro Cap Stock Screener – Bellatrix Exploration Ltd. (BXE) –

Howard Marks at Oaktree Capital – 3,750,000 shares

Jean-Marie Eveillard at First Eagle – 406,000 shares

Superinvestors who hold the #3 pick in our Large Cap Stock Screener – Micron Technology Inc (MU)

David Tepper at Appaloosa Management – 17,053,999 shares

David Einhorn at Greenlight Capital – 5,021,900 shares

Superinvestors who hold the #8 pick in our Small & Micro Cap Stock Screener  –  Global Ship Lease Inc. (GSL) –

Jim Simons at Renaissance Technologies – 1,240,200 shares


Investing Podcasts

Stock Market Melt-Up & Quantitative Easing with Richard Duncan (Preston Pysh & Stig Brodersen)

Dan Rasmussen, “The Crown Jewel Of The Alternative Universe Is Private Equity” (Meb Faber)

Crypto-pocalypse, with Preston Byrne (Patrick O’Shaughnessy)

Nobody Wants to Listen to Your Podcast (Ben Carlson & Micheal Batnick)

The Science of Timing (The Motley Fool)

Charge!: The Bull Case for Tesla (Adventures in Finance)

Northwest Contrarian – William Smead, Smead Capital Management (ValueWalk)


Investing Tweets

Acquirer’s Multiple Stocks Featuring In Watsa, Greenblatt, Simons Portfolios

Johnny HopkinsJim Simons, Joel Greenblatt, Prem Watsa, Stock ScreenerLeave a Comment

One of the new weekly additions here at The Acquirer’s Multiple features some of the top picks from our All Investable Stock Screener and some top investors that have added, or are holding these same picks in their portfolios. Investors such as Joel Greenblatt, Jim Simons, Prem Watsa, Jeremy Grantham, and Howard Marks.

The top investor data is provided from the latest 13F’s over at WhaleWisdom (dated 2017-09-30). This week we’ll take a look at the #2 pick in our All Investable Stock Screener:

Argan Inc (NYSE:AGX)

A quick look at the price chart for Argan Inc shows us that the stock is down 35% in the past twelve months. We currently have the stock trading at an Acquirer’s Multiple of 1.75.

Source: Google Finance

New Positions

Top investors who took new positions in Argan Inc in the latest reported quarter include:

Prem Watsa – Fairfax Financial Holdings – 61,000 shares

Chuck Royce – Royce & Associates – 183 shares

Added To Their Positions

Top investors who added to their positions in Argan Inc in the latest reported quarter include:

Cliss Asness – AQR Capital Management – 211,044 shares

Scott Black – Delphi Management Inc – 14,894 shares

Currently Holding

Other top investors who currently hold positions in Argan Inc in the latest reported quarter include:

Jim Simons – Renaissance Technologies – 1,280,100 shares

Joel Greenblatt – Gotham Asset Management – 152,269 shares

Ken Griffin – Citadel Investment Group – 10,270 shares

Paul Tudor Jones – Tudor Investment Corp – 3,894 shares

John Hussman – Hussman Strategic Advisors – 4,000 shares

David Einhorn – When Investing Feels Like You’re Running Into A Headwind, Don’t Capitulate, Stick To Your Strategy

Johnny HopkinsDavid EinhornLeave a Comment

One of our favorite investors here at The Acquirer’s Multiple is David Einhorn. Einhorn is the founder of Greenlight Capital, which according to WhaleWisdom manages a stock portfolio valued at approximately $6.67 Billion.

We’ve just finished reading through Greenlight’s latest Q4 2017 shareholder letter which shows that the fund has returned 1.6% year-to-date compared to the S&P 500, which has returned 21.8% year-to-date. Despite the recent poor results the letter does provide some great lessons for value investors. The two key takeaways are:

1. In investing you can be swinging well and hitting the ball hard, but just not delivering a satisfactory result on the scoreboard.

2. When it feels like you’ve been running face first into the wind, don’t capitulate, stick to your strategy.

Here is an excerpt from that letter:

The Greenlight Capital funds (the “Partnerships”) returned (1.6)%, net of fees and expenses, in the fourth quarter of 2017, bringing the year-to-date net return to 1.6%. During the fourth quarter, the S&P 500 index returned 6.6%, bringing its year-to-date return to 21.8%. Since its inception in May 1996, Greenlight Capital, L.P. has returned 2,134% cumulatively or 15.4% annualized, both net of fees and expenses.

David began playing fantasy baseball in 1985. In fantasy baseball you draft a “team” of individual players from different real-life major league teams at the beginning of the season and compete against teams picked by your friends. The player whose team does the best across a variety of statistical areas wins. In the pre-internet and even pre-ESPN Baseball Tonight days, you tracked players using newspaper box scores. Unless you saw the game, there was no other easy way to find out how your players did. To get a clue, you might get the scores from the local TV news. If you owned the best hitter on the Blue Jays and you saw the Blue Jays scored 10 runs, there was a good chance that the next day’s box scores would bring good news for your team. A teenager could fall asleep to that kind of happy thought.

However, once in a while the morning box score would reveal that despite the Blue Jays scoring 10 runs, your slugger had an uneventful and useless 1 for 5 game. It’s disappointing and feels worse than if your player had the same result in a game where the Blue Jays were shut out (unless you are also a Blue Jays fan). And, it doesn’t matter if your player was swinging well and hitting the ball hard every time or whether his evening was marred by ugly strikeouts, pop-ups and double plays. 1 for 5 is 1 for 5. Fantasy baseball only counts the statistical results.

Our quarter and year felt just like that. We had a non-descript result in a period where it seems like most around us did much better. This must be frustrating to you, our Partners. It is certainly frustrating to us. And, yet, as we were in the batter’s box so to speak, it felt like we were swinging well and hitting the ball hard. We just didn’t deliver a satisfactory result on the scoreboard. There were plenty of nights we happily went to sleep with company results that matched our non-consensus expectations, but it didn’t translate into a win the following day. It’s a long season and we are ready for the next game. Let’s see what happens.

