Steven Romick – Today’s Opportunities For Value Investors by Robert Huebscher
As of September 30, the FPA Crescent Fund (FPACX, FPC1Z**) has had an annualized return of 9.38% for the last 15 years, the longest time period for which Morningstar presents data. That is 233 basis points ahead of its benchmark, the Morningstar moderate-target-risk total-return index. It also places it in the top 1% of its Morningstar peer group.
Steven Romick, CFA, is a managing partner of FPA, having joined the firm in 1996. He serves as a portfolio manager for the FPA Crescent Fund and Source Capital, Inc.
Steven Romick was named a Morningstar Domestic-Stock Fund Manager of the Decade Nominee in 2009 and, along with Mark Landecker and Brian Selmo, Morningstar U.S. Allocation Fund Manager of the Year in 2013. Both awards were in recognition of his leadership with the FPA Crescent Fund.
I spoke with Steven on September 29.
** Schwab clients only.
In your June 2016 commentary, you remarked, “Value investing continues to be out of favor.” The underperformance during the past decade is nearly universal among value investors. Why do you think the style is having such difficulty, and what might happen to change that?
Growth sometimes wins, and other times its value. It goes through periods of time where one versus the other wins. Value did very well going up and into the great recession. But what generally happens when you go into a downturn and come out the other side, an economic recovery drives the market to higher and higher multiples the further you go into an economic cycle.
In any given year, we can’t figure out in advance which will outperform – growth or value. Looking over long periods of time, we are in the business of buying good businesses at good prices. That’s what value investing is to us, which means you’re investing with a margin of safety.
Although, I don’t think there’s a growth manager who would argue that what they own isn’t cheap. The same goes for value. But growth investors are willing to discount the future to a much greater degree than the traditional value investor, who wants more of a margin of safety in the here and now.
So as long as the market is good for a long period of time, growth can do better. But we’re in the eighth year of economic expansion. This is the weakest economic expansion we’ve had, relative to the size of the downturn, since the Great Depression. Cumulative GDP growth, relative to what we lost in GDP, shows that the recovery is punk by comparison to all other downturns since the 1930s.
What’s happened of late, in particular, is that people are paying up for yield. So PEs are going up, and the prices of a lot of high-quality, growing businesses are going up. But it defies gravity, to a degree, because we’re working on seven consecutive quarters of S&P 500 year-over-year earnings declines. It has never happened before that the market hits new highs at the same time bonds also hit all-time highs, and earnings are weakening. That’s an unusual combination.
So growth has outperformed value, as it has other points of time in the past. The reason it’s lasted as long as it has, I’d put firmly at the feet of central bank policies.
I’ll come back to central bank policies in a moment. But speaking of margin of safety, Seth Klarman, whom you quoted in a recent commentary, is on record along with Warren Buffett of warning of the dangers of using EBITDA in financial analysis. Do you use it in either debt or equity analysis and if so how?
EBITDA is just a number that’s calculated. We don’t use it by itself. We look at free cash flow.
If you look at the value of a company based on EBITDA, and compare it to some other company and value it on EBITDA, you’re assuming that the companies have equivalent cap-ex requirements.
Businesses have to be looked at based on the free cash flow they generate. That’s all it can spend. You don’t get to spend EBITDA. It’s cash flow you spend. I can go to the supermarket and buy my Campbell’s soup with my free cash flow. I can’t go there and buy my Campbell’s soup with my EBITDA.
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