Interview With Tim Melvin On Deep Value Investing by Lukas Neely, Endlesssrise Investor
Safe, Cheap & Skeptical
Tim Melvin is deep value investor all the way. He’s not just looking for cheap investments. He needs them to be “safe and cheap.”
Tim Melvin explains his intense focus on the balance sheet, his thesis of community banks being the “trade of the decade”, how he finds high quality community bank opportunities, and why he see upside in Sears Hometown, Home Trust Bancshares, Cape Bancorp.
Tim Melvin has been known within the deep value investing world for a long time. He’s been around the greats, such as Marty Whitman and Chris Browne. He is the author of the Junior Chamber Course On Value Investing, an investment education program geared towards young adults.
It’s his focus on community banks that has everyone’s attention right now. He calls it the “trade of the decade.”
“In the aftermath of the real estate and credit crisis many banks have seen their stock prices fall to levels not seen since the early 1900s. Small banks in particular are very cheap, “ says Melvin.
Today, in addition to community banks that are misunderstood by the market, he’s finding value in such areas as brick and mortar retail.
How did you get started in the world of investing?
I started with John Hancock Financial Services in the early 80’s, and that’s when we were all making a transition. We realized we weren’t going be life insurance agents anymore – we were going to be financial planners. I started in Baltimore, and eventually (for family reasons), moved out to a little town called Merced, California, in the San Joaquin Valley. We were selling insurance, mutual funds, and financial planning services, but across the street from us was an E.F. Hutton office. And these guys dressed better than we did, they drove nicer cars, they sure seemed to be having a lot more fun than I was.
So I dropped in and made a few trades. The most memorable was Bethlehem Steel, back in the 80s. At this time I started to get really fascinated by the stock market, so I started reading Barron’s, and the Wall Street Journal all the time, and all I wanted to be was a stockbroker. That was it. My mind was made up.
I eventually got hired with Dean Witter, and the rest was history.
I started picking people’s brains. We had a guy in the office, who was only a broker to manage his own family and friends money, because in the 80s, that would have been the most efficient to do it. Well, this guy made a lot of money. He looked like the shaggy-haired professor, he had the messy desk much like I have today, and I bugged him relentlessly to teach me, talk to me, and tell me how to do this. And he finally (I think to make me away) gave me a copy of the Intelligent Investor and Marty Whitman’s Aggressive Conservative Investor.
So that was the start. I was really sold on value investing, and have been most on my career. I’ve tried some forays into commodity trading and a few other things along the way. And, by the early 1990s, I was committed forever as a deep value investor. Mainly because, I don’t want say that those things don’t work for other people, but I will say I was no good at them, whatsoever. But following strict value criteria – I could do that.
And it’s been reasonably successful for me, and I haven’t deviated from it much at all, since the early 90s. You try to perfect yourself and learn new things all the time. But, I basically stayed with the deep value approach since the very early 1990s.
What does your typical day look like from beginning to end?
It is a very relaxed day since I left the brokerage industry in early 2008. My day is structured around my writing. I do have one morning deadline for RealMoney, but everything else is pretty much under control, as far as the Marketfy and Benzinga content is concerned. I get up, I have my coffee, walk the dog, and I go for my first walk of the day. I come back in, and the first thing I do every day is go to sec.gov, and I check the 13d and 13g insider filings from the day before. I’m looking for any stocks that I already own, and I want to know if anybody’s filing or buying.
For instance, I recently saw that Barrington Capital Group had filed a 13D on Eastern Corporation (EML). That’s interesting to me because Barrington is a really successful activist investor. If I see that PL Capital, Clover Partners, Basswood Capital, FJ Capital, Joseph Stillwell, or Lawrence Seidman file a 13D on a bank. I now know I need to go look at this bank. I want to see what their seeing because these are really smart and successful activist investors. What’s going on in community banks is so real and so powerful, and the best part – no one cares.
