The Value View is back after a short break. Last week I took the week off and for the first time in at least the last decade it was not a working vacation. I allowed myself two market checks a day to make sure nothing of a horrible or wonderful nature had occurred that needed to be dealt with and other than that ignored the overall news and market movements. The only news I followed closely all week was related to fishing reports and baseball. It was a nice change of pace from the usual working in a nice hotel room while everyone else does cool stuff vacation of the past. As I told subscribers to the newsletters when I returned it is something everyone should do once in a while. It was incredible relaxing and mind clearing. Fortunately the deep value approach to investing does not require being hunched over the screen every minute of every day.
We are now into the heart of earnings season and we are seeing the quarterly silliness dominate news and trading activity. Reports are mixed but I think we are over all seeing a slight negative bias so far. Tens, if not hundreds of billions of dollars are being bet on how close companies come to the always highly accurate analysts estimates and I suspect that the bulk of it will end it up in the hands of the few really good short term traders in the world. Most individuals will simply be making donations to the rocket scientists and supercomputing crowd that dominate the short term trading and options markets. It is a really silly way to trade in my opinion.
It is even sillier to base our capital markets on meeting a short term number. Far too many companies manage to the number and use things like layoffs and buybacks that are both financially and socially destructive to make or exceed the estimates. It is no way to run a company and I suspect that the fascination and focus on short term numbers works against the long term interests of the corporation and its shareholders and is a drag on the economy to some degree. Business, like sound investing, is a long term proposition and should be managed in that fashion, not to maximize bonuses by buying back over priced shares and firing a bunch of employees to beat the number and pump the stock price.
Earnings season does provide us a snapshot of how our portfolio companies are doing but it is just part of the long term puzzle. It is useful in spotting trends that may indicate a worsening position and reveal causes for concern and caution. Sometimes we get a wonderful surprise with better than expected conditions that leads to a sustained price increase that carries shares to full value. Most of them time for deep value investors it is just one snapshot of business condition changes within the context of a long holding period.
The real value of earnings season for long term value investors like us is that inevitably some quality company will miss the always highly accurate analyst estimates and overly panicked investors will dump the stock and the price will tumble to bargain levels. Pretty much every quarter we get a stock that tumbles and gets added to the portfolio. Last quarter it was Boardwalk Pipeline Partners and we have already seen our holdings in that wonderful collection of assets climb by 25% since investors pushed down after earnings miss and dividend cut. I haven’t found this quarter’s candidate but have little doubt there will be at least one battered bargain stock added to he portfolio before silly season is over.
As Ben Graham said in the Intelligent Investor investing works best when it is most businesslike. Betting on short term earnings performance has far more in common with the racetrack that long term investing and most folks should avoid the temptation. At least at the track you can get a tan and have a cold beer or two. It does make sense from a business point of view to take advantage of others mistakes and buy quality assets on the cheap when the opportunity presents itself. That’s where I will focus my attention and efforts as earnings season plays out.
The markets showed some signs of fear creeping in today. The markets sold off sharply with the S&P 500 dropping off by 2% and the NASDAQ dropping my more than 3%. The iShares Biotech ETF (OIBB) led the charge lower as it declined by more than 5%. The big tech and social media took a pretty good shot today as well with many of them down 5% and more during the session. The money appears to be going straight into bonds as treasury yields fell sharply. That is not what you might have expected to see when the Fed is tapering and the economic news has not been entirely horrible. The jobless claims report this morning was actually pretty strong with new claims at a multi-year low.
Naturally the pundits and gurus have been on all day predicting what is next for the stock market. Some think it is going up forever and you can throw a dart at the stock tables and make money from here. Some think it’s the beginning of the end and markets are going to make a big move down from here, particularly if prices penetrate one chart point or another. Personally I will predict that stock prices will fluctuate vigorously in one direction or another on a daily basis for an extended period of time. In other words I have no clue what stock prices will do and I do not think anyone else does either. The limited opportunity set has us holding a lot of cash so I hope this becomes an inventory creation event but I would be a fool to try to predict or bet on a continued decline in stock prices. As it stands now we are less than 5% off all-time highs and it is still time to do not very much at all. I like the stocks we have in our portfolios but I am in no rush to buy more right now.
Although Alcoa’s (AA) report on Tuesday is the traditional start of earnings season its really just the warm-up. The real season starts tomorrow when JP (JPM) and Wells Fargo (WFC) report earnings and then next week the floodgates open. Once again folks will wager billions of dollars on whether their guess about the analyst’s estimates is better or worse than the analysts have estimated (guessed). These “trades” are basically a wager on a guess about a guess and I suspect I could do better at the track than most traders will do with their earnings bets . This is particularly true of those who make bets using options during silly season. A few experienced traders armed with supercomputers will clean up the markets using rocket science and pricing power to pick the pockets of all the wannabe Soros’ who make earnings bets. A few smaller traders will get lucky and win a bet or two, thereby dramatically increasing their odds of eventual bankruptcy.
