In value investing, it is imperative that one considers the state of the industry invested in, the balance sheet of the company, and earnings quality. These are basic concerns for any investor, and all of my failures in investing can be be linked to neglect of one of these three items.
Ben Graham used the phrase “margin of safety.” Actuaries, even less poetic, use “provision for adverse deviation.” In either case, the idea is investing in such a way that you won’t get badly hurt if you are wrong. It handles risk at the security selection level — choose your companies carefully; make sure they are survivors.
Does the industry have pricing power? Is it under pressure from rising costs? (Credit losses are a cost for financials.) Pricing power, and lack thereof, should be considered in valuation decisions. Are things so bad that companies are going bankrupt? Perhaps it is time to buy the strongest one in that industry, because it often takes defaults to make pricing power turn. Fewer competitors means profit margins can rise.
Does the company have a lot of debt? Is the tangible net worth small relative to the liabilities? Be careful, because a small negative change in the economics of the business could kick the company over the edge.
Do the earnings come from cash earnings, or do accruals dominate the earnings? Cash earnings are always higher quality than accrual earnings. This is one reason why financials almost always trade at a discount, because they are a bag of accruals. Also, with financials, the quality of the accrual entries affects valuations. Asset managers will have higher valuations than long-tail P&C insurers. Who knows whether the reserves are right or not?
All that said, it was with sad amusement when I heard on the radio this afternoon that Legg Mason had become the largest shareholder of Freddie Mac. Is Bill Miller (or Private Capital) doubling down? He will look like a genius or a fool after this, depending on the outcome. I think it is foolish, and an willing to say that he doesn’t understand the credit risk in the current environment, and should get advice from someone who gets the current credit crisis better, like me, or Eric Hovde.
After all, at the present time, even the rating agencies are downgrading everything at Fannie and Freddie except the senior debt ratings.
Value investors often invest in financial stocks. That is their undoing in the present market, as earnings and net worth get eaten by credit losses. But to any value investor that does industry analysis, this was avoidable, because the risk of credit losses to the banks grew as the banks were willing to lend on terms that were loose.
As a value investor, I have been able to avoid the current crisis. I avoided credit-sensitive financials, and have bought cheap names among industrial stocks. But that was yesterday, what of tomorrow? I don’t think the credit crisis is done, and so I urge a conservative posture at present.
Related Articles
|
Top Rated Comment Streams:
-
1.Hedged In662
- 2.
-
3.Smarty_Pants418
-
4.axelrod608314
-
5.cos1000277
- Free E-Newsletters
- About Seeking Alpha
- About Us
- Contact Us
- What's New
- Readers Feedback
- Advertise With Us
- Contributors
- Contribute an Article
- Feature Your Book
- Our Contributors
- Anonymous Contributions
- Dispute an Article?
- Legal
- Terms of Use
- Privacy
- Copyright
This article has 9 comments:
-
friend
-
17 Comments
Aug 12 11:02 AMIt is not a matter of blaming the naked shortings in relations to the oversolds of financials .
It is a matter that naked shortings are unlawful and they ought to be policed effectively at all costs .
Isn't it true that the stability of the financials is in fact , the stability of the US economy ?
-
Owen
-
138 Comments
Aug 12 11:47 AMParking within 15 feet of a fire hydrant is also unlawful and ought to be policed, but neither this practice nor naked shorting have anything to do with the article or the stability of the US economy.
-
wes mantooth
-
24 Comments
Aug 12 12:31 PMAbout the only people naked shorting are the banks. They're probably naked shorting their own shares in fact.
I agree that it should be illegal.
-
Larry House
-
259 Comments
Aug 12 02:13 PM-
JasonC
-
367 Comments
Aug 12 02:33 PMValue investing as such does not care about the sign of the next item of news. It does not try to time the bottoms of every cycle. It does not take risks when it expects a trend to be up and pull in the horns when it expects the trend to be down.
Value investing, if it means anything, means investing or refraining from investing or selling, based on whether an independent appraisal of the real value of the item differs materially from the current market price on offer.
Value investing, as such, never believes the current market price, and it never believes the trend in that price nor in news thought to be driving it, contains the most relevant information. Instead, it gets its ideas of the true value of a company from objective information and mathematical models, typically of the discounted present value of expected future cash flows.
If someone wants to sell you dollar bills for 20 cents, you don't care a lick whether yesterday's headline was bright and sunny or dark and gloomy. You look at the item on offer and objectively measure it, and see it is fairly worth a dollar. And you look at the level of the price - not the trend, not the sign of the trend, past or future, but the *level* - and simply ask, is it materially different from the current price?
A value investor might decide that financials are not a buy at present prices - if his model of their future cash flows tells him that they are dollar bills selling for $3 apiece. But if his model of their future cash flows tells them they are worth 5 times to 2.5 times the current quote, he is not sure which, then he buys them or he isn't a value investor.
There isn't a line in the article about what the author thinks any of the items he discusses are actually worth. Instead, he is talking about the news and trends and trying to call bottoms.
That is a perfectly legitimate activity and he may be doing it well and his advice on it may be sound. More than I know or care. But it isn't value investing. It isn't value anything.
Market timing and trend following and news trading in stocks with lower PEs isn't value investing.
-
blackbody
-
36 Comments
Aug 12 02:45 PM-
Owen
-
138 Comments
Aug 12 03:30 PM-
madasiwannabe
-
98 Comments
Aug 12 09:11 PMThe only value anyone cares about is what they can extract from a company and put in their pocket at the end of the day. Charts mean nothing and only add value to deep pocket players trying to catch smaller investors leaning. It's the thrill of the kill that spurrs the market; nothing more, nothing less. The victom or benificiary companies are merely bait fish chosen by the media for the sharks to feed on. It's not just financials either. I can't think of a single sector you can put your money in without worrying if it will be there tomorrow.
If your looking for safe, value based investing in today's markets, keep your money in your pocket for a little while longer. There's no safe place in this pool for investors with charts or floaties.
-
Cargan
-
2 Comments
Aug 13 12:59 PMFor a value investor, determining whether to buy or sell is necessarily preceeded by an analysis which, as JasonC notes, usually includes a discounted estimate of future cash flows. How any investor can confidently make that calculation at this point in time is what has me stumped.
What are the actual assets and liabilities worth, with one being written down and the other being accrued for each quarter in such meaningful amounts?
I have due respect for Mr. Miller, but I wonder if perhaps he is using a different calculator on this one.