A Return to Value

A Return to Value

We are currently going through the second market correction this year. The first one occurred in February. This second correction is deeper of course and scarier. Corrections are a healthy part of the market process and they occur largely to clean up the excesses of the previous upswing. The market at its core is no more than a complicated thought form and the energy within it, is made of all the various market participants. When the market goes up strongly people get bullish and feed off of each other’s energy (the fear of missing out on easy money). They will climb over each other in their desire to buy stocks. They will reach and put in a higher bid in their zest to buy and own shares. A premium is put on the future growth potential of companies as people get increasingly bullish about the prospects of the future. When this happens things can get sloppy and overdone on the upside and it reaches a point where everybody who could buy has already bought and a correction ensues to siphon off the excesses of the previous bull run. (see the blogposts about the Speculator's Edge for more insight into the nature of the marketplace.)

But as I mentioned earlier, this is the second correction this year. That is rare and I have a feeling the inner workings of the market are going through a pivotal change in their nature. The market is chameleon-like in its essence and as time goes by it changes and morphs into something it wasn’t before. We have gone through an incredible period since the 2008/2009 financial crisis. The powers that be had to pump an incredible amount of liquidity into the financial system to offset the damage inflicted by the financial crisis. Almost all of that money went into the stock market (especially the U.S. market). But the Fed has had to put themselves in so much debt in creating all this liquidity that they now find themselves forced to siphon it back out of the market.

Couple that fact with the rare occurrence of two market corrections in one year and I think a changing of the guard is occurring in the marketplace. Growth stocks will no longer be given a premium valuation for their earnings potential. As there is less money sloshing around in the system, investors will be more careful in committing their funds to investments. They are liable to become more value orientated. Value investing has under-performed Growth investing since 2008/2009. That is a market anomaly. The reverse is usually true.

Once this correction runs its course I believe investors will be looking out on a new world. One in which value will again regain the investing mantle it has given up to growth over the last decade. People will be more careful with their investment dollars because they will have less of them to invest….The way I see it anyway…

How to find Investment Ideas with a Margin of Safety

How to find Investment Ideas with a Margin of Safety

As a follow-up to yesterday's post, remember at times of emotional extremes it pays to be contrary. The great irony of the current sell-off is that it presents an investor who can stand aside from the mania of the crowd, an opportunity to buy the stock's of good companies on the cheap. The price you pay for these companies will have a built-in 'margin of safety.' And in the long run that is what the game is largely about.

The best investment opportunities usually come in big waves, such as when the entire market declines. Big sell-offs in the market can cause forced selling. When this happens money managers are forced to sell the stocks in their funds because of client redemptions who panic at all the bad news and just want to liquidate their holdings as fast as they can (the herd effect of the crowd). The fund managers may know that they’re selling under-valued securities but they have no choice. This can create a vicious feedback-loop effect where indiscriminate selling begets more selling, as some stocks will just be dumped for reasons that have nothing to do with the companies underlying fundamentals. Hedge funds that use leverage are even more susceptible to this forced selling as they no longer can make their margin calls and are forced to dump everything so they can raise liquidity. The solitary investor, who can stand aside from the galloping herd of the market, can take advantage of the situation and cherry pick the low hanging fruit the market is offering him.

The beauty of forced sellers is that they have no choice. They have to sell regardless of price. If chaos is widespread, many people will be forced to sell at the same time and few people will be in a position to provide the required liquidity. The difficulties that mandate selling – plummeting prices, withdrawal of credit, fear among counter-parties or clients – have the same impact on most investors. Prices can fall far below their intrinsic value. This can cause an imbalance between the sellers and buyers in the market place. It can be a scary time but an alert investor who puts an emphasis on the importance of his purchase price can buy things at this uncertain time which will have a built in ‘margin of safety’. So ironically at a time of seeming danger and fear an investor with the right disposition can actually do the safest thing in the long run and buy cheap.

Where there is Uncertainty, there is Opportunity

Where there is Uncertainty, there is Opportunity

An argument is made that there are just too many question marks about the near future; wouldn’t it be better to wait until things clear up a bit? You know the prose: Maintain buying reserves until current uncertainties are resolved,” etc…Before reaching for that crutch, face up to two unpleasant facts: The future is never clear and you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.