Our approach to earnings season will be one of reacting rather than predicting. Even at the racetrack I prefer to have the math in my favor and there is no mathematical formula that is going to give me insight into what earnings will be and how the markets will react to that information. What I do know about earnings season is that just about everyone for the past couple of decades has created at least one safe and cheap stock as investors over react to a short term hiccup in the quarterly results. Almost without fail some quality company will see millions or even billions of market capitalization melt away even though the value of the assets owned by the company didn’t change at all. The undying truth about Wall Street and earnings season is that the combination of human psychology, a too short time frame and leverage leads people to make really stupid decisions and we can prosper from that.
I have no idea what the market is going to do in the weeks or months ahead. I do that with a portfolio of safe and cheap stocks and a large cash stockpile we are in a great position to react to whatever does happen in the circus that is the stock market.
There will be no Value View next week. I am going to take an actual vacation. For the past ten years vacations have consisted of me working in a hotel room, albeit with a pretty nice view, while everyone else in the family ran around doing interesting things. This will be the last trip with the two oldest before my daughter gets married so I am going to try and actually take some time off. This of course practically guarantees that something big happens next week that requires my attention but barring some sort of fantastic inventory creation event, I am going to take most of the week off.
Have a great couple of weeks everyone!
Song of the Week
The Earnings Season Song
From week to week you will find that my thoughts on the opinions on the overall market do not change very much. Right now I still think we are on the high side of fair and am very well aware of comments from folks like James Montier and Seth Klarman that are far smarter than I that paint a pretty ugly picture of the market right now. However I have disciplined myself over the year to strictly follow a simple rule. I try to ignore the market for the most part and if I can find something that is safe and cheap I just buy it. I actually bought three stocks this week, all right around 75% of book value with sound balance sheets and fundamentals. They pass my tests for safe and cheap and following the “find it, buy it rule” I bought them. Two of them have sparkling dividends over 7% so they went into both Deep Value and the Income Letter portfolio. Safe and cheap trumps market opinion and noise every time.
When I buy a stock for the portfolios I generally post in the blog a description of the company along with the price to book value, the Ongoing Concern Value, Liquidation value and credit and fundamental scores. I am often asked what was the catalyst for buying the stock and what did I anticipate to happen to unlock the value? The truth is that the catalyst was the price to asset value discount being steep enough and the Credit and Fundamental score being high enough to justify purchase. There usually is no story or catalyst involved. I have no idea how long it will take to get to fair value or exactly what will drive the price higher. I just know that I found it, it as the characteristics of a winning stock based on my strict value principles. Think of it as semi-quantitative value investing.
I hear talk all the time about catalyst for unlocking value and there is a ton of fund managers who boast that they look for stocks that have a catalyst. Usually this means they have a really good story to go along with the stock. I can usually tell you a story about each of my stocks but it would be exactly that-a story about what I hope and think is going to happen. There is a story for all the shipping stocks, the energy stocks and the banks stocks that I buy and it is a real powerful one in most cases. However I cannot tell you when the story will play out or how long I think it will take to realize the full value of the stock. I bought it because it was safe and cheap not because there was a catalyst. Even with the banks, as powerful as the Trade of the Decade story is, at the end of the day I bought each individual stock based on the numbers.
There are 3 catalysts that I have found almost always deliver value in cheap stock situations. Management change, insider buying and the presence of a powerful activist have all been shown to get a stock moving in the right direction. I consider all of these when doing the drill down on stocks before putting them into the portfolio. Remember only the all too rare stocks with a C&F score of 12 or higher go into the portfolio without much question. These are the true bullet proof stocks. These ranked above the buy level of 8 but below the bulletproof 12 threshold get a through drill down. However they are just a part of the process and may take years for the so called catalyst to actually move the stock higher.
During the course of my life Ace-King offsuit, blonde hair and a good stock story have cost me enormous amounts of money. Today I am married to the most wonderful brunette in the world, only go all in with absolute best hand and prefer the numbers that identify safe and cheap stocks to any story, no matter how good it may sound. I buy safe and cheap stocks and have adopted the private equity mindset that is willing to hold the stock until I can sell for more than it is worth no matter how long that takes.
Song of the week
Stick with safe and cheap stocks and we should always be able to do this