Thursday, February 18, 2016

Why Isn't Value Investing Working?

A correspondent writes,

This sort of stuff really killed it in 2001-2007 because investors totally abandoned "real asset" business in favor of tech in the late 1990s.

In the 2009-2012 period some of this stuff did well because commodities all came back so quickly (look at something like FCX in that timeframe)... a lot of stuff went 10X, but this time it was probably just trading up with commodities rather than trading up for half-off and then the commodities go up.

I learn more and more every day how much "value investors" have a serious psychic need to quantify value because they think the most important thing is buying something half off.  Even though Munger and Buffett have been saying the opposite for a long time, people don't understand that and go back to "half off".

Since you can't value most good businesses (i.e. what is google worth?  20X the analyst estimate of 2018 earnings????).  Buffett has always stayed away from tech and growth, but I think this has been an interesting period because a lot of the really good businesses have been tech/growth businesses. 

so all the value guys spend most of their time with commodities.  you can model and "stress test" everything.  And you can model the future... good businesses like google will never tell you "we think we can grow FCF from here at 20% for a couple of years", but almost every commodity company will tell you something like that.

Probably the most seductive thing is that you can quantify the downside.  So you get an investment "that doesn't lose money even if oil falls 50% and can double in two years at flat prices" and this investment fits perfectly into the Kelly Criterion, just like Mohnish said in his first book (which he has also walked back).  Unfortunately the "best" investments that look like this are companies like SD and EXXI 12 months ago.

Most value guys aren't stupid, so they say "why is this so cheap" and "why am I so lucky?"  Unfortunately, the crappier the company, the easier it is to answer this question.  With "good companies" like LNG and KMI (obviously jury still out on both), most value guys always put them in the two hard pile, because they weren't dirt cheap, and there wasn't anything wrong with them to suggest that the value guy had an edge by doing more work and being braver.

Unfortunately, with Sandridge Energy or some other terrible company, it is easy to understand why the company is so cheap.  Now that a value guy knows everyone hates it, he can concentrate on modeling the upside and downside "just like Buffett did with American Express during the Salad Oil Scandal period"....

Basically I think all the value guys have put together a bunch of "mental models" like Munger says they should, but they have all the wrong models because the right ones are too hard to understand.  Buffett buying AXP is easy to understand and quantify, but his best purchase ever might have been See's Candy.  What the hell do any of us know about See's Candy?  He paid like 20X earnings for a maturish chain of stores selling chocolates and made a long term IRR of the type that has only recently been replicated by some of the most successful tech companies. 

So after all the "real value guys" had a tough time in 1995-2000, they got a huge reward in the next 6-7 years, due in no small part to rising commodities... not that far off from claiming "Asset Allocation" is the best money management strategy or Bill Gross is a genius after a 30 year bull market in bonds.

I can't recall a decent investment Buffett has made in the last 10 years, other than his "loan sharking" investments from the crisis.  I'm not really sure what the moral here is, other than that I believe markets have gotten much more efficient since around 2005 (when everyone became a value guy).  There is so much brainpower going towards valuing assets that all you have left is the type of stuff Klarman has been doing (only buy stuff with forced sellers), or a lot of what Buffett and Klarman are doing that no one is talking about - basically buy the safe 8% IRR that is overlooked because everyone is looking for the 15% IRR.

I would add that small caps have probably allowed great value guys to continue to add value over the last 30 years even after everyone became a value investor and all the corporate raiders showed up, but in the last 15 of those year, rates have been so low that private equity has become a major player.

Private equity has killed it in the small/mid cap space over the last 15 years because they can go to any company and say, "let me see your books, and if we like them, we will buy your company and double your pay"...  value investors have been left with all the companies that looked like crap after private equity looked over their books, or have management teams that weren't interested in maximizing value.

10 comments:

Unknown said...

so all the value guys spend most of their time with commodities.

???