So if one of those funds or individuals files a 13D or 13G, I still have plenty of time to investigate the bank, and still buy at a healthy discount to book value. So I want to see those SEC filings, then I’m going to collect my thoughts, and I’m going to run my screens and hope that they can provoke a really good idea for the RealMoney article (if I don’t have something already lined up). Then I’m going to write that article, get it in to the editors. At this point it’s around 10:30 – 11:00am. Then I’m going to answer emails, and any freelance stuff I want to do that day for Investor Place or Benzinga and I’m going to get that done.
“Investing is NOT complicated — It’s just hard.”
At this point it’s around lunch time and that’s when I start reading the 10Qs, 10Ks, articles, newspapers, and portfolios news. This is my news collection period of the day once all the writing is done. Wednesdays I do a portfolio update video usually for my international portfolio. Towards the end of the day I check some closing prices and news. I may run some more screens too. I have a few that I run every day and some that I just run once a week or so. For screeners I use screener.co.
There is a caveat to using screeners though: you cannot depend 100% on the numbers. As a rule of thumb you should never depend 100% on any of the numbers at any point in time. Screening is a starting point only. If you buy a stock off the screen without reading the Qs and the Ks, then you deserve what happens to you.
What’s a little known secret about you that no one knows, but should?
I take a nap everyday. But I think everybody’s figured that out by now. Not going to college surprises folks sometimes, but I’m pretty open about it. I don’t really care where I did or didn’t go to school 30-something years ago. But I guess the one thing I could say that sets me apart from other people in the market, is something I hear a lot of people talk about. They talk about being willing to hold stocks for five years or more, but I think I’m one of the few people that actually does it.
I rarely even check prices on a regular basis. As long as I’ve got the valuation right, and nothing’s changed in the latest financial numbers, I’ll sit through stocks going down 50% and not blink. I’m incredibly patient with my holdings. As long as I think I’m right about the valuation, I’ll stick with it. People always ask, “What’s your holding period?” And I always respond, “until it works.”
I really get some nasty looks when I give that answer, cause people think I’m giving them a hard time. But it’s true. I’ve had stocks that work out in 6 months, and I’ve had stocks in the portfolio from 2008. I think I’m one of the very few that actually acts that way. I just rarely meet anybody that’s on the stock for five years.
I met Marty Whitman at a Chris Browne book signing years ago when Chris’ book came out. Marty sat down and he talked with me for a while, we were talking about investment styles, and he said, “I’ve come to the conclusion over the years that I am the last of the true, or one of the last of the true deep value investors. Everybody says their value investors, but when you look close, it’s usually some sort of relative value.” I still buy stocks based on the price to book value. I stick to Marty’s adage of safe and cheap.
Who are the people that inspire you the most? And why?
Well, obviously the guy who gave me the books at Dean Winter years ago. He turned into something of a mentor to me. He doesn’t like it when I call him that. Now he runs a nice firm on the west coast. He was very patient with me, explained a lot of things to me. He helped teach me how to value securities, how to work up and down the capital structure of a company.
He lived the life he wanted to live. And that’s one of the most important lessons I’ve learned along the way of the 50 years – you really have to build everything you do towards living the life you want live. He was one of the first people who talked to me about that. Everybody else was about making as much money as they possibly could. He taught me to live the life that I wanted to live and I thought that was very cool.
Also, being a Baltimore kid who grew up in the 60s, 70, Brooks Robinson and Johnny Unitas has an impact on my life. They had that hardcore, blue collar, Baltimore attitude. You play fair, you play hard, you take risks, but you play to win. And they were never high on money like today’s athletes. People were running into Brooks and Unitas at the shopping center on the weekend. And they were just incredibly nice guys, no matter how famous they got, they were incredibly down to earth.
What are the top 3 books you would recommend to an investor?
I love that everybody mentions books like Security Analysis, The Intelligent Investor and Margin of Safety, but nobody’s read them. Everybody talks about them, but nobody’s read them. I think that’s interesting.
James Montier’s book, Value Investing: Tools and Techniques for Intelligent Investment is an excellent book, he really redefines the basics of value in more modern terms. He is very asset focused, which of course I like. His columns over the years have really helped investors understand how value and behavioral investing, quantitative value and behavioral investing, are the ying to the other’s yang. In combination, they work extraordinarily well.
