The Value View. Stocks, Gold and Dart Throwing Monkeys

​The market continues to gyrate along and is now trading at record highs. Before we get too terribly excited about that factoid it is important to keep in mind most of the heavy lifting was done in 2013. The S&P 500 is up less than 5% in 2014 and in spite of all the noise about new highs and market melt ups there is not a long going on in stocks right now. The real issue among the people I have spoken with lately is the confusion between stocks, bonds and gold. Stocks are moving up as if the economy is improving while binds and gold are predicting the economic collapse of Western Civilization.
I am not smart enough to know which way this all plays out but in my lifetime bonds have been the smarter market. The GDP numbers this morning would seem to give bonds the valedictorian status once again but it is pretty much beyond unpredictable we shall have to see how this plays out. The GDP report is concerning but it has never been a predictive indicator of stock prices. The specter of lower rates could keep money flowing into stock prices all summer long as some of pundits are anticipating.

There was interesting exchange this morning between Stephen Dubner and Steven Levitt of Freakanomics and the CNBC anchors. The pair told the network that most investors would be better off throwing a dart instead of relying on a portfolio manager. Dubner said “We talk about the ability of experts to predict the future, whether the future is geopolitical or financial. And if you look at, let’s say, stock picking advice specifically, you find that the experts, the people that we must revere, the people that we pay the most, are generally about as good as a monkey with a dart board. So if you’re a buyer you have to consider what their incentives are, what their research says and how counter intuitive you can afford to be.”

Levitt went on to add “There’s somebody on the other side of that trade who is just as confident, just as optimistic…one of you is right and one of you is wrong. It’s part of what markets are so great. You have all of these incredibly smart people and that’s why markets are so efficient. Because on every side of the transaction you’ve got these good people doing it.”

While most will take this as an argument for indexing I would suggest that this thought process is exactly why value investing works as well as it does. Consider the fact that with short term trading dominating the market and even the alleged long term investors like mutual funds turning portfolios over by more than 80% a year you have a lot of smart guys buying and selling to each other in a compressed time frame. Most of them are also trading the same 1000 or so stocks as the first job of a portfolio manager is too not get fired and no one ever got fired for buying IBM. The short term guys need the liquidity of the large cap stocks and indexes. They tend to move in herds as well and buy the same stuff at the same time. If you randomly flip through 13f filings each quarter as I do you will quickly discover that the vast majority of the portfolios look a lot alike.

These attributes create tremendous opportunities for individual investors. As the big and fast money dumps a sector because of poor short term prospects huge opportunities are created for those who have longer time frames and an affinity for safe and cheap stocks regardless of near term prospects. Consider gold and silver miners right now. The near term outlook for these stocks is pretty poor as the metals markets have been terrible. Now many of these stocks trade for far less than their tangible book values and they have decent balance sheets. If you are willing to step in here and buy these businesses with an eye on the next five to seven years there is a tremendous amount of money to be made. If they just drift back to their asset value you can double your money. If the metals markets get hot again, a reasonable assumption over the next five years, the returns can be many multiples of the current prices. The same situation exists in companies in industries like natural gas and offshore drilling right now as well. Those focused on the quarterly performance derby are selling them and now you have these incredibly attractive long term assets priced at huge discounts. By extending your time frame and focusing on the margin of safety you can exploit the movements of all these smart professional stock pickers for your long term profits.

You can also use their size restrictions to make money for yourself. Consider the small bank stocks. There are no high frequency traders or swing traders trying to trade these little $30, $40 or $50 million market cap banks. In spite of the very favorable economic and demographic reasons these stocks should move a lot higher over the next decade your order won’t run into competition or Goldman Sachs or Fidelity. No one is mentioning them on TV driving the price up. You can buy a nice collection of them trading under book value and reap the benefits of the changing banking industry.

These size restrictions are also the reason that things like net-net stocks work so well. There is not much competition to buy these little out of favor stocks so you have time to get in and hold them until conditions improve and the stock price moves higher on its own merits.

The vast majority of Wall Street is trading the same stuff at the same time and they have a relatively short time frame. By extending your time frame and adopting that 5 to 7 year private equity mindset and buying what Wall Street is either selling or avoiding your chances of making money in the markets go a lot higher.

The unofficial start of summer has come and gone and we are moving into the best of the year. My orioles are fighting in the AL East with a powerful offense and a horrid bullpen leading to some inventive new language explosions around Chez Melvin. The new release list for publishers so far in May has been semi-spectacular and the hits keep coming in June. I am about halfway through Tiger, Meet My Sister And Other Things I Probably Shouldn’t Have Said by Rick Reilly and if you are sports fan at all you should like this book. Jeff Shaara’s has a new book out next week , The Smoke at Dawn. On the same day Stephen King and Alan Furst have new titles appearing. Fans of Lee Childs Jack Reacher series will be glad to know he has a new one out in June as well.