Warren Buffet

While most value investors are typically considered a risk-averse lot, that’s more to do with the price they’re willing to pay for a given investment. Often the types of situations that attract them are fraught with uncertainty and are perceived by the crowd as being downright dangerous. As companies constantly evolve and change in response to industry or company-specific challenges and opportunities, the lack of clarity around those changes - and the risks that are entailed in the potential outcomes – can cause share prices to diverge widely from the underlying value of the business. The ability to recognize and take advantage of that dynamic is a key element of what sets the best investors apart from the crowd. There are two kinds of events that create uncertainty (volatility) which can offer the investor who can think for himself, an opportunity to take advantage of the herd-like behaviour of the crowd. 

The first revolve around individual companies, such as earnings misses, unexpected news, M&A activity, restructurings and legal issues – things that can make prices and valuations change relatively quickly. In general, prices change much faster than the fundamentals of businesses change. It is the individual investor’s job to investigate what made the price change and then figure out whether the facts have changed as much as the price, if they haven’t changed that much that can be an opportunity to buy something cheap.

The other major source of uncertainty is when a macro event or trend causes the markets to move. These can be industry – specific, but more often than not it involves interest rate moves, currency moves, political instability, and the overall economic outlook. The market reflects at any moment what the stock market crowd think a business is worth, so if macroeconomic factors force people to buy and sell a companies’ stock  while ignoring the long term fundamentals of the company, this can create a disconnect with the price of its stock and what the underlying company is really worth. This can create an opportunity for the observant self-aware investor who can think for himself, to move in and take advantage of the disconnect between the stock's price and its value.

Know What You Own

Know What You Own

In lieu of the recent sell-off, the DIY investor at home often panics and sells off a lot of his holdings impulsively as the fear in the marketplace gets the better of him. To help protect an investor from himself it’s usually wise to understand the companies he owns and why he bought them in the first place. That in fact might be a better way to achieve a margin of safety than to just blindly diversify his holdings into a lot of companies he doesn’t understand.

The first step in building a margin of safety is to research the company.

There is a plethora of literature available for anyone who is interested in learning how to analyze a company…Read the financial statements. Since the passing of the Safe Harbor Act in 1995, U.S. companies have been incented to provide timely and accurate financial statements in their 10-K, 10-Q, and proxy statements. The 10-K and 10-Q (annual and quarterly reports) each provide three financial statements: income statement, cash flow statement, and balance sheet. There is plenty of information available in these three statements to allow an investor to thoroughly understand how the company operates. The proxy statement discusses management compensation. A brief examination of the proxy statement will offer great insights into how top management compensates itself.

For investors who are seeking a deeper understanding of the company, there are many more questions to pose. Has the company increased its earnings, revenue, and cash flow consistently over the long term? Is it in an industry that has long-term growth potential? Is the management team stable and experienced? Has management laid out its goals and milestones? Has it delivered on those milestones? Has it been successful in expanding its services or its product line? Has the company treated its shareholders fairly?

Recent changes in the disclosure laws plus the ubiquitous Internet have given individual investors the ability to easily access and read transcripts of quarterly management conference calls and corporate presentations to institutional shareholders. These transcripts often give investors valuable clues into the mindset of top management. There is no excuse today for any investor, large or small, to be insufficiently informed on any public company.

Benjamin Graham and the Power of Growth Stocks,

Frederick K. Martin

The Financial Media, Market Indexes and the 10 Year Treasury Bill

The Financial Media, Market Indexes and the 10 Year Treasury Bill

If you don't control your own thinking, someone else will control it for you.

Neville Goddard

Price is a function of supply and demand characteristics, which are often influenced by the news of the day and short-term results. This has always been true, but is even more so today with social media, the 24‑hour news cycle and all the information available to investors. Value, on the other hand, is the net present value of future cash flows based on assumptions for growth, discounted at an appropriate interest rate. The Price of a publicly traded security is often not the Value of it. The trading Price is known daily. Value takes knowledge and experience to fully define, and is more often an art than an exact science.