Despite it being a good year in the market, it was a challenging environment for our investment style. We do not mimic any index and we can think “outside the box.” We have a value orientation and we take comfort from the margin of safety afforded by the low valuations of our long investments. Though most people understood our last quarterly letter as tongue-in-cheek and while we certainly don’t believe value investing is dead, it is clearly out of favor at the moment. Last year the Russell 1000 Pure Growth Index outperformed the Russell 1000 Pure Value Index 38% to 4%. While it feels like we have been running face first into the wind, we don’t intend to capitulate and are sticking to our strategy of being long misunderstood value and shorting “not value.”

You can find the full Q4 2017 letter here.

Charlie Munger – How Can Professional Investors, With Thorough Analysis, Continue To Underperform

Johnny HopkinsCharles Munger, Mohnish PabraiLeave a Comment

Here’s a great presentation by Mohnish Pabrai to the folks at Google. During the presentation Pabrai relays a story about a time he had dinner with a small group at the home of Charlie Munger. During the dinner Munger posed a question to the group:

Why did the ‘best ideas fund’, established by the Capital Group, continually underperform?

The ‘best ideas fund’ consisted of a collection of the best stock picks from each of their portfolio managers, which when combined into a fund, was expected to outperform.

Here is an excerpt from that interview:

In Los Angeles there is a large active asset management shop, that some of you might have heard of, its called Capital Group. They’ve been around for about 85 years and they manage about 1.4 trillion. The Capital Group has a number of different funds, kind of like Fidelity but unlike Fidelity which has the star managers like William Danoff or Peter Lynch, Capital Group runs things a little bit differently.

They assign teams of managers to manage a specific fund and each manager will for example manage a few hundred million or a hundred million or maybe a billion out of the larger fund. Then they collect all the different manager picks and that’s what comprises the whole fund.

A few years back I was at a dinner at Charlie Munger’s house, it was a small group. He posed a question to the group. He said that the Capital Group a few years back had set up what they call the ‘best ideas fund’. They asked each of their portfolio managers to give one stock pick, their highest conviction idea, and then they created a ‘best ideas fund’, which was taking one pick from each of the managers.

Charlie said that this ‘best ideas fund’ did not do well. It underperformed the benchmark, underperformed the S&P; and so on. He was asking the group why that was. Then before we could get further into the discussion dinner was served. Everyone kind of moved, the conversation shifted and this thread got left unanswered.

I think this was five or six years ago and I would meet Charlie once in a while but either I’d forget or they’d be a lot of people around and I thought I had the answer for why this happened but I didn’t know because God hadn’t told me why it happened.

So earlier this year I was with Charlie. I said, no this time I’m going to make sure this is the first thing I bring up, so that I’m bringing closure to this issue. I said, Charlie you know you might remember five or six years ago, and I’ve brought up the Capital Group, and he beamed.

He said, oh yeah I remember that really well.

So I said, what was the reason the best ideas fund didn’t well?

He said, well it wasn’t once, they tried it several times. They tried setting up these best ideas multiple times and each time it failed. So he said before I answer the question why it failed I want to give you a story from my days at Harvard Law School. Sometimes when they had classes at Harvard Law the professor would bring up a case where the facts was such that it wasn’t obvious which side was in the right. It could go either way.

Then they would divide the class into two halves randomly and one half would argue for the defendant and the other half would argue against the defendant. Then the two sides went off and studied the facts and made their arguments.

Then after all of that was done, when they surveyed the entire class, overwhelmingly the students who had argued for the motion believed strongly that they were right, and the people who had argued against the motion believed strongly that they were right. Again these were folks that before they had studied the facts they didn’t particularly have a leaning one way or another.

Then Charlie quoted this English actor, Sir Cedric Hardwicke. Cedric Hardwicke basically was a little bit of a smartass. He said, you know you’re already fooled and I’ve been a great actor for so long that I can no longer remember or know what I think about any subject. Charlie said that even the temples and churches make you repeat stuff because as you shout it out, you pound it in!

Basically the best ideas fund, Charlie said, the picks were the ideas that the managers had spent the most time on. So when they spent the most time on these ideas they were the most excited about them and of course when they put all of these ideas together things didn’t go so well.

You can watch the entire presentation here:

Howard Marks – Investors Are Like Those Drivers Changing Lanes Every Minute, Cutting Off Half The Cars On The Road

Johnny HopkinsHoward MarksLeave a Comment

One of the best free resources for all investors are Howard Marks’ memos. Marks is the Co-Chairman of Oaktree Capital, which currently manages a portfolio valued at approximately $6.7 Billion. Since 1990 Marks has written 100+ memos which are full of valuable investing insights.

One of our personal favorites here at The Acquirer’s Multiple is the 2002 memo is which Marks likens investing to driving saying:

“The fact that crowded highways are efficient allocators of space doesn’t mean people don’t try to beat them. How often do we see the guy in the souped-up ’67 Mustang careen back and forth just in front of us, changing lanes every minute and cutting off half the cars on the road? But does he get there any faster? Should he expect to?”

Here’s an excerpt from that memo:

The Tactics Others Adopt

The fact that crowded highways are efficient allocators of space doesn’t mean people don’t try to beat them. How often do we see the guy in the souped-up ’67 Mustang careen back and forth just in front of us, changing lanes every minute and cutting off half the cars on the road? But does he get there any faster? Should he expect to?

Of course, the analogy to investing holds beautifully. Knowing which lane to drive in has nothing to do with which lane has been going fastest. To chart the best course, one must know which one will go fastest. As usual, outperforming comes down to seeing the future better than others, which few drivers on crowded highways can do.

So half the time the lane-jumper moves into a fast-moving lane that keeps going fast, and half the time into one that’s just about to slow down. And the slow lane he leaves is as likely to speed up as it is to stay slow. Thus the “expected value” of his lane changing is close to zero. And he uses extra gas in his veering and accelerating, and he bears a higher risk of getting into an accident. Thus the returns from lane changing appear modest and undependable – even more so in a risk-adjusted sense.

There are lots of investors in our heavily populated markets who believe (erroneously, in my opinion) they can see the future, and thus that they can get ahead through market timing and short-term trading. Most markets prove to be efficient, however, and most of the time these machinations don’t work. Still, investors keep guessing at which lane on the investment highway will go fastest.

They are encouraged by the successes they recall and the gains they dream of. But their recollection tends to overstate their ability by exaggerating correct moves and ignoring mistakes. Or as Don Meredith once said on Monday Night Football, “they don’t make them the way they used to, but then again they never did.”

