Saturday, October 25, 2014

Value Investors Obsessed With "Compounders", ROE; Don't Care About Liquidation Value Or Margin Of Safety

Young Money did a post called "Two great posts from Credit Bubble Stocks":

"I find this fascinating because it shows how much valuation standards can change over time. Today, a company is praised for earning a high return on equity (ROE). In Graham's time, companies were praised for having significant assets, even if reporting significant assets depressed their stated ROE."
I sent this to Oddball Stocks, who responded with a great comment:
"It seems the high ROE trend has been born out of the crash of 2008. I don't remember anyone talking about it before then. Now I see things all the time saying 'they earn 4% on equity so they're only worth 40% of book value'. Of course that's insane, someone could purchase them and unlock the value. Or new management could unlock the value.

It seems since the crisis investors have lost their imagination. We have investors believing that anything good will go on forever; these are the growth companies. A company doesn't grow to the sky. Wells Fargo isn't going to grow at 15% a year for decades, if they do in something like 15 years they will be 100% of the banking market in the US. The other are value investors who can't imagine a bad company changing. Things happen, management changes, people change, things change. Nothing is static, yet we live in this static market. It's weird."
I would summarize this by saying that "value" investors are currently obsessed with "compounders" (i.e. "quality" businesses with high returns on equity, and they don't care about liquidation value or margin of safety.

I'm not saying you can never make money buying a high margin, high ROE business at over five times book value, but that's not value investing as the style was traditionally known.

To me (and to Graham), value investing is buying a consistently profitable bank at 60% of book, or closed end muni funds when they are trading at historic discounts to NAV.

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