I don't see this at all. At CoBF, compounders are by far the most popular kind of investment. Some guys there invest in commodities, but there's also a lot of interest in compounders/platforms, Apple, concept stocks like TSLA, bank stocks, and many other things.


So after all the "real value guys" had a tough time in 1995-2000, they got a huge reward in the next 6-7 years, due in now small part to rising commodities...

I never saw this either. From 2003-07, many value investors couldn't stop talking about how small caps were overvalued, cyclicals were overvalued, and quality large caps were incredibly cheap compared to the rest of the market.

The guys who chased commodities during the bubble were mostly hot-money funds (e.g., Atticus pressuring Phelps Dodge to sell itself), pension funds that poured money in futures-trading strategies with high historical returns, or sector specialists who rode the bubble. There was one manager, RAB, that stated with a few million, earned a 1000% return in its first year buying mining-stock warrants, and ended up managing billions in commodities investments at the peak.


I have an alternative explanation for why so many "value investors" buy dogs. Most of them are nerds and geeks, which means they're ultra-logical but don't pick up on the subtle, quantitative things that make or break an investment. The fact that they're nerds also explains why they can buy call themselves value investors yet buy anti-value concept stocks like Tesla: if they aren't geeking out about Buffett or Munger, they're geeking about some new technology.

Nate Tobik said...

James,

Most of them are nerds and geeks, which means they're ultra-logical but don't pick up on the subtle, quantitative things that make or break an investment.

This is an interesting comment that I want to riff on. I have three boys, the youngest is a baby so no qualitative comments on him because he's too young. The oldest is extremely intelligent, he has an elephant memory, very logical, just 'gets' things, a smart kid. But his social IQ is low. If a joke is funny he'll tell it 10 times. He doesn't pick up on the subtleties of social cues. My second is extremely social (like his dad) and gets this. He will tell great jokes and place them judiciously. He has excellent social intelligence. He loves people and is in his element when he can talk and play with other kids. The first will make fun of the second for being slower on math or letters or academic type items. But I know that the second will probably blow past the first in life. Why? Life is social, it's about social IQ, it's about reading the unspoken messages. Knowing when someone is lying because of how they talk.

I've been described as an out of the box investor. But I think this is more of a reflection on others rather than myself. I'm extremely extroverted, big picture, optimistic etc. Me in a cube with Excel for eight hours a day doesn't work. What I think of when looking at companies is 180 degrees different than most. Not because I'm smarter, but because I'm thinking about it from a different context. I'm constantly trying to relate situations to the real world, business situations I've lived trying to understand how people might act.

The paradox of all of this is that I also believe that the financials and numbers are important. The numbers tell a story. The numbers are a litmus test to all of those social elements. The social elements are important, but the numbers are the judge.

There's an information gap that exists that I believe the growth guys get and value guys don't. It's called "talking to people." and "asking questions". I am naturally curious, I ask anything and everything. If someone says to me "we unload 10 trucks a day" I ask "is that a lot?" I was at a car dealer recently and found myself asking what their monthly volume and profit per car was. I don't think this is normal, but guess what, when people are asked a question they often answer. These guys gave me the numbers. I had no purpose, I was simply curious. The downside to this is I have found myself in conversations with people that last forever because I impulsively continue to ask questions. I will ask curious questions about things I don't even care about. I will talk to women at Kohl's about their vacations and families while my wife tries on clothes and I'm sitting in the waiting area and I can't stop talking. There is literally no value, but I just talk and continue to question, this is the dark side..

I wrote a piece in 2013 maybe 2014 about how investors have abandoned the concept of a margin of safety. I think this is still true. Most "value" investors are looking at the upside and forget that bad things can happen. Liquidation value is important, but paying debt more important, or paying salaries. Equity holders will get the shaft much quicker than Paul who's been a janitor for 45 years will. Shareholders don't believe this, but that's the human element. Shareholders are faceless things out there in the ether. Paul the janitor is around everyday to chit chat about sports and talk about cars, shareholders don't have that same connection.