So most investors go on trying to time markets and pick stocks. When it works, they credit the efficacy of their strategy and their skill in executing it. When it doesn’t, they blame exogenous variables and the foolishness of other market participants. And they keep on trying.

In the ultimate form of capital punishment, the hyper-tactician – on the road or in the market-stands a good chance of repeatedly jumping out of the thing that hasn’t worked just as it’s about to start working, and into the thing that has been working moments before it stops.

This is why it’s often the case that the performance of investors in a volatile fund is worse than the performance of the fund itself. On its face this seems illogical . . . until you think of the unlucky lane-jumper described just above. People often jump into a hot fund toward the end of a period of good performance, when overvaluation in the market niche (or hubris on the manager’s part) has set the stage for a fall, and when the great results have brought in so much money that it’s impossible to keep finding enough attractive investments.

By the time a hot fund falls, it’s usually much larger than it was when it rose, and thus a lot more money is lost on a 10% drop than used to be made on a 10% rise. It’s in this way that the collective performance of a fund’s investors can be worse than that of the fund.

There are prominent examples of money managers who started small, made 25% a year for 25 years, got famous and grew huge, and then took a 50% loss on $20 billion. I often wonder whether their investors enjoyed any cumulative profit over the funds’ entire lives. Just as lane-jumping is risky on the road, following the hot trend is risky in the
investment world.

Isn’t There a Way to Make Good Time?

– If crowded highways are truly efficient, and the fast lane is destined to slow down, is there no way to do better than others? My answer is predictable: find the inefficiencies. Go where others won’t. Do the things others avoid. We all have our tricks on the road. We’ll take the route with the hazards that scare away others – after we’ve made sure we know the way around them. Or we’ll take the little-known back road. We’ll go through the industrial area, leaving the beautified route to the masses. Or we’ll drive at night, while others prefer the daylight.

All of these things are analogous to the search for inefficiency in investment markets. At Oaktree we invest in things that others find frightening or unseemly – like junk bonds, bankruptcies and non-performing mortgages. We spend our time in market niches that others ignore – like busted and international convertibles, and distressed debt bought for the purpose of obtaining control over companies.

We try to identify opportunities before others do – like European high yield bonds and power infrastructure. And we do things that others find perilous, but we approach them in ways that cut the risk – like investing in emerging markets without making sink-or-swim bets on the direction of individual countries’ economies and stock markets.

I continue to believe there are ways to earn superior returns without commensurate risk, but they’re usually found outside the mainstream. A shortcut that everyone knows about is an absolute oxymoron, as is one that’s found where the roads are well marked and mapped. The route that’s little known, unattractive or out of favor may not be the one that’s most popular or least controversial. But it’s the one that’s most likely to help you come out ahead.

You can read the entire 2002 memo here.

The Acquirer’s Multiple Gazette – (Investing Reads, Podcasts, Tweets, Superinvestor News)

Johnny HopkinsStock Screener, Value Investing NewsLeave a Comment

The Acquirer’s Multiple Gazette is a roundup of this week’s best investing reads, podcasts, tweets and superinvestor news:

Investing Reads

Complexity Bias: Why We Prefer Complicated to Simple (Farnam Street)

Will Big Tech Do The Right Thing? (The Felder Report)

The Fatal Mistake Crypto Investors are Making Now (The Reformed Broker)

10 Things Investors Can Expect in 2018 (A Wealth of Common Sense)

The Thrill of Uncertainty (Collaborative Fund)

Less Phone, More Nature: 34 Resolutions For a Better 2018 (Jason Zweig)

2018 Investment Outlook (Above The Market)

Lessons from the 1980s for disruption. (13D Research)

The Fallacy of Instant Success (Intelligent Fanatics)

 

Superinvestor News

Carl Icahn: Open letter to the Board of Directors of SandRidge Energy (carlicahn.com)

Bill Miller: Market could be headed for a ‘melt-up (CNBC)

Warren Buffett: Cryptocurrency will come to a bad ending (CNBC)

Charlie Munger: Bitcoin and other cryptocurrencies are also bubbles (CNBC)

David Tepper says market is as ‘cheap’ as a year ago (CNBC)

Prem Watsa: The world’s greatest investors (MoneyWeek)

Bill Ackman: Pershing Square fund to slash management fees (New York Post)

 

Investing Podcasts

Michael Lewis Returns (Motley Fool Money)

Blair Hull, “Emotions Will Kill You in This Game” (Meb Faber)

Animal Spirits: Meltup (Michael Batnick & Ben Carlson)

The Art of the Good Life by Rolf Dobelli (The Investors Podcast)

Creative Investing, with CoVenture’s Ali Hamed (Investor’s Field Guide)

Five Investing Podcasts You Should Listen To (Alpha Architect)

 

Investing Research

Investing: Top White Papers 2017 (Savvy Investor)

2017: The Year in Charts (PensionPartners)

Since 1950, the S&P 500 in 2017 Ranks First, Fourth, Tenth or Twenty-third? (The Aleph Blog)

 

Investing Tweets

Acquirer’s Multiple Stocks Featuring In Greenblatt, Simons Portfolios

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One of the new weekly additions here at The Acquirer’s Multiple will feature some of the top picks from our All Investable Stock Screener and some top investors that have added, or are holding, these same picks in their portfolios. Investors such as Joel Greenblatt, Jim Simons, Jeremy Grantham and Howard Marks.

The top investor data is provided from the latest 13F’s over at WhaleWisdom (dated 2017-09-30). This week we’ll take a look at the #6 pick in our All Investable Stock Screener:

AU Optronics Corp (ADR) (NYSE:AUO)

A quick look at the price chart for AU Optronics Corp shows us that the stock is up 8% in the past twelve months, but still remains undervalued:


(Source: Google Finance)

New Positions

Top investors who took new positions in AU Optronics Corp in the latest reported quarter include:

Joel Greenblatt – Gotham Asset Management – 38,247 shares

Added To Their Positions

Top investors who added to their positions in AU Optronics Corp in the latest reported quarter include:

None.