I have no idea what the market will do over the summer or even beyond. I do know that buying cheap stocks that have a margin of safety should continue to work as well in the future as it has for the past 100 years or so. Smart and patient works as well in the market as well as it does in other areas of life.
Song of the week:

Income and the Trade of the Decade

​One of the biggest problems facing investors yet again this year will be the search for income producing investments.

The last few years of a zero interest rate policy render the best income opportunities in real estate, business development companies, and preferred stocks.

The Tim Melvin Income Value Letter portfolio buys companies that are capable of providing rapid dividend growth over the next three to five years. The goal is to keep your income stream growing.

At my core, I am a deep value investor. So I never lose sight of our main mission of buying cheap stocks.

We use a wider range of valuation techniques in the income portfolio and use EV/EBITDA along with price to book value to uncover stocks that are cheap and have the potential to provide very high, or very fast growing dividend yields.

It is a fully invested portfolio, divided into 25 or so positions of about 4% each. Adherents to my strategy stay small and move slowly when putting together an income portfolio, buying dips and down days, scaling into stocks and making the market work for them – not against them.

Note that there is some cross ownership between the two portfolios, so make sure not to duplicate holdings and overexpose yourself to any one stock.

Think of the income portfolio like you would a long term income security. Don’t worry too much about the day-to-day fluctuations – the portfolio generates long-term income and holds stocks for a long time.

If any changes need to be made I will get that information to you right away.

As a subscriber, you’ll enjoy:

Instant alerts to all of the portfolio’s trades
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What you get with The Tim Melvin Value Income Letter

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Receive access to Tim Melvin’s latest blog posts as well as an archive of his past entries. These blogs will help you keep up with insights on past trades, thought on current market conditions, and will update you on Tim Melvin’s upcoming events and appearances.

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Right now the portfolio has an average price to book value of just 1.05 and a yield of 7.3%​. Thats a lot higher than most income alternatives right now and this income stream should grow over the years ahead because of our focus on including dividend growth stocks in the portfolio.

If you are an investor in search of income signing up for this service could be the best money you ever spend and this week you can spend less to become a member. Normally I sell the Income Letter for $199 a year but to kick off Summer I am making it available for just $149. To make it an irresistible offer I will throw in a copy of my Ten Tiny Banks For Huge Profits E-book that outlines why I think small bank stocks are the “Trade of the Decade” and gives you ten stock picks to benefit from this powerful trend. That usually sells for $99 and it is yours free when you become a member of the Value Income Letter.

If you need to produce more cash flow from your portfolio I hope you will become a part of our growing value investing community by taking advantage of this special offer.

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Correlations, Pigs and Groovin

In the course of doing some research for an article today I noticed that only 25 stocks in the S&P 500 currently trade for less than their stated book value. Of those, just 12 trade for less than tangible book value. Compare this to March of 2009 when 126, or more than 20% of the index traded below book value. Opportunities are very thin on the ground right now and it is hard to put new money to work in the current market environment. You can listen to a million different pundits and end up with a million and one different opinions on future market direction but the loudest voice in the room is coming from simple math. There are not enough cheap stocks, and even fewer safe and cheap stocks, to allow for full investment at this moment. As a result we are pretty heavy in cash at the moment.

Does that mean we should run out and sell all our stocks? No. If you have stocks in your portfolio that have not yet reached fair value, hold onto them. If you find something safe and cheap buy it. There are not many cheap stocks so a new portfolio will have a lot of cash but eventually new opportunities will be created by broad market or company specific news. You must practice patience and discipline to make this deep value thing work over time. We do necessarily need a market meltdown to create inventory. A long a sideways move could create inventory as selected companies temporarily stumble as well.

Predicting what is going to happen in the stock market is pretty much a futile exercise. Even less productive is trying to predict what is going to happen is going to happen in the economy and how the market will move in response to that information. It is guessing about how the unknowable will affect the unfathomable.

Not too long ago a few of us were bored on a day when it was cold up in the northeast and we started running correlation tests on various economic indicators and stock prices. What we found was that most of the stuff the talking heads on TV talk about all day have very little real life correlation with the direction of the stock market. The discussion of GDP, unemployment claims, PPI and CPI reports do not have much direct influence on the direction of direction. They may have some indirect impact as the one data set that highly correlated with stock prices is interest rates. However we were not really able to put together any sort of time lag between economic data releases, bond market moves and eventual price movement in stocks. Most of the stuff analysts and pundits spend the majority of their time yacking about on the TV has very little to do with what will happen in the stock market.

