Broyhill Asset Management annual letter for the year ended December 31, 2015.
Investing in public markets can be challenging in an average year. Last year was not an average year by any standard. Markets were particularly difficult to navigate. Global equity indices were down for the year. Anything that looked or smelled like a commodity was down a lot. Few investors made money. Most underperformed. Many lost their shirts. According to the Mutual Fund Observer, investors saw losses in:
- 8 of 9 domestic equity categories
- 17 of 17 asset allocation categories
- 8 of 15 international stock categories
- 14 of 15 taxable bond categories and
- 6 of 6 alternative or hedged fund categories
Against this backdrop, opportunities for big gains were limited. Those that bet big on “being right” lost big. Last year, not “being wrong” was far more important. Big gains are certainly far more exciting than avoiding losses, but we’ve never been particularly fond of excitement. We missed most of the year’s big winners, but more importantly, we managed to sidestep most of the market’s landmines. We made some mistakes but generally walked away with minor bruises, rather than critical injuries. As a result, we worked very hard to end the year about where we started.
Broyhill Asset Management - The Value in Value
Given the broad-based underperformance of active management outlined above, investors are naturally beginning to question the merits of value investing. So many of us have learned that outperforming the market is impossible, that some have actually convinced themselves that markets are efficient. Others point to central banks, high-frequency traders and big-data algorithms as impossible competition for value investors. Still others point to the general outperformance of growth relative to value, which has now reached levels not witnessed in over three decades. All good stories; but we’ve heard them before.
For value investors, one variable wall always ensure long-term success – human nature. Central banks can distort asset prices; increased capital can chase smaller and smaller inefficiencies; and exponential growth in computing power and advances in artificial intelligence may account for most of the volume traded in a given day. Logically, one might conclude that competing in such a zero-sum world was an impossible task. But despite these seemingly insurmountable hurdles, we’d suggest that the most important determinant of success remains constant – investors will make the same mistakes they have been making forever because they simply can’t help themselves. Those mistakes (i.e. chasing fads and riding unicorns) will always offer patient value investors an endless pool of opportunity. Returns from value investing will be lumpy, as they’ve always been, but they will come in time.
Value investing requires patience and a thick skin to withstand occasional periods of underperformance. This past year was one such occasion. Investors piled into a handful of “growth” stocks ultimately turning 2015 into a momentum trade. While last year’s gains were driven by an extremely narrow cohort, the current streak of underperformance actually began in July 2014 when value peaked relative to the market. After several years of underperformance, investors are again questioning the “value” in value-based approaches. A longer term perspective may be helpful.
While there have been many periods where value has temporarily underperformed, the benefits of a value-based approach are abundantly clear in the long-run. But in the short-run, investors have driven the premium paid for growth to historic levels. We don’t know how high it will go or how long it will last. But we do know that past cycles have lasted about two years; and that we are about eighteen months in today. We also know that once the cycle ends, recoveries have been powerful. What we cannot know, with any degree of certainty, is precisely when the market will see the value in our portfolio. But we believe the rebound will be equally powerful when it does. Fundamentals eventually matter.
Broyhill Asset Management - Portfolio Update
Our goal is to compound capital over time at an above average rate while taking below average risk. If given the choice, we’d clearly prefer profitable years versus stagnant or falling values.
Unfortunately, this is not a choice we get to make in any given year. Until that changes, it’s important to keep in mind that markets don’t accurately reflect changes in value day-to-day or even year-to-year. So the only thing we can do is figure out what something is worth, buy it below that price, and wait.
After a year of waiting, we believe the current gap between price and value for our portfolio companies is more attractive today. And as this gap closes, we expect more acceptable returns. In the interim, we will spend most of our time thinking about the value of our investments, rather than worrying about their price. You should too. Given the dramatic volatility in market prices since year-end, we discuss the underlying value in our five largest holdings below.
Time Warner Inc.
Time Warner Inc. (TWX) was our largest individual investment as of year-end. It was also our biggest loser last year declining nearly 23% in 20151. Last year’s poor performance was driven by both broad-based sector weakness as well as stock-specific challenges. Earnings multiples in the media sector compressed from 18x to a low of 12x as crowded longs sold stock in response to minor subscriber declines. As a result, investors valued TWX at a 25% discount to the market in December versus the 20% premium 21st Century Fox (FOX) was willing to pay for the same shares little more than one year ago.
We don’t believe today’s price is representative of the value at TWX; however, we do understand investors’ frustration. In 2014, the company refused to engage with FOX to explore an offer then valued at $85 per share. The logic? Its board claimed their strategic plan would create significantly more value than any proposal that FOX was in a position to offer. Roughly one year later, TWX shares hit a low of $63 as it became clear that this plan was out of reach.
Put bluntly, management has lost credibility. They flat out rejected a premium bid for the company then put together a dog and pony show designed to demonstrate shareholders were better off independent. Less than a year later, they lost the pony. Needless to say, we are disappointed, but we do not believe recent price declines reflect intrinsic value. While near-term earnings expectations have fallen, we believe long-term earnings power at TWX (a greater determinant of intrinsic value) is far higher.
Time Warner has one of the best collection of media assets in the world2 but the company’s most valuable asset (i.e. HBO) is being weighed down by the weakest link (i.e. Turner). HBO is a crown jewel: it owns much of its content; it generates consistent and growing cash flow; it is a premium distribution platform for programming. Yet the market values Netflix at a price nearly equivalent to the entire market capitalization of TWX, while HBO is being valued like