Currently Holding

Other top investors who currently hold positions in AU Optronics Corp in the latest reported quarter include:

Jim Simons – Renaisance Technologies – 10,186,784 shares

Sarah Ketterer – Causeway Capital Management – 210,600 shares

Jeremy Grantham – GMO LLC – 104,100 shares

Warren Buffett: Why Stocks Beat Gold, Bonds… and Bitcoin

Johnny HopkinsWarren Buffett2 Comments

It’s quite incredible to watch the latest euphoria surrounding cryptocurrencies and Bitcoin. Whether or not we’re witnessing a bubble, only time will tell. But at the time of writing there are 1395 cyrptocurrencies with a combined market cap of approximately $730 Billion. Of which Bitcoin has a market cap of $242 Billion and Ethereum, a market cap of $126 Billion. As a value investor these numbers appear staggering.

This does seem like the perfect time to revisit one piece from Warren Buffet’s 2011 shareholder letter titled – The Basic Choices for Investors and the One We Strongly Prefer, and how it might relate to the current market. Buffett was making the point that stocks are a better investment than bonds and gold. There’s one paragraph in particular which encapsulates why gold is not a great investment when compared to stocks:

“What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.”

Now, if we insert ‘bitcoin’ in place of ‘gold’ in the paragraph above, this may give us a possible sense of what is actually happening in the investing world today:

“What motivates most bitcoin purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.”

I guess we will just have to wait and see.

Here is an excerpt from that letter:

The Basic Choices for Investors and the One We Strongly Prefer

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it’s important to understand the characteristics of each. So let’s survey the field.

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”

For tax-paying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points.

It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency based investments – and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Under today’s conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain – either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we’ve exploited both opportunities in the past – and may do so again – we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.

My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See’s Candy meet that double-barreled test. Certain other companies – think of our regulated utilities, for example – fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot.

Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well). Berkshire’s goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety – but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.

You can find the complete Berkshire Hathaway 2011 shareholder letter here.

Shelby Cullom Davis & The Wisdom of Great Investors

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One of the best papers ever written on investing is The Wisdom of Great Investors, provided by Davis Advisors.

Davis Advisors was founded by legendary investor Shelby Cullom Davis, a leading financial advisor to governors and presidents, who parlayed an initial investment of $100,000 in the late 1940s into more than $800 million by the end of his career in the early 1990s. In 1969, Shelby Cullom Davis’s son, Shelby M.C. Davis, founded Davis Advisors after serving as the head of equity research at The Bank of New York.

Shelby Cullom Davis famously said:

“You make most of your money in a bear market, you just don’t realize it at the time.”

This timeless paper is a great reminder that wherever we are in the history of investing it is crucial that we don’t forget the painful lessons from investors of the past. Here are the most important take-aways from the paper:

Overview

It is important to understand that periods of market uncertainty can create wealth-building opportunities for the patient, diligent, long-term investor. Taking advantage of these opportunities, however, requires the willingness to embrace and incorporate the wisdom and insight offered in these pages. History has taught us that investors who have adopted this mindset have met with great success.

Understand That Crises are Inevitable

Crises are painful and difficult, but they are also an inevitable part of any long-term investor’s journey. Investors who bear this in mind may be less likely to react emotionally, more likely to stay the course and be better positioned to benefit from the long-term growth potential of stocks.

Recognize That Historically, Periods of Low Returns for Stocks Have Been Followed by Periods of Higher Returns

Low prices have helped increase future returns. Investors who bear this in mind are more likely to endure hard times and be there to benefit from the subsequent periods of recovery.

Don’t Attempt to Time the Market

Investors who understand that timing the market is a loser’s game will be less prone to reacting to short-term extremes in the market and more likely to adhere to their long-term investment plan.

Don’t Let Emotions Guide Your Investment Decisions

Great investors throughout history have recognized the value of making decisions that may not feel good at the time but that may potentially bear fruit over the long term—such as investing in areas of the market that investors are avoiding and avoiding areas of the market that investors are embracing.

Understand That Short-Term Under-performance is Inevitable

Almost all great investment managers go through periods of underperformance. Build this expectation into your hiring decisions and also remember it when contemplating a manager change.

Disregard Short-Term Forecasts and Predictions

Don’t make decisions based on variables that are impossible to predict or control over the short term. Instead, focus your energy toward creating a diversified portfolio, developing a proper time horizon and setting realistic return
expectations.

***

While the paper provides a number of great charts and infographics, one in particular illustrates the importance of avoiding self destructive behavior:

Avoid Self-Destructive Investor Behavior

Emotions can wreak havoc on an investor’s ability to build long-term wealth. This phenomenon is illustrated in the study below. Over the period from 1994 to 2013, the average stock fund returned 8.7% annually, while the average stock fund investor earned only 5.0%. Why did investors sacrifice close to half of their potential return? Driven by emotions like fear and greed, they engaged in such negative behaviors as chasing the hot manager or asset class, avoiding areas of the market that were out of favor, attempting to time the market, or otherwise abandoning their investment plan.

Great investors throughout history have understood that building longterm wealth requires the ability to control one’s emotions and avoid self-destructive investor behavior.

You can find the entire paper here.

Bruce Berkowitz – Our Successful Three Step Approach To Value Investing

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One of our favorite investors here at The Acquirer’s Multiple is Bruce Berkowitz. He is the Founder and Chief Investment Officer of Fairholme Capital Management, and President and a Director of Fairholme Funds. In 2010 Berkowitz was named as the 2009 Domestic-Stock Fund Manager of the Year by Morningstar as well as the Domestic-Stock Fund Manager of the Decade (2000-2009), also by Morningstar. Most recently, he was named 2013’s Money Manager of the Year by Institutional Investor Magazine.

Here’s an excerpt from an interview with Berkowitz in which he succinctly lays out his three step approach to value investing, including the example of Bank of America:

At Fairholme we’re very focused on price. Price matters most to us. And we think that price determines much of the success you’re gonna have in the future. So rather than predict what’s going to happen with the company we try to price it correctly with a large margin of safety. So pricing with a significant margin of safety is very important in our rule number one of not losing.

Once we determine what a cheap price is, our next step is to look at the investment and the underlying company and stress test it to determine all the ways that business can go wrong, the environment can go wrong, the balance sheet can go wrong. Try to kill the company.

