Value Investing

Value Investing: Turning An Oxymoron Into An Opportunity – Tocqueville

In his latest piece, Francois Sicart, Founder and Chairman of Tocqueville Asset Management, discusses contradictions in investors’ disciplines.

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"...I feel in total harmony with the contrarian and value disciplines that have guided my investments for 40 years.  At the same time, I also claim (and aim) to be a long-term investor.  Yet, almost from the start of my career, I have had the somewhat uncomfortable feeling that, in practice, these claims may be contradictory."

Mr. Sicart cites Benjamin Graham's advice that an investor sell once a security is up 50 percent or in two years, whichever happens first (not exactly long-term).  He also notes contradiction in Warren Buffet's value approach -- that it incorporates some growth investment characteristics.

He believes that in a time of constant news and flow of information, time horizon "is the individual investor's last remaining edge on professionals," stating that the "most attractive underused horizon is three to five years."

Mr. Sicart concludes: "A stock price doesn't tell you anything about a company's worth, but it tells you a lot about the popularity of the company with the crowd of investors.  Simple contrarian opinion tells us that these stocks are not in favor and that, on a three- to five-year horizon, this is where we should be looking for opportunities -- with our calculator in hand."

Long-term Contrarian / Value Investing: Turning An Oxymoron Into An Opportunity

In my observation, there is more than one discipline that can lead to investment success, and some of the proven ones are quite different from each other.  The secret to investing successfully, therefore, is to adopt and follow a discipline that is in harmony with your personality.

For my part, I feel in total harmony with the contrarian and value disciplines that have guided my investments for 40 years.  At the same time, I also claim (and aim) to be a long-term investor.  Yet, almost from the start of my career, I have had the somewhat uncomfortable feeling that, in practice, these claims may be contradictory.

The value discipline implies more trading than one would wish

The basic tenet of value investing is that you should buy a stock well below a conservative calculation of its intrinsic value.  This, however, implies a corollary:  When a stock gets well above that purchase price, and thus no longer represents value, it should be sold.  With the well-known bipolar characteristics of the stock market, this means that value investing is bound to cause more trading than a conservative, long-term investor would in theory prefer.

Ben Graham, godfather of value investing, advised buying stocks of companies at a conservatively adjusted value of liquid or nearly liquid assets, reduced by all liabilities.  On the sell side, his advice was fairly simple:  Sell once you're up 50 percent, or sell in two years, whichever happens first.  This tells us that Graham, whom many still revere as the epitome of a long-term investor, did not in fact have a time horizon much in excess of two years.

Warren Buffet, Graham’s self-proclaimed disciple, in practice has adopted a somewhat different approach during his career, as illustrated by statements in Berkshire Hathaway Chairman’s Letters:

  • “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” (1989) weakens Graham’s narrow criteria for purchase; and
  • “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever” (1988) seems to do away with the sell side of the value discipline.

This evolution reflects the fact that, after being schooled by Graham, Buffet became importantly influenced by Phil Fisher, who could have been labeled the godfather of growth investing.  In particular, while the early Buffet claimed to find all the information he needed in companies’ annual reports, Fisher advocated research based on deep and frequent contacts at all levels of a company – he was looking for excellence in the management of businesses he selected.

In 1987 investment adviser John Train described Warren Buffett as 85 percent influenced by Benjamin Graham and 15 percent by Philip Fisher (The Midas Touch, Harriman House, 2009).  Today it is quite possible that these proportions have been reversed, which allows Buffet to keep a significant portion of his Berkshire Hathaway portfolio with little or no trading.

However, it seems that the performance of that portfolio has become more average in recent years.  This may be due to the fact investments in small- and medium-sized companies, which are followed by fewer analysts and where value is thus somewhat easier to uncover, are less meaningful in a portfolio of the size now held by Berkshire Hathaway.

Contrarian investing and the acceleration of everything

Seth Klarman, founder of The Baupost Group, summarizes:  “Value investing is at its core the marriage of a contrarian streak and a calculator” (Outstanding Investor Digest, March 17, 2009).  This gives me a convenient transition to a review of contrarian investing:

Value Investing: Turning An Oxymoron Into An Opportunity - Tocqueville

Value Investing

I saw an earlier version of the cartoon on the left several years ago, and it stuck in my mind as a perfect illustration of the insanity of blindly extrapolating the recent past, as many stock market investors tend to do.  The more recent cartoon on the right, quoting comedian Steven Wright, is a wonderful warning of the dangers of complacency.  Put another way, to a contrarian, the tendency just to follow recent market momentum because the consensus complacently dictates doing so is no better than assuming there is no danger in walking toward a cliff just because you haven’t fallen off yet.

In 1949 Life magazine hailed Humphrey B. Neill as the father of contrary opinion.  In The Art of Contrary Thinking (Caxton Press, 1954), Neill wrote, “No problem connected with the Theory of Contrary Opinion is more difficult to solve than…how to know what prevailing general opinions are and how to measure their prevalence and intensity.”