Another great book is Victor Niederhoffer’s, The Education of the Speculator. He’s a brilliant man. And I’ve been fortunate enough to have several long conversations with him. He’s a great guy, but this book is almost like poetry in the way it reads. Victor’s a great writer. But he talks about using things such as books, board games, and card games, to deepen your understanding in the market. The chapter on Tom Wiswell’s checker maxims alone, is worth the read. He’s a speculator so he trades within an extremely short time frame. So it’s nothing to do with value investing and in fact, our conversations will go off the rails very quickly if I bring up the concept of value investing. But, he thinks in a very unique way and can help you think differently. And I think it can help investors make more money. I think everybody should read the book.
Tobias Carlisle’s, Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations is a brilliant book.
And if you’re going invest your money in the markets, I think everyone should read Poor Charlie’s Almanac by Charlie Munger. Munger thinks in a whole different way about the world. The way he builds mental models, not just for picking stocks or buying companies, but for solving real life problems, and living your life in the most effective way. It’s so incredibly deep and rich in common sense. And common sense is so rare. We have similarities, but he does say Ben Graham was a horrible investor. I have to disagree with him on that one. But Munger’s way of thinking is incredibly unique.
Explain your deep value philosophy and process to investing more in-depth?
When I look at the world and the market, I’ve got two baskets of money.
1) The first bucket of money would be value investing.
I don’t want to get caught up in stories and excitement and enthusiasm. I want the numbers to tell me the story. We’re focusing on book value, and balance sheet matters. Rarely will I look at the income statement. Unless I see a red flag in the balance sheet that takes me back up to the income statement, I’m not too worried about it.
When I do look at the income statement, I use the Robert Novy-Marx’s definition of quality, which is gross profits as a percentage of total assets. So occasionally we’ll look at those first two lines, of the income statement, but that’s about as far down as I feel like I need to go. Quality Investing and The Other Side of Value are the two papers that he wrote, where he combines this definition of quality, which is an unusual definition of quality because it ignores everything below the third line on the income statement.
He calls everything else “information pollution.” If you combine it with price to book, the returns are just unbelievable. More importantly, the draw downs are minimal. And he’s studied this from the early 1960s up through 2013. So that includes the crash of ’87, the internet bubble burst in 2000 and our most recent misadventure in 2008. In large caps alone, the maximum draw down was 18%. So, that’s pretty impressive. We added this to the toolbox in the last year.First and foremost, we always want to make sure the book value is there. You must have that discount to tangible book value.
2) The other bucket of value is community banks.
That’s a specialty that I’ve kind of developed since the 1990s (just as the S&L crisis was starting to roll over and improve). Well, community banks are looking attractive again. Price to book, equity to asset ratios–everything looks great. In finding the higher quality community banks, we look for lots of capital on the balance sheet. So we want equity to be at least 10% of total assets. We don’t want one loan to come along and wipe out our little bank. So at this point we’re looking for non-performing assets. Generally I like them below, say the 2-2.5% level. But I can deal with it being a little higher, as long as the equity to assets is correct, and it’s been dropping every quarter since about 2010. If those characteristics are there I’d consider that as a special situation bank, and we’ll usually go ahead and get involved.
“Price to Value is Key.”
As I mentioned briefly before, we love to see activist investors involved in our community banks. Sterne Agee did a study of community banks. They did a study that showed that when an activist was involved in a community bank, they outperform the index by 28 percentage points. The real returns from the time the activist bought to the bank till when it was sold, or the activist exited after forcing through changes, was on the order of 46% per annum. That’s ridiculous. But the other interesting thing is, this was a decade long study.
On those positions where the activist filed a 13D with a 5% or greater position, one third of those banks were sold. And we know that they weren’t sold at a discount to book value, they were sold at a premium. So, you get some idea of the opportunity in the community banks, when you can buy them below 85% off the book. If you have activist involvement with the community bank, your odds of producing out-sized returns are very good as long as you are consistently buying below tangible book value.