The “Big Tent” of Value Investing: Approaches, Lessons, Ideas

The “Big Tent” of Value Investing: Approaches, Lessons, Ideas

John Mihaljevic, CFA presentation titled “The “Big Tent” of Value Investing: Approaches, Lessons, Ideas” from the Value Investing Seminar, Trani, Italy, dated July 17-18, 2014.

Value Investing Approaches: Selected Value-oriented Idea Generation Approaches (That We Like)

  • “Magic Formula”
  • Advocated by Joel Greenblatt
  • High ROCE, high EBIT/EV
  • Earnings-based
  • Sum-of-the-parts
  • A staple approach of activists
  • Investment case often rests on monetizing non-core and/or excess assets
  • Earnings-and/or asset-based
  • “Net-Nets” (and similar deep value strategies)
  • Advocated by Ben Graham
  • (Current assets minus total liabilities) > market value
  • Asset-based
  • Other Approaches
  • Special situations
  • Equity stubs
  • “Jockey” stocks
  • “Super-investor” stocks

Value Investing Approaches: Observations on Graham-Style Approach

“The problem is to distinguish between being contrary to a misguided consensus and merely being stubborn.”—Robert Arnottand Robert Lovell Jr.

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  1. Unabashedly starts with the price of a stock
  2. Studies (e.g., Fama/French) show equities with high book-to-market ratios outperform
  3. Holy grail: companies with asset protection and high normalized returns on capital
  4. Return of cash to shareholders can make low-return businesses a great investment
  5. Investors may overestimate liquidation value (dying businesses hide nasty surprises)
  6. Acceptance of discomfort can be rewarding in investing, as fearful equities frequently trade at exceptionally low valuations
  7. When we invest in an asset-rich but low-return business, time may be working against us; as a result, catalysts become a relevant consideration
  8. Businesses at deep value prices are most likely to be creatively destroyed; unwise to allocate a large portion of investable capital to any one deep value opportunity
  9. Suggested screening factors for Graham-style bargains: share repurchases, insider buying, and cash generated through working capital shrinkage
  10. Valuation based solely on readily ascertainable balance sheet values runs the risk that values erode over time, negatively impacting future equity value

Value Investing Approaches: Observations on Sum-of-the-Parts Approach

“Vodafone does not consolidate Verizon Wireless and, as a result, sell-side analysts seem to ignore its significant value.”—David Einhorn

  1. Some companies best appraised by analyzing each business/asset separately and then adding up those components of value to arrive at an estimate of overall value
  2. A reason for occasional mispricing of companies with multiple sources of value may be unwillingness to value assets that differ materially from a company’s core assets
  3. Companies with distinct components of value often enjoy greater strategic flexibility
  4. Sometimes investors slice a company into too many parts, creating an attractive investment thesis in theory but not in reality
  5. Sum-of-the-parts ideas are prone to becoming value traps absent strategic action
  6. It matters whether the offer is “buy one, get one free,” or “buy 10, get one free”
  7. Sum-of-the-parts opportunities come in a few different flavors, each of which demands a slightly different approach to screening
  8. Usefulness of sum-of-the-parts analysis grows when the various business segments demand distinct approaches to valuation, making corporate-level data less relevant
  9. Investors may become patsies by failing to realize that “hidden” value is not hidden
  10. Focus on how the value in “hidden” assets will accrue to shareholders—and when

Value Investing Approaches: Observations on “Magic Formula” Approach

“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”—Warren Buffett

  1. Advice to buy good companies only when they’re cheap seems glib at first glance
  2. According to MF, the higher the return on capital employed, the better the business
  3. Use of EBIT/EV and EBIT/CE eliminates the effects of leverage and taxes
  4. In theory, outperformance of MF methodology should prompt investors to flock to it, eliminating its attractiveness; in practice, MF is likely to keep outperforming
  5. Highly concentrated long-only MF portfolios could suffer debilitating volatility
  6. Mr. Market overvalues businesses whose returns on capital derive from explosive but transitory trends or fads; Mr.Market often undervalues unhypedquality businesses
  7. A key adjustment is to use forward-looking earnings data in the MF calculation
  8. If we run the MF screen on a database that includes both U.S. and non-U.S.-listed companies, the greater number of candidates should enhance performance
  9. It might make sense to introduce a hurdle above which all companies are tied from the perspective of ROCE —the cheapness factor then carries more weight
  10. High ROCE is almost meaningless without an ability to reinvest at high returns

See full The “Big Tent” of Value Investing: Approaches, Lessons, Ideas in PDF format here.

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