If we can’t kill the company and we’re buying it at a price that reflects near death we may be onto something very good.

The next step in the Fairholme process is to search for catalysts to understand how the environment, the ecosystem is going to change over time. And how that’s going to affect the company getting closer and closer to a more normal return on investment or on capital employed. That’s the third part of the investment process.

We could use for example a current investment, Bank of America. So 2008 the financial world almost comes to an end. Government comes to the rescue. Most investors have lost eighty to ninety percent of their investment in the company. So we’re watching. We see how Bank of America is recapitalized. We see how their earnings power is maintained, in fact the franchise is intact. But because of what just happened the pain and suffering of so many, the diminution value, the company is priced for death.

But it has been restructured. We capitalized and you can see through the business fundamentals and the quarterly earnings that the company’s actually in better shape than probably it’s been in the past fifty to one hundred years.

So here we have a situation, priced for death, looks to have tremendous value, franchise intact, earnings power foggy because of what just happened in the time that’s going to be needed to resolve the sort of legacy issues from the last debacle.

But you know, if you know business and you know banks, the bad burns off, the good increases, you return to  a normal, and the price follows it. And this is a good example of what we do and how we can invest a dollar and eventually see that dollar become two and four and six.

You can watch the entire interview here:

Acquirer’s Multiple Airline Stocks Featuring In Top Investor Portfolios

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There are currently three airline stocks listed in our All Investable Stock Screener. They are:

Hawaiian Holdings, Inc. (NASDAQ:HA)

JetBlue Airways Corporation (NASDAQ:JBLU)

Alaska Air Group, Inc. (NYSE:ALK)

And it seems we’re not the only ones that think these airline stocks are cheap. A quick look at the latest 13F’s over at WhaleWisdom (dated 2017-09-30) shows that a number of familiar investing names have also taken an interest in these airline companies:

Hawaiian Holdings, Inc. (NASDAQ:HA)

New Positions:

Chuck Royce – Royce & Associates LP – 353 shares

Paul Tudor Jones – Tudor Investment Corp –  15,041 shares

Added to their existing positions:

Joel Greenblatt – Gotham Asset Management, LLC –  115,181 shares

JetBlue Airways Corporation (NASDAQ:JBLU)

New positions:

Louis Moore Bacon – Moore Capital Management, LP – 60,000 shares

Richard Snow – Snow Capital Management, L.P. – 47,544 shares

Added to their existing positions:

Donald Smith – Donald Smith & Co –  314,961 shares

Robert Olstein – Olstein Capital Management, L.P. – 1,300 shares

Alaska Air Group, Inc. (NYSE:ALK)

New positions:

Paul Tudor Jones – Tudor Investment Corp – 12,036 shares

T Boone Pickens – BP CAPITAL FUND ADVISORS, LLC – 51,946 shares

Added to their existing positions:

Joel Greenblatt – Gotham Asset Management, LLC – 151,058 shares

Lee Ainslie – Maverick Capital ltd – 10,050 shares

Steven Cohen – Point72 Asset Management – 350,372 shares

Reuters – Value Stocks Expected To Jump In 2018

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s an article from Reuters, written by David Randall, that should be of interest to value investors, regarding the prospects of value stocks in 2018.

NEW YORK (Reuters) – Value stocks are getting a once-over from some U.S. growth fund managers in early 2018 as they prowl for overlooked shares they think have more upside in a market that gained nearly 20 percent last year.

Value stocks, so labeled because they typically sport lower price-to-earnings valuations, tend to be in more staid or out-of-favor industries and often lag during outsized stock rallies, which is exactly what happened in 2017.

The S&P 500 Value index .IVX – a measure of companies such as Berkshire Hathaway Inc (BRKa.N) and JP Morgan Chase & Co (JPM.N) – gained just 12.6 percent last year. That is a tortoise’s pace measured against the far more hare-like S&P 500 Growth index .IGX, which doubled that performance. It clocked a 25.4-percent rise courtesy of its heavy contingent of tech giants like Apple Inc (AAPL.O) and Microsoft Corp (MSFT.O).

As a result, even some growth funds are moving out of high-flying technology stocks and increasing their positions in stocks they see as more reasonably valued at a time when the American Association of Individual Investors survey shows the greatest exuberance for stocks since November 2014.

“There is some risk to the technology sector after the big run we’ve had. Where we see opportunities now are sectors that have attractive valuations and higher visibility into their revenue streams,” said Matthew Litfin, a co-portfolio manager of the $4.7-billion Columbia Acorn fund (ACRNX.O).

Litfin is now underweight technology and has been adding to its holdings of financial stocks, such as asset management Lazard Ltd (LAZ.N), which trades at a trailing price to earnings ratio of 15.1 versus 23.7 for the S&P 500 .SPX as a whole. Lazard shares are up 5.8 percent so far in 2018.

Thyra Zerhusen, a co-portfolio manager of the $4.2 billion Fairepoint Capital Mid Cap fund (CHTTX.O), said she has been moving into the likes of toymaker Mattel Inc (MAT.O) and General Electric Co (GE.N), whose corporate upheavals overshadow the value of their underlying assets.

GE, for instance, trades at a trailing P/E of 21.2, and its shares are down 41.7 percent over the last year as new chief executive John Flannery has announced plans to shrink the company and exit some of its sprawling business lines. Shares of Mattel, meanwhile, slid 46 percent over the last 12 months as it suspended its dividend and cited the bankruptcy of Toys “R” Us, the biggest U.S. toy retailer, as a factor in its weak sales.

“Last year was not a good environment for value, but now is a time when you can find investments that will go up substantially over the next two years,” she said.

So far so good: Mattel is up 4.3 percent since the new year rang in, and GE is up 6.1 percent. The S&P is up about 2.3 percent.

NO GUARANTEES

A good year for growth stocks does not necessarily mean that value stocks will bounce back the following year, of course.

In the 20 previous occasions that the S&P 500 jumped by more than 18 percent in one year since 1951, the index rose by an additional 10 percent or more the following year 10 times, according to Credit Suisse, with growth stocks leading the way. The other 10 times the S&P on average declined 1.7 percent the next year.

Over the first three trading days of 2018, the iShares S&P 500 Growth index ETF (IVW.P) is up 2.9 percent, while the iShares S&P 500 Value index ETF (IVE.P) is up 1.6 percent.

