Old School Value Nugget Fest (Jan 16th Edition)
This was originally published on 1/16/19 to our OSV VIP email newsletter subscribers. Sign up now to get these right away!
Here’s our latest post, in case you missed it:
Margin of Safety Saves the Day in a DCF Valuation of Harley-Davidson – Old School Value blog
This is a dive into a DCF I built in 2006 when deciding whether to buy Harley-Davidson (HOG today, then HDI). Comparing the projected cash flows with what actually happened is quite a lesson in humility, but also a reminder of why having a Margin of Safety is so critical.
ESG Investing: Too Good to be True? – Factor Research
Honestly, I think this article misses the point of why one might be an environment/social/governance investor. A company’s commitment to any or all of these ideals speaks significantly to its long-term sustainability as a company. This is what you want to be assured of as a long-term investor, and is absolutely something you should be factoring into your value research.
Not only do good ratings suggest that negative corporate, legal, and regulatory actions are less likely to occur, but these values can also be the source of real moats when fully embraced.
Reminders On Why You’re a Value and/or Dividend Investor
What Happens When Valuations Decline – Euclidean Technologies 4Q18 Investor Letter
I really like Euclidean’s investor letters because they are so data-driven. Here’s another, reprising an analysis from a few years ago.
During optimistic times, you may have done well by being insensitive to price, and investing in the best companies (the 100% weighted ROIC portfolio [of the top 50 stocks ordered by ROIC]) while ignoring the value opportunities.
On the other hand, investors sometimes are less willing to pay premium valuations. When this occurs and overall market valuations come down, it appears that index investors would have generally realized poor returns. During these pessimistic periods, however, we believe a good place to hide has been with the overwhelming advantage offered by the least expensive companies (e.g., the 100% weighted EY portfolio [of the top 50 stocks ordered by earnings yield]).
Perhaps as we end 2018, after years of increasing valuations and growth stock outperformance, we are moving from an exuberant period to a more pessimistic one.
Although growth has outperformed value of late, we should expect mean reversion. Mean reversion has value outperforming growth, on average, and we can likely expect that change soon as things go from rosy to less so.
Low P/E will work (i.e. will lead to successful Value investing) when many low-P/E stocks incorrectly assess Quality and/or Growth, when the the market comes to realize that Growth and/or Quality are better than previously assumed. The Value factor works when Mr. Market is too pessimistic.
Also, high P/E will falter (i.e. lead to unsuccessful value investing) when investors come to realize that the Growth and/or Quality considerations that motivated high P/Es were too optimistic and that expectations need to come down So the Value Factor also works when Mr. Market is too optimistic.
Putting all this together the Value factor works when Mr. Market’s assessment of company turns out wrong and needs to be adjusted.
Dividend Investing Is Bizarre – Fat Tailed & Happy
This is one I strongly disagree with, and I’ll likely write a full blog post on why. Most of my readers will probably disagree, too, so I put this in the “reminders” section because I think as you answer the guy’s questions, you’ll feel better about why you like dividends.
The author’s argument basically boils down to: dividend stocks are partly like stocks and partly like bonds, so why don’t you just buy those individually? Here are some of my answers, real quick:
- Dividends are always a positive contribution to total returns.
- Dividend growers (my preferred style) outperform over time.
- Even just looking at the 2008 downturn, and using Vanguard’s Dividend Appreciation Index (VIG), dividend growers went down less than the S&P 500 and stayed ahead for years.
- Over longer periods, dividend growers outperform non-dividend payers and dividend-maintainers in terms of total return (and absolutely crush dividend cutters).
- They’re “all weather.” A 60/40 portfolio (or 70/30, or even 80/20) of stocks vs. bonds would’ve massively underperformed the S&P500 in the last 10 years because yields were so low. Dividend growth has had nearly identical returns.
- Tax treatment is better than bonds, but yes, worse than pure capital gains.
- I also believe a secular shift into dividend stocks is likely to occur as the Boomers retire and shift into income generation. With bond yields so low, there’s no other way to get income while preserving principal. Increased demand should increase prices.
There a probably a lot more reasons to like dividend stocks. Reply to this and send me yours, and I’ll include them in a longer blog post.
A review of chapter 4 of Sven Carlin’s book, “Modern Value Investing: 25 Tools to Invest With a Margin of Safety in Today’s Financial Environment.” Some good reminders in here, like:
- Sell when a stock is no longer a good value, but factor taxes into your calculations
- The market constantly misprices stocks, so take advantage
- Have a long-term perspective. Recessions are blips when you take the long view of economic growth.
- When valuing companies, look for real internal growth, not just improvements due to buybacks or dividend increases.
- Fees eat your returns if you’re not careful.
We’ve seen a lot of guidance cuts and downward revisions to analyst estimates so far this year. (See also: “We’re finding out now why the stock market tanked in December” – CNBC.)
I don’t care about the details, what I do want to point out is how lots of people were talking about how forward estimates of whatever value metric to whatever price metric you want to talk about looked so great in Q4. Now, estimates are coming down, so having used a forward estimate, your thesis might look pretty bad right now. (To be clear, though: value still abounds if you’re analyzing it correctly.)
It’s because just like you, analysts have no clue what’s going to happen. They are really not much better at analyzing a company’s future than you. Their top incentive is not accuracy, either, so maybe they are in fact worse than you.
My point is that you have to understand a company before you buy it. Don’t just take some analyst’s number at face value.
Also, take the long view. For example: Apple is pretty beat up right now. This was not a great release cycle for them, but the ‘S’ cycle rarely is. Will they ever have another release? Are they too dumb to figure out services? Plus, China’s economy is slowing, which is a huge problem for Apple. But is China going away? Will we still be in a trade war in 6-12 months? Or is this going to be a blip in terms of China’s long-term economic growth?
I want to set aside some time to really think about Apple, because this might be a great time to buy. My general point is that you should not get caught up in the buzz of the moment, and you should think for yourself.
In December, you should have been thinking, “forward earnings estimates show a lot of growth, but do I believe that?” Now, you should be asking “how much do these estimate cuts matter if I’m in it for the long haul?”
I like this outlook because, although it has tons of charts that make it a bit overwhelming, it does a very good job connecting them with a compelling, data-driven narrative.
[W]e want to use periodic dislocations like we saw in the fourth quarter of 2018 to overweight areas that fully seem to be pricing in a recession, or some type of sustained downturn, i.e., a 2008-type event (that we do not, however, think is likely to occur)…
…If we are wrong and market conditions do sour notably from here, it will be because money supply growth remains negative and corporate margins fall faster than expected. This is not our base case, but it is one we are watching closely. Alongside these headwinds, Credit too could turn downward more than we have modeled.
Overall, though, our base case is that there is now a fair amount of valuation “cushion” built into the prices across the global capital markets, Public Equities in particular, at current levels. Hence, our bottom-line for 2019: Thoughtful asset allocation preferences, coupled with several key top-down investment themes, can drive above average returns from current levels.
This one looks worthy of further exploration. A cursory DCF in our tools looked pretty positive.
- Better Value Than U.S. Stocks: Asian Shares Hit Fire-Sale Valuations – WSJ
- PayPal Quietly Took Over the Checkout Button – Bloomberg
- Great Food Options Can’t Save The Mall From Extinction (UK focused) – Bloomberg
- Foreword to the Chinese Edition of Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger (By Li Lu) (PDF)
- Stanley Druckenmiller on Liquidity, Macro, & Margins (1988) – highlights from the article we sent last week if you wanted it boiled down even more for ya
Thanks for reading!