Here is what I find really interesting about that information. We know that the Fed has kept short rates low and intends to for some time. The long end of the market has been strong of late as bond market traders are skeptical of the strength of the economy. Should we get the type of economic growth the stock bulls are looking for, then long term interest rates will go up and that’s not great for stocks. However if rates are going up it is because conditions are improving and that will mean earnings and revenues are growing and that should be good for stocks. Now flip that around and you can also make a really good argument for a weak economy being either good or bad for stocks depending which side of the fence you want to sit yourself.

And you want to bet real money on one specific scenario? I will pass and wait to react to what the market actually does as the rest of the year unfolds. If there is new inventory created I am a buyer. If not I will sit here with my cash and sell any stocks that reach fair value. React , Don’t predict. If I wasn’t t needle phobic I might have that tattooed somewhere.

Occasionally I am asked if I feel stupid or get concerned by holding high levels of cash when stocks are going higher. The answer is unequivocally no. I kind of did back in the late 1990s which was the first time I ran across the nothing to buy phenomenon as the internet boom was still booming. Since then it has happened a few time, notably late 2006, and I felt a lot more confident that something would come along and cause an inventory creation event. I may underperform for but I would also side step something rotten. I might not be able to say in advance what would cause it exactly or when it would happen but unless everything is changed forever and really and truly different this time something will cause new safe and cheap stocks to pop up and I will get busy buying.

By the way I will be called all sorts of names and have my sanity questioned when I start aggressively buying while prices are collapsing as well. Like out old pig farmer friend Mr. Womack I will laugh all the way to the bank over time. Buy low, sell high works amazingly well but very few have the discipline to actually do so.
Song of the week :
Holding cash and

The Value View 5-15-2014. Expensive markets,cheap banks and a good deal.

​The markets have been spooked today by David Tepper’s comments at the SALT Conference this week. Mr. Tepper has been one of the biggest bulls over the past few years so his comments that he is nervous sent investors running for the hills. The rise in bond yields that is seemingly forecasting a weaker economy ahead is not helping investors gain any confidence either and stock traders gave into the dark side and did some serious selling today. We will set aside the question for now if any one person should be able to scare the market to this level. For today the bears were firmly in control and the talking heads are on the verge of ecstasy dissecting Mr. Tepper’s comments.
He is just the latest in a long list of people who have warned us of a potentially over valued markets. Sam Zell, Leon Black, Seth Klarman and others have sounded the alarm over the past year.

I myself have humbly pointed out that using measures like The Value Line Median Appreciation Potential, Tobins Q Ratio and Market cap to GDP US stocks seem to be on the high side of fairly valued. The biggest indication that we may be a tad frothy is that there simply are not a lot of cheap stocks around right now. Every time this has happened in the almost 30 years of my career we saw a pullback that served as an inventory creation event. I see no reason this time will be any different and am pretty pleased with the ultra-cheap stocks and high cash levels we hold in the portfolios right now.

Having said that, I am a lousy timer and have no idea exactly when the market might make sustained downturn. I had lunch with a good friend today and as we watched some day baseball and caught up the talk naturally turned to the stock market. I suggested, as I always do, that one needed to pay as little attention to what the broad market is doing and look for those stocks that are cheap and have the potential to be many multiples of the current stock price in a few years. There is not a lot of that around but those that do make the grade seem to be clustered in mining, energy and the small banks.

I suggested to my friend that one of the best places to be right now was the micro and nano cap banks. These little banks are not impacted too much by the day to day movements of the stock market. In fact I like to call them bunny rabbit stocks. They tend to trade sideways for long periods of time and then eventually leap in one direction or another based on significant news. In 2009 they jumped down as loan losses grew and earnings evaporated. The next leap will be forward in my opinion.

The really small banks will have a tough time dealing with the costs of compliance going forward. The rules and regulations have come down from on high at a steady clip the past few years and that will not change. You are going to have a willing pool of sellers as these banks realize that the cost of independence is just too high.

You will also have a willing pool of buyers as the larger community banks and smaller regionals realize that there is no organic growth to be had in the banking sector right now. We are still over banked in terms of bank branches around the country. To get their stock price higher and make shareholders happy they will have to grow their earnings. To grow their earnings they will have to buy smaller banks and expand their footprint and market share. This will be a long term trend that pays out over the next decade and a lot of money will be made by investors who get in while these stocks are cheap in my opinion.