Today’s constant flow of news reports that are both instantaneous and repetitive, as well as the multiplication of commentaries and opinions on both old and new media, makes it even harder than in 1954 to evaluate the importance and significance of a consensus.  Our natural tendency to think that we belong to the original-thinking minority leads us to exaggerate the size and strength of views contrary to our own.

One fact remains true, however:  The more media coverage predictions we receive, the more inaccurate they are likely to be.  Neill said it some 60 years ago:

I think I am on safe ground in asserting that so long as predictions remain popular and are so numerous as they are today – and so long as they receive notoriety through repetition in the press and on the radio – contrary opinions will increase in importance as thinking aids.

Several knowledgeable and successful investors helped refine the notion further.  For example, Barry Ritholtz reminds us that the contrarian should be looking at what will frustrate the largest number of people; Michael Steinhardt warns that contrarian investing isn't just about going against the grain – it's about exploiting expectations; and Seth Klarman tells us to look for cases where uniform belief has led to a mispricing of expectations and thus a way to make money.

The problem in recent years has been the exponential growth and acceleration in the dissemination of news, opinions, and forecasts.  It helps to remember that when you see an expert opinion quoted in the newspapers or expressed on television, it reflects less a recent conclusion reached by an expert than the journalist’s choice to quote or invite that expert.  Not only do journalists constitute a crowd; because of their race for novelty and sensationalism, theirs is a particularly volatile crowd.

In a way, the Internet – where the available information is often selected, not by a person, but by an algorithm based on the popularity of posts – is an even better measure of the crowd; but unfortunately it is just as volatile in its offerings.  As a result, except for rare consensus extremes, the contrarian approach is even less useful than in the past to time investments precisely.

Saved by the clock!

In a March 25, 2015, article, The Motley Fool offered the following quote from Charlie Munger:

Time is the individual investor's last remaining edge on professionals.  If you can think about the next five years while most are focused on the next five months, you have an advantage over everyone who tries to outperform based on sheer intellect.

In doing my research for this paper, I came across an article by Andrew Szabo, managing director of Greenwich Financial Management Inc. (January 31, 2005).  I do not know Mr. Szabo, but I believe his conclusion makes a lot of sense:

The horizon over which you intend to invest is very important.  There is a tremendous amount of money around that is seeking short-term returns.  First, there are the “day traders,” which includes almost every market maker on Wall Street and many amateur investors.  Next, there are the hedge funds, which tend to be very influenced by monthly reporting.  Mutual fund managers tend to think in terms of quarters and full years, which is how pension fund consultants rate them.  I believe the most attractive underused horizon is three to five years.

Opinions and consensuses about the financial markets and the economies will continue to fluctuate along cycles that will often be too short to make a systematic contrarian approach compatible with a long-term investment strategy.  But opportunities remain for a contrarian/value approach if one carefully selects one’s time horizon.

We receive an enormous number of research reports on individual companies from brokers and other organizations.  What is striking is how few analysts look beyond one or two years into the future.  These are intelligent and educated individuals, so the chances of the consensus of analysts being drastically wrong in its anticipation of sales and earnings over such short horizons are relatively slim.  This is especially so as, contrary to historical practices, company managements now “whisper” guidance about forthcoming results to the investment community.

(Incidentally, and ironically, whenever a company’s actual results fail to reach the whispered numbers, analysts now report that it has “missed” the estimates.  Of course, if the analysts had done their jobs, their estimates might have been different from the company’s whispers – and in fact, in such cases, it is the analysts’ estimates that “missed” the actual results.)

My experience of recent years is that, if we are defining opportunities in terms of stocks about which expectations have fallen well below what common sense and our calculator tell us the underlying companies are worth, the three-to-five-year horizon should prove a fertile ground.  Most analysts do not venture that far ahead, most institutional investors with supervisory guidelines and an eye on short-term relative performance are not interested, and the media’s time horizon keeps getting shorter rather than longer.

At this writing, a majority of investors is still in shock from the tremors of the last few days, when major stock markets suffered their first significant corrections in six years.  After such a long period of levitation and complacency, it could be argued that many stocks resembled flies in search of a windshield.  As usual, once the flies found the windshield, experts and others frantically got busy pointing the finger to possible culprits: Greece, China, oil, governments and central banks, etc.  Yet, I am convinced that there was no need for a particular trigger:  Experience could have told us that such a correction was inevitable and that only the timing was uncertain.

It is entirely possible that the current correction might continue and even worsen for a while, so there is no reason to indulge in a routine that became fashionable in recent years: “buying the dips.”  On the other hand, we should not lose sight of the fact that stock-market performances have not been uniform in 2009-2015.  With the general market indices down only modestly from their highs (though with a fanfare in the last few days), there is a broad sample of stocks that are already 30 to 50 percent below their five-year highs – a performance more in line with historical bear markets.

A stock price doesn’t tell you anything about a company’s worth, but it tells you a lot about the popularity of the company with the crowd of investors.  Simple contrarian opinion tells us that these stocks are not in favor and that, on a three-to-five-year horizon, this is where we should be looking for opportunities – with our calculator in hand.

Francois Sicart

Monday, August 24, 2015

This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized.


Francois Sicart

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