Bruce Flatt, CEO of Brookfield Asset Management

You encounter life with your attention. Attention is awareness, mindfulness, and watchful consciousness. When millions of people focus their attention upon listening to the same words, seeing the same pictures, and hearing the same descriptions, tremendous energy is generated and a massive thought-form is created (many bodies sustaining the same belief.)

The financial media wants to capture your attention so they can expand their viewing audience and in doing so, attract the attention of advertisers who will in turn pay them for the privilege of obtaining access to that viewing audience. In this way the advertisers and the media both make money…at your expense.

The media captures your attention by preying on your worst fears by manipulating you into believing something that at its core is not true. The following illustrates two examples of misinformation involving interpreting market behaviour and interest rates.

Market Indexes do not represent the market. Many of them are capitalization weighted meaning that a handful of huge companies can move the whole index all by themselves. A much better barometer of the health of the overall market is the momentum of market breadth. Momentum of the market breadth bottomed in late October and is currently higher now than it was then. In other words the worst is over and its now time to go shopping the same way one would when the supermarket is running a sale, only in this case many of the stocks of public companies are for sale.

The last couple of months the media have been sounding the alarm of rising interest rates, indicating that it is bad for the return of stocks going forward. The risk free rate I watch is the yield on the 10 Year Bill. When you get a chance go on the net and take a look at a long term chart of the yield of the 10 Year Bill. You will be shocked how low it is relative to its history. In other words the discount rate for a company’s future cash flows is still very accommodative

David Driscoll is a Smart Guy…But

David Driscoll is a Smart Guy…But

I think you have to find the right approach to investing that fits into your own psychological makeup. One size may be a good fit for a lot of people, but not for everybody. I write this blog for DIY (do-it-yourself) investors at home, but I really write it for myself. I’ve always been unconventional and prefer to go my own way. I’ve read a lot about the markets both before I started to invest and after. It’s a passion for me and I find it endlessly fascinating. The markets are a dynamic, multifaceted, sometimes contradictory phenomenon that is constantly in motion and changing its shape. What follows are some basic truths I’ve come to believe in at this point in my investing life.

I believe in buying and holding positions for long periods of time. I believe in running a concentrated portfolio where you know what you own on a fundamental basis. Volatility is not risk, its noise and if you invest for the long term you can safely ignore it. Permanenetly losing money is the risk I'm concerned about. Volatility is something I believe you have to embrace as a long-term investor. It is not something to avoid (that is how most people think.) People are frightened by volatility because they are not familiar enough with what they own in their portfolio. Accept volatility and concentration. To me diversification is the bane of performance. Know what you own and why you own it. I haven’t always followed this rule and when I haven’t I have regretted it.

Running a portfolio is a solitary activity. Don’t discuss it with other people. They will only impose their own biased opinions on you and create doubt in your mind. I prefer to make my own mistakes. I can live with that. And when I do make a mistake, I try to learn from it. Leave your decision making uncontaminated and develop your own sources of information.

I’ve developed a knowledge base that has deepened and widened over time…and as it has evolved my intuitive powers have heightened and have come more and more into play. Maybe some news item might trigger a thought process that develops into an investment opportunity. Investing is more of an art form, not a science. Leave the quants and propeller-heads with their algorithms and spreadsheets...along with their under-performance.

I’ve learned to exploit the edges I think I have over my competition; both informational (utilizing  underused information) and emotional (knowing and observing my own behavior under emotional extremes).

Maybe most important of all, I try to be different because I am different. We all have hidden resources within ourselves which we can utilize once we get out of the ‘victim’ mentality...Every individual investor has to find his own truth.

David Driscoll on BNN-Bloomberg’s Market Call – Dec 07, 2018

David Driscoll on BNN-Bloomberg’s Market Call – Dec 07, 2018

David Driscoll both educates as well as invests in the markets. I don't always agree with what he says but he is always worth listening too. the following piece lays out a good part of his investing philosophy.

MARKET OUTLOOK

Given the sharp drop in equity markets since Oct. 1, it’s certainly a wonderful thing to be holding 20 per cent cash multiplied by the equity weight in clients’ portfolios. Despite not being fully invested, our client equity holdings are up this year while the market is down. The difference is what’s known as “alpha.” If an investor is up five per cent and the market is down five per cent, then the alpha is 10 per cent. That’s the way to evaluate a portfolio manager. If their alpha is consistently greater than two per cent or more each year after fees, you’ve got a good portfolio manager.

