Value Traps & Value Investing: Readers’ Links, Comments And Questions by CSInvesting

Value Traps

A Reader’s Article on Value Traps

I found a very interesting piece of writing about Value Traps and Value investing

http://www.wyliemallory.com/blog/how-does-one-avoid-blowups-in-deep-value-investing/

I must say lot of valuable advice from a seasoned investor.

I read the linked article, but I wonder if the folks here took away the key lesson(s)

OK, why was this investment a “Value Trap?” What can we learn from this example or ignore in this article? Are you investing when buying this bank? What makes a bank very different from investing in a widget factory? The article goes on to say you should wait for a catalyst. Is there a flaw to that argument? What about checklists? Can checklists save you from faulty thinking?

A Frustrated Reader:

Moreover, I wonder if it would be possible to have an index or anything like that in order to program and coordinate all classes and materials.

I teach under the chaos-and-mayhem method to force you to choose what is important to you. In a more serious light, we are going chapter-by-chapter in DEEP VALUE and it is supplement by Quantitative Value and other readings.

Next, use the search box in the upper right corner of this blog to type in: Lesson 1 Deep Value. Then scroll to the links and begin there. The blog supplements the readings. You should have already received a link to the book folder. Much of the materials are supplementary. For example, we read in Chapter 3 in Deep Value about Buffett’s career, so various case studies were linked in the various posts that correspond to the chapter like See’s Candies or Dempster Mills. Also, the Essays of Warren Buffett were sent out, but that is up to you if you want to read further (I highly recommend that you do and reread every year).

A Reader provides links:

Was on reddit’s Security Analysis sub (www.reddit.com/r/securityanalysis) and stumbled upon these notes from some other readers, good supplementary reading:

II Notes: https://docs.google.com/document/d/106U79BVHzzeCiO5SjWD1eCz4Lp6nm3VJ0rYThUk1Shg/edit

Buffett Notes: https://drive.google.com/file/d/0B8B1Rxv9hy1oOGM4eFZfcjF2eVk/view

For reference, if you don’t have the Buffett Annual Letters: http://www.rbcpa.com/WEB_letters/WEB_Letters_pre_berkshire.html

A Reader with Good Questions

John,

While I agree completely with your analysis, I think its worth noting additionally that:

  1. Quant Value proponents (e.g. Graham, Greenblatt & Carlisle) are not arguing that any given filter (EV to EBIDTA for instance) accurately measures the intrinsic value of a given company. Agreed
  2. But rather they argue that some filters (or combinations of filters) can capture mis-pricings in a basket of stocks. Agreed
  3. And on average, over time the captured mis-pricings will deliver a return that dramatically exceeds the index and all but the most exceptional stock-pickers. Agreed. “Experts” may even degrade the results of a quant model!
  4. So while a given filter (EV to EBITDA for instance) may be just the beginning of the analysis for a stock-picker working a concentrated portfolio,
  5. that same filter alone may be enough for a Quant Value portfolio to outperform 99%+ of stock-pickers,
  6. and with far less work.

To the extent this finding is true and replicable in real time, it is a remarkable finding. What puzzles me is this:

  • Given a huge economic opportunity–some screens deliver 2X market returns in back tests
  • Given the Quant Value idea has been around for 75+ years–since Graham described the Net Net idea in Security Analysis
  • And given the vast resources dedicated to optimizing portfolios

Why are there so few examples of this simple idea being executed effectively in real time?

The best answers I’ve heard to this question (most of which were mentioned by Greenblatt in TLBTBTM) are:

  • Quant Value strategies are difficult to stick with because they will under-perform the market for years at a time
  • Much of the excess return is found in small cap stocks so it cannot be run in a large portfolio
  • The stocks selected by the Quant Value screens are “ugly” stocks which are difficult to own and defend

While all these explanations make sense, it still appears to me that the lure of 2X market returns would be enough to overcome them. So I am left with the puzzle: why is this opportunity not more widely exploited? I would be interested to hear any thoughts from the group on this…

I will post tomorrow my thoughts on your other questions.

Value Traps