Yet Matthew Watson, a portfolio manager at James Advantage funds, said that his firm has been bracing for a significant correction in the so-called FAANG group of large tech stocks, such as Amazon.com Inc (AMZN.O) and Google-parent Alphabet Inc (GOOGL.O) that jumped by 30 percent or more in 2017 and pulled the broad index higher.

Instead, the firm has been adding to positions in out-of-favor energy stocks such as Diamond Offshore Drilling Inc (DO.N) and retailers such as Macy’s Inc (M.N) that have under-appreciated assets, he said.

Macy‘s, for instance, is trading barely above the value of its underlying real estate portfolio, Watson said, while Diamond Offshore trades at 70 percent of its book value, a measure of the value of the assets on a company’s balance sheet. Macy’s is down 3.3 percent in the first week of 2018, while Diamond Offshore is up 2.1 percent.

“There may be positive momentum in the stock market right now, but that is only going to make it more expensive,” Watson said. “We think that the only choice you have now to find opportunities that will pay off in the long-run is to look for value.”

(The story was refiled to corrects ‘fund’ to ‘funds’ in paragraph 4)

You can read the original article here.

This Week’s Best Investing Reads

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Here is a list of this week’s best investing reads:

If Everyone Knows Pensions Are Screwed Why Are They Investing In The Exact Same Fashion? (The Felder Report)

My Favorite Charts (The Irrelevant Investor)

Dow 25,000 (The Reformed Broker)

Profit Margins, Bayes’ Theorem, and the Dangers of Overconfidence (Jesse Livermore)

When Things Don’t Make Any Sense (A Wealth of Common Sense)

Intuition vs. Rationality: Where One Stops the Other Starts (Farnam Street)

Making History By Doing Nothing (Collaborative Fund)

Value Investor Insight – December Edition (Cook & Bynum)

Warren Buffett Shares the Secrets to Wealth in America (TIME)

TIP171: The Power of Moments w/ Dan Heath (Business Podcast) (The Investors Podcast)

Investing Lessons From A Surreal 2017 (Financial Samurai)

GMO’s Grantham: Brace for a Melt-Up in Next 2 Years (ThinkAdvisor)

Highest Returns Are Often Realized During Early Stages Of Bubble Formations (Price Action Lab)

Managing success: How do active mangers handle increasing AUM? (Advisor Perspectives)

Predicting Stock Returns Using Firm Characteristics (Alpha Architect)

Michael Mauboussin – Here Is The Best Way To Compare Investment Opportunities

Johnny HopkinsMichael MauboussinLeave a Comment

One of the problems that we face as investors is making comparisons between investment opportunities. Similarly, company management has to make comparisons between strategic merger and acquisition opportunities. So the question is, what is the best way to do this?

One answer can be found in Michael Mauboussin’s recent paper titled – How Well Do You Compare. The paper highlights how humans are flawed when it comes to making investment decisions based on comparisons. He presents a number of systematic strategies that will help improve our outcomes.

Here’s a summary of Mauboussin’s findings:

“Comparing is something we humans do quite naturally, but you and I are not always good at it. If you are a perfectly rational person, you gather all of the salient information about your alternatives and select the option that maximizes your utility. This is a fancy way of saying you pick what makes you happy.”

The problem for us humans is that we use ‘analogy’ as our basis for comparison. Mauboussin describes ‘analogy’ as follows:

The primary mechanism we use [for comparison] is analogy. Analogy is an “inference that if two or more things agree with one another in some respects they will probably agree in others.”

Douglas Hofstadter, a renowned professor of computer and cognitive science, has suggested that analogy is “the core
of cognition.” The application of analogical thinking generally has four steps.

  • First, we select a source analog that we will use as the basis of comparison with the target. Usually, the source comes from our memory.
  • Second, we map the source to the target to generate inferences. Here, we are often looking for similarities.
  • Third, we assess and modify these inferences to reflect the differences between the source and the target.
  • Finally, we learn from the success or failure of the analogy.

Analogy can be a powerful way to compare, but there are common mistakes in its application. Here are a few based on the first three steps:

Step 1 mistakes: Most people rely on their memories to retrieve analogies. Psychologists call this the availability bias, and it shrinks the scope of inquiry. Because our experiences and memories are limited, we fail to identify proper analogies.

Step 2 mistakes: The second failure is a lack of depth. This is a faulty inference based on the superficial features of the analogy. Another way to say this is the analogy suggests correlation but fails to identify causality. Solid theory is rooted in causality. The process of theory building raises the level of understanding from one based on attributes to one based on circumstances.

Step 3 mistakes: The third failure has to do with the inferences we draw based on whether we focus on the similarities or the dissimilarities between the source analog and the target. Psychologists call this the “contrast model,” and it says the similarity between two entities is a weighted function of matching and mismatching features.

So how does that apply in the world of investing?

Comparable company analysis. It is common for an investor to assess the relative attractiveness of a company’s stock or bonds by comparing the valuation to the appropriate securities of comparable firms. Common metrics for stocks include multiples such as price to earnings (P/E), enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), and price to book (P/B), as well as dividend and free cash flow yield. The common metric for bonds of similar maturities and terms is yield.

Which companies an analyst selects as the basis of comparison can play a large role in shaping the conclusions he or she reaches. There are two basic approaches to selecting peer companies.

  • The first, which most fundamental investors use, is based on industry classification. The most popular of these is the Global Industry Classification Standard (GICS). GICS classifies companies by sectors, industry groups, industries, and subindustries. The narrower definitions are more specific but have fewer companies.
  • The second approach selects companies based on the fundamental characteristics that drive value. Two companies in different industries may have more in common with one another than they do with other firms in their respective industries.

The approach using GICS misses the connection while the approach using fundamental drivers captures the link. Most fundamental investors and investment bankers do comparable company valuation analysis based on industry peers.

Both approaches have the same goal: use an input (GICS or fundamental characteristics) to generate an output (valuation). When researchers examined how analysts actually select companies for comparison, they found that analysts pick peers with high valuations when they want to argue that a stock is cheap. It appears that the comparable company analysis is less an exercise in objectivity and more an exercise in persuasion.