The reasons behind our positive alpha are:

 1) The stocks in our portfolios are companies that generate consistently rising free cash flows. They have the financial flexibility to deal with whatever the macroeconomic environment (slower growth) or politicians (tariffs, trade wars) throw at them. As a result, we have no need to trade these stocks and then incur transaction costs and capital gains tax. Instead, the clients can keep the nickels and dimes for themselves while never missing out on a dividend payment. Remember: two thirds of all performance comes from rising dividends and the re-investment of those dividends, not stock price movement.

2) We have a fully diversified, global portfolio (both stocks and bonds) with no correlation risk. Each of the 30 stocks in the portfolio is out there in the world doing its own thing and not competing directly with other stocks. We own one Canadian bank (TD), not all six of them. Since the Canadian banks’ price performances have all been negative in 2018, we’re not suffering from their underperformance.

3) We currently hold 20 per cent cash times the equity weight in the portfolio. For example, if the asset mix is 60 per cent stocks and 40 per cent fixed income, the cash holding is 20 per cent times 60 per cent, which equals 12 per cent cash. If it’s an all-equity portfolio, the cash weight is 20 per cent. Cash is known as a “synthetic short,” meaning if you’re 80 per cent in stocks and 20 per cent in cash, your equity exposure is only 60 per cent (80 per cent minus 20 per cent) and you won’t go down with the market unlike investors in index funds or ETFs, who are suffering the full brunt of this current equity sell-off.

4) Our portfolios all have a weighted average portfolio beta of less than one. This means less volatility relative to the market. If an investor had a portfolio of only semiconductor stocks whose betas are around 1.50, their performance would be 50 per cent worse than the market indexes. For example, if the market was down 10 per cent, they’d be down 15 per cent.

5) The dividend growth among the Liberty global stocks has averaged 15 per cent in 2018: about double the historical average of all publicly-listed stocks worldwide. This helps the portfolios to provide both income and growth. The faster the income grows, the greater the downside protection it provides. This is because that dividend income is guaranteed and provides cash for future purchases in a down market at cheaper prices.

6) Our bond portfolios are laddered. Think of each rung of a ladder as a year in which a bond matures. If a bond matures each year from 2019 to 2029 and interest rates rise, there’ll always be a bond maturing that can be rolled over into a higher coupon instrument. This is known as bond immunization. Think of it as an annual flu shot against rising rates.

7) If you own fixed income it’s important to own some inflation-protected bonds. For our clients, we have five per cent of the portfolio allocated to these types of bonds. They’re the only instruments that protect you from inflation on the fixed income side of your portfolio. If you own the Canadian three per cent real return bond (RRB) due in 2036, the coupon is three per cent plus the inflation rate (currently 2.4 per cent in Canada), for a total payout of 5.4 per cent for 2018. Given the current inflation rate, investors in short-term bonds or GICs are earning a “real return” (after tax and inflation) that is negative; that means their spending power is declining, not rising.

8) Being invested in international securities (stocks and bonds) gives you protection against a drop in the Canadian dollar (currently down about five per cent this year against the U.S. dollar). While some may say they don’t want to be invested in European markets or emerging markets, it’s an imprudent comment. Year-to-date, our European stocks are up three per cent while the comparable benchmark is down 11 per cent and our investment in Jardine Matheson,  a company with subsidiaries in Southeast Asia, is up 10 per cent against the Asia-Pacific indexes, which are down anywhere from four per cent (Japan) to 21 per cent (China).

If you own a fully diversified global portfolio, then you have nothing to worry about regardless of what’s happening in the stock markets today.

Price versus Value

Price versus Value

Price is a function of supply and demand characteristics, which are often influenced by the news of the day and short-term results. This has always been true, but is even more so today with social media, the 24‑hour news cycle and all the information available to investors. Value, on the other hand, is the net present value of future cash flows based on assumptions for growth, discounted at an appropriate interest rate. The Price of a publicly traded security is often not the Value of it. The trading Price is known daily. Value takes knowledge and experience to fully define, and is more often an art than an exact science.