I wrote an E-book not long ago that is called Ten Tiny Banks For Huge Profits. This outlines ten very small little banks of less than $25 million of market cap. I didn’t include them in my Banking on Profits newsletter as I could not guarantee everyone could buy shares as they are very thinly traded. I did suggest that my members buy them as they should sell for many times the current price ten years from now. Most of them will have changed names several times as they get rolled up during the takeover wave I see developing

Here how that works. The $300 million bank buys a few of these little $20 million banks to grow their branch network. A year or two later a $1 billion bank buys the $300 million bank to grow earnings. Eventually a $5 billion bank will buy the $1 billion bank to increase their market shares and finally a $10 billion bank will be looking for an acquisition to take them to the next level and they buy the $5 billion bank. Each deal is done at a premium to book value and the interim the book value is growing as the economy and banking industry conditions improve. That’s the perfect storm trade and many of these tiny banks are going to experience something very similar to this.

We gave this book to members and sold it to the public for $99. Last night at the Festival of Traders presentation I offered it for just $29 and I am going to throw that open to everyone this week. I think that those of you have the patience and discipline to invest in these little banks will see the book pay for itself many thousand times over. These banks are in sound financial shape and trade at an average price to book value ratio of less than 70%. Click here to buy your copy:

I have no idea what the markets will do tomorrow, next week or next month.I do know that little banks are way too cheap and should sell for many times the current quote in the next decade and investors can make potentially life changing profits from them.


Song of the week.
Where little banks are going to go over the next 10 years

The Value View. 5-8-2014

I got a great email from a subscriber today asking if he should position or protect himself against deflation. He pointed out that Prem Watsa of Fairfax was clearly positioned for such an event and even Buffett seems to own a lot of bonds right now in the total Berkshire (BRK) Portfolio. It is an interesting proposition but then I consider that economists have been making predictions about what the economy was going to do for as long as I recall with a shocking lack of success. For every investor who is worried about deflation I can point to other smart guys who are worried about inflation. The folks at Leucadia (LUK) for example have a great track record own a lot of assets that will do well with high inflation like beef and timber and have been buying oil and gas assets. At the end of the day , although debating the economy’s direction and the relative level of sanity involved in US economic policy can be great fun, it is best to stick to just buying cheap stock.

I get asked about hedging quite a bit as well. I have at various points in my career attempted to hedge portfolios as we got near the point where markets were on the high side of fairly valued as they are now. Sometimes it worked, often it didn’t and I never felt like it added a whole lot of value to the overall process. Again I am better off sticking with the whole idea of buying cheap stocks. I find that if I buy a 1-2% position at around 80% of book; add if the stock trades below liquidation value and sell when a stock reaches intrinsic value I create a sort of natural hedging process. I will own a tremendous amount of cheap stocks at market bottoms and be underinvested near tops. I find that this approach underperforms at the turns and kicks the markets butt worse than Larry Holmes beat Tex Cobb in the middle.

The difficult times are those like we are in now. The market is at relatively high levels and there are not a lot of cheap stocks around. Everybody has an idea or 12 to talk about and there a lot of stocks that even if they do not trade at absolute value levels look pretty interesting. If you have been around as a value guy for a while you are probably 50-60 invested but a new money portfolio like the Deep Value or International Deep Value Letter that started in the last year or two you have 50 to 70% cash and are underperforming a bit. Hell, even Seth Klarman underperformed by about 50% last year. Value lags at tops and tops usually take longer to form than we were hoping to see.

I find that although lots of people talk about long term investing and the idea of buying low and selling high there are very few Mr. Womack’s out there. It turns out that the hardest thing to do is to wait for stocks to collapse and rush into buy. The waiting as all the news, ideas, tips suggestions and sales pitches roar by us is almost overwhelming at times. Holding large amounts of cash for months at a time when rates are low can be infuriating as well. However it is the right thing to do.

The second hardest thing will be after a big correction and you buy stocks that keep going down for a period of time before the market eventually bottoms. It takes some fortitude to pull the trigger when everyone from your broker to your spouse is panicking and selling stocks. You will be judged insane and foolhardy while buying stocks at 80% of book value that have dropped 50% or more in value. You may question your own sanity when they all drop another 10 to 20% before reversing course. But if you have the valuation right and have established that areal margin of safety exists you will eventually be rewarded.

We live in a world that focuses on quarter by quarter results when the real money is made in three, five years and longer. The constant demand for bigger better faster now in the stock market is designed to get your cash into the hands of Wall Street. They have some big building to pay for and the light bills alone on those things are atrocious. When your buy a small bank stock at 80% of book and hold it for several years and eventually sell at close to 2 times book in a takeover no one is making money but you and that does not feed the machine. Buying a silver miner and holding until the next time the precious metals markets heat up whenever that may be is not generating any cash to pay for all those slick adds with babies and bulls that brokers like to run all the time. Long term is not Friday at 4 folks. It is May 8, 2019 or even longer that matters when you are buying cheap stocks. The proper time frame is as long as it takes.