Another flaw in selecting industry peers is that multiples may vary for justifiable economic reasons. For instance, two companies with the same growth rate in earnings but with different returns on invested capital will justifiably trade at dissimilar P/E, EV/EBITDA, and P/B multiples. A failure to recognize the impact that return on invested capital has on valuation can lead to superficial, and incorrect, conclusions.

Comparable company analysis, like many of the methods we use to compare, can be an effective tool if used appropriately and misleading if used improperly.

So how can investors improve their ability to make comparisons?

We need to address the common mistakes in order to improve our ability to compare. Dan Lovallo, Carmina Clarke, and Colin Camerer, researchers who study decision making, describe the problem of relying too much on analogies drawn from memory and offer a solution they call “similarity-based forecasting.” They suggest considering two dimensions (see exhibit 4). The first is the reference class, or what you are comparing to. The second is the weighting, or how much emphasis you should place on a particular analogy or feature.

They start by recognizing that most of us use a single analogy that we draw from memory. The reference class is one analogy, and we place all of our weight on it. If you happen upon a proper analogy, this is a quick and efficient way to compare. But single analogies can be very misleading because the scope of inquiry is too narrow.

You can prompt decision makers to consider more than one analogy and to weight them relative to the focal decision. This is called “casebased decision theory” and is generally better than single analogy recall. But it also runs the risk of having too little breadth and depth.

Lovallo, Clarke, and Camerer ran an experiment with private equity investors and found that prompting the investors to consider relevant, additional cases improved the quality of their forecasts. There are ways to be effective with case studies, but executives and investors are generally not as careful as they should be in curating and developing appropriate cases.

We tend to compare by relying on recall. Kahneman wrote, “People who have information about an individual case rarely feel the need to know the statistics of the class to which the case belongs.” This suggests we typically stop at the boundary of our memory. The decision-making research shows that the thoughtful integration of an appropriate reference class improves the quality of comparisons and forecasts.

“Reference-class forecasting” asks the question, “What happened when others were in this position before?” It is an unnatural way to think because it deemphasizes memory and experience and requires a decision maker to find and appeal to the reference class, or base rate.

But research in social science shows that the proper integration of a reference class improves the quality of forecasts. Since comparisons often rely on forecasts, reference-class forecasting is a marked improvement relative to relying solely on memory.

For example, say you are comparing two companies, one with sales of $40 billion and the other $4 billion, that both have an expected annual sales growth rate of 20 percent in the next 5 years based on the average projections of analysts. In this case, you can examine the past five-year growth rates of all companies of comparable sizes to get a sense of the plausibility of achieving that growth. The percentage of $40 billion companies reaching that rate of growth is less than half that of $4 billion companies.

Reference-class forecasting confirms that rapid growth occurs more frequently for smaller firms than for bigger ones.

Reference-class forecasting goes from using memory for comparison to a large distribution that reflects an appropriate reference class. But the approach evenly weights each outcome in the distribution. When we compare the growth rates of $40 billion and $4 billion companies, we are not asking whether some of the companies in the sample are more similar to the focal company.

Lovallo, Clarke, and Camerer argue for “similaritybased forecasting,” which uses a large distribution but then weights some of the cases more than others based on how similar they are to the relevant target.

Mergers and acquisitions (M&A) provide a good example. Historically, M&A deals have failed to create value for the acquiring company around two-thirds of the time. But acquirers fare better when they pledge a small premium, pay with cash instead of stock, and do a tuck-in as opposed to a swashbuckling deal to chart a new strategic course.

In comparing alternatives for capital allocation, an executive should consider the full reference class but may weight certain deals more than others based on their similarity to the transaction at hand.

In summary…

Comparing, while essential to effective decision making, comes naturally to humans. But our basic approach of relying on analogy can limit our ability to compare effectively. Analogy is a natural and potentially robust way to compare, but you must be careful to avoid the common mistakes, including a lack of breadth and depth as well as misallocation of attention. In each of these cases, we can use systematic strategies to improve our outcomes.

You can read the entire paper here.

Ray Dalio – The Holy Grail Investing Strategy

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Bridgewater founder Ray Dalio has written a lot about his principles, but not so much about his investing principles. In his latest book – Principles: Life and Work, Dalio discusses the purpose and importance of having principles, his most fundamental life principles, and his management principles at Bridgewater. But in terms of his investing principles he writes:

“One day I’d like to write a Part 4 on my investment principles.”

So it’s rare to find an interview with Dalio discussing his investing principles. One such find is a 2011 interview that Dalio did at the Bloomberg Markets 50 Summit with Erik Schatzker, in which he discusses his investing principles and his Holy Grail investing strategy.

Here’s an excerpt from that interview:

(3:43) Eric: They [the audience] want to know a bit more about your principles for investing. Can you give us a few good examples?

Dalio: Okay, an example would be, what I call the Holy Grail. If you get this, you will get all the riches in the universe. You’ll make a lot of money. That is, if you have fifteen or more good, uncorrelated return streams. That the math of that is such that if you go from one to two uncorrelated return streams. That you will reduce your risk by about eighty percent at about fifteen.  And there’s a certain math to it. There’s a certain structure to it.

If I was to show you a chart, I could describe mathematically. So for example, if I had return streams that were sixty percent correlated, and I had a thousand of them, I would only reduce the risk by about fifteen percent. And after five or six, it’s limited.

So there’s a certain notion when approaching investing. What do I want? I need to have a certain structure. That can come in the form of alphas and betas. What is my risk neutral position? I’ll say everybody in the room, they say what should I invest in? They don’t start off, I think, with what is a neutral position. What represents a good neutral position, balance.

For example, does gold represent a part of my portfolio? What should, if I had no view, what should the concentration in dollars be? What is a structural beta portfolio? And then how do I take a deviation from that beta portfolio, which is the alpha, in order to add value. How do I do that in an uncorrelated way, so that I can then maximize my return to risk?

So in that first principle, what I’m saying is that if you follow that first principle and you get fifteen good, don’t have to be great, uncorrelated return streams, you’ll improve your return to your risk by a factor of five. That means five times the return for the same amount of risk. That’s just a principle, that’s a reality. Everybody would agree on the math of it. And then that will determine an action. So what am I going to do when I’m structuring my portfolio? That will influence the way I structure my portfolio to get what I want.