Nate

Anonymous said...

But what is really the definition of value investing ?
Lot of people talk about it but I still have to get a clear explanation.
Same goes for growth.

Anonymous said...

Seems to me like the term "value investor" has become synonymous with "fundamental investor" in many contexts (as distinct from quant/momentum). Along the lines of the post, Einhorn getting crushed in coal and complaining that value doesn't work anymore seems very disingenuous. In 2015, the FANG rally was remarkable and, other than google, most investors scoffed at the valuations, crying 'its not fair' at the end of the year. At some point, oil will be back at $80 and facebook growth will slow and the recent trends will reverse, but to survive in the investment game requires a keen understanding of the game one is playing. In my opinion, absolute returns over a reasonable timeframe should be the goal.

High Plateau Drifter said...

There is a near infinite number of styles and strategies of value investing.

My problem with value investing is that value investors tend to think of stocks as long term investments, with their acquisition being and end in itself.

I prefer to think of buying and stocks as a means of adding cash to my account, as much and as fast as possible. That mind set tends to clarify matters in the most helpful way.

You all forgot to mention one class of value investor - the short seller! As a short seller who loves overvalued stocks and especially cocktail party - fad stocks, I would never short one merely because it is overpriced relative to some valuation metric. Rather, I watch the chart until it begins to distribute and roll over, as the smart money begins to exit.

Unknown said...

I have three boys, the youngest is a baby so no qualitative comments on him because he's too young. The oldest is extremely intelligent, he has an elephant memory, very logical, just 'gets' things, a smart kid. But his social IQ is low. If a joke is funny he'll tell it 10 times. He doesn't pick up on the subtleties of social cues.

Nate,

Your oldest son sounds a lot like me when I was younger. I think the good news is that it's possible, with practice, to get better at reading social cues. A smart kid can use his intelligence to understand social dynamics and learn how to relate to other people, even if he can't change his basic personality.

With investing, I was lucky to have some early experiences that taught me the importance of reading these social cues. I bought a couple stocks with great stories that never panned out, a la ZINC, and learned a painful lesson. I cringe when I see people on CoBF walk into obvious value traps, because they're making the kinds of mistakes that I've made in the past.


There's an information gap that exists that I believe the growth guys get and value guys don't. It's called "talking to people." and "asking questions".

Good point. I'm guilty of this, in that I hate calling people up and doing scuttlebutt research. Part of it is being introverted, but part of it that a lot of scuttlebutt is useless or even misleading, and I'm not patient enough to invest a lot of time in something that has only a 50/50 chance of panning out. By comparison, a lot of macroeconomic reports are also useless, but it doesn't take any effort to get the latest trade or GDP data, so it's less frustrating.

Unknown said...

But what is really the definition of value investing ?
Lot of people talk about it but I still have to get a clear explanation.


In Ben Graham's time, it meant buying things at a discount to their liquidation value. Warren Buffett placed a greater emphasis on intangible qualities and the future, and his success made people take a more expansive definition of value: companies that had competitive advantages and opportunities to grow became value stocks, even if they traded far above liquidation value. I think the other Anonymous is right that value investing has been diluted to the point of being meaningless: now, anyone who isn't explicitly a momentum investor calls himself a value investor.

Buffett's cult of personality has also trained value investors to hero-worship successful investors, so nowadays value investing has a bigger emphasis on personalities than in the past.

David Merkel said...

This wasn't worth the time. It is a caricature of value investing.

HPD said...

David,

A wise economist once said, "you get what you pay for".

Also, what the author clearly meant was that most so-called value investors today are practicing a "caricature of value investing". E.g. the people on Corner of Berkshire and VIC forums.

Credit Bubble has Security Analysis as a 5/5 timeless classic. This conversation is clearly about the pretenders/mimics that are involved in bungles like VRX.

-HPD

Anonymous said...

"This wasn't worth the time. It is a caricature of value investing."