Bruce Flatt, CEO of Brookfield Asset Management

Read the above very carefully. When the markets go down sharply as they did yesterday, it is a time to buy stocks, not sell them. Avoid getting emotional and stay rational. It’s the only way. At times of emotional extremes, be contrary. Tune out the mindless media who are more interested in attracting advertising revenue by selling fear and catering to the worst instincts of the retail investor. Read Howard Marks or the public disclosures of great CEO’s like Bruce Flatt. Remember why you bought your holdings in the first place. The short-term price movement of a security is as fickle as the attention span of a goldfish. Now is the time to buy quality at a discount price. The chances of doing that now are much greater than they were two or three months ago. Think long term and be aggressive while others are running for the exits. And if you have little money to invest right now, just hold. Six months from now, you’ll be glad you did...Demand Supply...

Stephen Takacsy on BNN-Bloomberg’s Market Call – Dec 03,2018

Stephen Takacsy on BNN-Bloomberg’s Market Call – Dec 03,2018

MARKET OUTLOOK:

Over the past few months, we finally saw a massive sell-off in stock markets led by the U.S, which we believe is a healthy and long overdue correction. The U.S stock market was disconnected from the rest of the world (which was already struggling), with rich valuations led by a small group of tech stocks, and an escalating U.S-China trade war to start which were going to start having an impact on corporate earnings. There were also increasing financial risks from rising interest rates, potential wage inflation from a tight labour market and higher cost imports subject to Trump’s tariffs. Also, there were other signs of a market top as evidenced by various speculative manias such as cannabis stocks and cryptocurrencies which have been crashing in value.

However, the sell-off was magnified by algorithmic trading, momentum and quant funds selling, and retail panic selling from margin calls and ETFs. This explains a lot of the volatility we've have been seeing on an intraday basis. Also, the Canadian stock market has been suffering from institutional outflows due to our energy sector challenges. We’ve seen indiscriminate liquidation exasperated by current tax loss selling which has created huge opportunities, particularly in the small and mid-cap sectors. There are many great companies trading at historic low valuations despite record results and strong prospects. Also, some higher-yielding dividend stocks and preferred shares have dropped to very attractive levels as a result of the rise in interest rates.

TOP PICKS:

CENTRIC HEALTH (CHH.TO)
Last buy around $0.25

Centric is one of Canada’s largest specialty pharma providers of medication and healthcare services to senior residences serving 31,000 beds. A new CEO from Cardinal Health was recently hired to improve profits at the pharma business which was recently impacted by drug price reforms in Ontario and Alberta and its sale of non-core assets to pay down debt. Centric also announced an agreement with Canopy Growth to supply medical cannabis to senior communities and is launching a revolutionary automated drug delivery device for seniors living at home called Karie. The company is one of the best bargains on the TSX. Once the surgery clinics are sold in the next few months and the pharma profits start to increase, the stock could easily double. The technology investment in Karie alone could be worth more than Cnetric’s entire market cap which gives it additional upside. The stock is trading at under six times earnings before interest, taxes, depreciation, and amortization (EBITDA) pro-forma asset sales.

VELAN (VLN.TO)
Last buy around $9.00

Valen is an Industrial valve manufacturer is based in Montreal and is the world leader in nuclear valves. After a few down years, backlog has been growing and management is focused on improving margins through production efficiencies and selling higher value added products. Velan is a classic value investment trading at a massive discount to tangible net book value. The strock trades at $9 versus a tangibale net book of $17 and has $3 per share in cash. We don’t think the company should remain public. Instead, it should be sold to a large multinational player in order to be competitive on a global scale. If Velan were to be sol to a larger stategic player,  the stock should be worht $20. 

NFI GROUP (NFI.TO 1.16%)
Last buy around $38.00

NFI Group is one of three major manufacturers of transit buses and motor coaches in North America. The stock is down nearly 40 per cent in the past few months and yet it released record profits. While growth has slowed from acquisitions and the multiple has contracted, backlog is strong and margins are steady with little impact from tariffs. NFI is also a leader in electric buses. This recession proof business is trading at under 10 times earnings. It also has a 4 per cent dividend yield. We expect this company to continue growing its earnings per share and the stock to move back into the $50s.

Stephen Takacsy, Lester Asset Mangement