Some returns from value 'legends' in 2015

All of these people have very impressive long-term track records. 2015 was fairly tough for many of them.


2015.pdf (106 KB)

It’s not always easy to spot when the trends shift and things don’t work any more.

I mean not to say that value is not working any more, but maybe the specific ideas by those individuals tumble or it is maybe the value style that has a hard time. