Third Avenue Funds third quarter report and shareholders letters.
Dear Fellow Shareholders:
There was an interesting article in the July 22, 2013 issue of Fortune entitled “The Party Could be Over for Stocks.” The most interesting part of the article is that it describes precisely what Third Avenue Management does not do when it comes to analyzing equity securities. The Fortune analysis seems irrelevant for Third Avenue shareholders.
The gravamen of the article is that the Federal Reserve Board might reduce its $85 billion of monthly bond purchases and end the program entirely by mid-2014. As part of the change in the Fed, the government agency will no longer deploy extraordinary measures that have driven down interest rates over the last five years. Low interest rates resulted in a bull market for equities because the yields on bonds that compete for investors’ money stayed so unenticingly low.
This bull market was never justifiable based on so-called fundamentals—dividend yields and earnings potential. Also, lower interest rates mean that earnings are not likely to increase. Further, Price/Earnings ratios are currently quite high—the S&P 500 P/E ratio stands at 18.4x for the latest twelve months period and 23.6x for the 10-year average of inflation adjusted earnings.
The article ignores completely three fundamentals that are crucial in any Third Avenue analysis of a common stock — first the credit worthiness of the company issuing the equity; second, the ability of the issuer to grow net asset value (“NAV”) (or its surrogate book value) over the intermediate to longer term; and, three, the price of the common stock relative to NAV.
While anecdotal, it seems likely that U.S. corporations whose common stocks are publicly traded are more creditworthy today than has been the case since the 1950s and the 1960s. In part this is an outgrowth of the era of easy money from 2007 to 2013.
NAVs have continually increased. At July 31, 2013, the book value of the companies making up the Dow Jones Industrial Average (INDEXDJX:.DJI) was 60.7% higher than it had been at December 31, 2007; and the comparable increase for the S&P 500 (INDEXSP:.INX) was 28.4%.