When you get agitated and all the noise and swirling about of stocks makes you crazy step back and concentrate on the important stuff. Focus on valuation and always look for a margin of safety. If you do that you should be just fine if you just add time to your investment recipe.

Now, the Orioles are in contention in the AL East. Ace Atkins has a new book out in the continuation of the great Robert Parkers Spenser series, John Sandiford and John Lescroart have new ones out this week as well and Jeff Shaara has one out in a few weeks. In fact no matter what your taste in books is the big publishers are releasing their summer titles right now and for a book person it is almost like Christmas. We will eventually get an opportunity to get more money to work and the cheap stocks we do own have the potential for enormous long term returns.

I have no idea what the future holds or what markets and the economy will do in the near term I do know a simple mantra will always help me make money in the stock market.

We buy cheap stocks.



Song of the week. When the market noise makes you crazy say margin of safety three times quickly , grab a good book and listen to this repeatedly.

Value View 5-1-2014. Cash, Oil and Dirt

I talk a lot about adopting the private equity mindset. Buying assets on the cheap and holding them for 5 to 7 years is a much more effective strategy than attempting to trade short term moves and pitting yourself against math geniuses with massive computing power on a daily basis. It is virtually impossible for you to spend a few minutes of even hours a day and beat the guy with a supercomputer who is working twelve hours a day and sits up all night reviewing stats and charts. Your efforts to be a superstar trader are how he pays for his big house and kids Ivy League education. You can however track what the really smart patient money is doing and get your money in alongside them.
Tracking what the private equity folks are doing with their money can be incredibly productive and profitable. When you see the long term equity and distressed types moving into a sector or asset class the bottom is usually in sight and it’s a good time to start looking for stocks and bonds in the space for your long term portfolio. I have gotten into the habit over the last few years of spending several hours a week looking into the activities of private equity funds to spot trends and ideas. It has, to put it mildly, been a pretty productive use of my time.

When I look at what’s going on in private equity right now the most obvious trend is that they are aggressively selling assets they picked up on the cheap a few years ago. Leon Black of Apollo Global Management said at last year’s Milken Conference that he was selling everything that wasn’t nailed down. This week he spoke at the 2014 Conference and confirmed that it is still very much a sellers’ market. He said that every purchase he’s made thus far in 2014, there have been four or five deals involving the selling of assets. He has only made about 3 purchases this year as he just cannot fund bargain assets.

Jonathan Nelson CEO of Providence Equity Partners pointed out that the while the industry has a lot of cash available it is staying firmly in their pocket. “We’re finding good deals to be scarce. Most of us want to be very careful with the capital we have and not repeat mistakes made on the eve of the last crisis.”

There are some areas where private equity is putting some cash to work. One is North American energy as shale oil has changed the game. One consequence of this is that the companies that produce a lot gas are cheap. This is a long cycle play as it will take some time for natural gas prices to rise but eventually we will use more of the stuff and develop more of an export market and these stocks will trade several times the current price. Odds are that some of the names will be very bumpy (one of out energy stocks is down 10% today on weak earnings) but at some point in the next 5 to 7 years I expect to sell them for many times what I paid for them.

We have also seen some private equity money ease into the mining space. Just this month we saw a $1 billion fund raised to invest in precious metal miners. Large firms like KKR, Apollo Global Management, and Carlyle Group have made moves in the sector in the recent past. Warburg Pincus hired mining experts and executives to start a new fund focused on the industry. Pretty much everything that comes out of the ground, and the companies that do the digging, are very cheap right now. Again there will be lots of bounces and bumps along the way but at some point we will get a stronger economy and the companies that mine industrial and precious metals will see their stocks trade much higher than today’s depressed prices.

We are also seeing private equity firms move back into Brazil recently. Mr. Nelson said his funds have been very active in Brazil recently. Carlyle Group is focusing its emerging market efforts in the country. Brazil has been a train wreck the past few years and assets are very cheap right now. It will be a long grinding process but there is a lot of money to be made buying shares of undervalued companies and holding them unit Brazil booms again in the future.

It makes a lot of sense for investors to emulate private equity funds. Find cheap assets and hang onto them until they are not cheap anymore. That approach is why PE is consistently one of the highest performing asset classes and more folks should approach markets in this manner. It should also be very profitable to watch where this pile of smart, patient money is investing and follow them. Right now the recipe seems to be lots of cash and digging stuff out of the ground.