Eric: People say correlation among different asset classes is increasing, making the job of being a macro hedge fund manager harder. Is that true?

Dalio: No! I think that there is an intrinsic characteristic that determines the returns of asset classes. A very simple example would be if you knew that inflation was to come down by a certain amount, you multiply that times the duration of the bonds, and all things being equal it will carry over to the bond return. There is a certain structure that exists in asset classes.

There is no such thing as an intrinsic classic correlation. So the relationship between bonds and stocks for example, can either be positively correlated or negatively correlated, and both of them make sense if you know what determines the pricing of that asset class.

Bonds are always logical in that way. Stocks are always logical. But if you come into a time, for example, when economic uncertainty and volatility is greater, then they will be negatively correlated. If you are in a period of time where inflation uncertainty and volatility is greater, they will be positively correlated.

Both of those things are logical if you know how they behave. Therefore it’s that understanding, not a fixed notion that there should be a correlation. That fixed notion of a correlation doesn’t exist. There’s no such thing as correlation, there’s only the logical behavior of each of those two markets that then will determine its relationship.

When I say uncorrelated asset classes, what I’m really doing is not using the classic measure of correlation, like stocks and bonds are forty percent correlated. What I am instead really referring to is, do you know how they behave, and is it going to intrinsically behave alike or differently.

ES: Many other, call them macro-managers, very few have had great runs of consistent big returns. George Soros, Bruce Kovner, just stepping down as of this week. Is what they do comparable to what you do? Some of what you just described?

Dalio: I don’t know enough about exactly what they do to comment on that. I can better answer your question if it is directed more toward what I do. I would describe some things that I do that I think might be different. I think that every transaction, every price of anything, is a function of a transaction. There’s a transaction that takes place. And that transaction is an exchange between buyers and sellers. And what happens is that a buyer gives money and a seller gives the thing. The thing being a stock or a widget.

The price of that will be a function of the total amount of the buyers spending divided by the quantity of things exchanged. And if I can go down and understand the behavior of those, then it’s all logical and it makes sense for me.

You can watch the entire interview here:

Mohnish Pabrai – “Stop Losses Make No Sense” – Here’s Why

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Mohnish Pabrai recently did a great interview with BloombergQuint, the Indian financial news organisation. While Pabrai has said many times that he’s not a fan of stop-losses, in this interview he provides a great example of how stop-losses can seriously hurt your performance.

Here’s an excerpt from the interview:

Pabrai: So just to clarify, we’re not talking about the speculators and traders. More power to them!

But when we come to investors I actually find plenty of pundits on TV who have done fundamental analysis and they give targets and they give stop-losses. I find that really peculiar. One of the reasons why we can make a lot of money in equity markets is because their auction driven, and auction driven markets are very different from almost any other kind of market.

So to give you an illustration. Let’s say I bought a flat in Mumbai for one crore (US $155,000). I don’t know if we can get one for one crore or not but let’s play along. We got one, maybe in the periphery of Mumbai.

Okay so we paid a crore (US $155,000) for the flat and we did research and we found that it’s the right price and we bought it. Now we want to know how the price of that flat changes every day.

So I have a friend who’s a real estate broker and I tell my friend the real estate broker, listen we’re going to have chai with Pabrai every day, you and I are going to have a cup of tea. Every day just come and tell me what the market price of my flat is okay.

So you bought the flat. Next day you invite your broker friend. I ask him, what’s the price of the flat? He’d say, “listen idiot it’s still one crore (US $155,000)”.

Okay, I call him after two days, he still says one crore (US $155,000), and after maybe two months he says, “You know the little change in transactions it’s 1.005 crores (US $157,000). It’s gone up a little bit.

And if you did this every day and you just wrote down the price he was giving you. Did it for 365 days, you would at the extreme end find that it went to somewhere between 95 lakhs (US $148,000) and maybe 1.1 crores (US $172,000) or 1.15 crores (US $180,000), in that range.

Now, let’s say my flat is a listed company on the Bombay Stock Exchange. But the only asset is this flat, and every day the price is doing whatever it’s doing in the market, and we chart that daily price movement.

What we’re gonna find is in a 52 week period the range maybe something between 70 lakhs (US $108,000) and 1.3 crores (US $203,000), and the reason is that auction driven markets undershoot and overshoot, and it is the under shooting and over shooting that creates the opportunity for people like me.

So basically the idea of a stop-loss would be, I bought the flat for a crore (US $155,000) and after six months my broker tells me, “You know prices have dropped about five percent”. I say to him okay that’s my stop-loss and I’m now going to sell you my flat for ninety five lakhs (US $148,000). Please sell it. It would be the equivalent of doing that.

The reason you bought the flat for one crore (US $155,000) was because you thought that it was fairly priced. The second reason you bought it is because you wanted to hold it as a long-term asset. So the same thing with stocks.

If you bought a stock for two hundred rupees (US $3.13) or it has a market cap of 1000 crores (US $156 Million), you bought it because you thought it’s worth two thousand crores (US $312 Million). So if it goes from one thousand crores (US $156 Million) to nine hundred crores (US $141 Million) you will sell it with stop-losses. It makes no sense.

So I own a company called Rain Industries. I bought that stock about two and a half years ago. And when I was buying the stock it was at about thirty rupees (US $0.47) a share. By the time I finished buying it got up to forty five rupees (US $0.70) a share. Went up almost fifty percent because I almost bought ten percent of the business.

After I finished buying it proceeded to go down. Just like everything I buy. The stock knows that I bought it and it decides Mohnish is done now let’s go down.

If I had engaged in stop-losses, Rain went down to forty (US $0.63), even went down to thirty five (US $0.55) after I finished buying, and I did nothing. So now Rain is north off, I don’t know, three hundred and sixty rupees (US $5.64). So that whole opportunity would have been gone. It would have been no sense for me to put a stop-loss at thirty or thirty-five or forty because I thought it was worth a lot more.

I think investors ought to focus on making sure that the stock is within their circle of  competence. That it’s worth a lot more than its valued at and, once you have those two things a stop-loss makes no sense.

*Special thanks to Sumanth Culli, one of our readers, who helped me with some tricky crore, lakh, and rupee conversions.

You can watch the entire interview here.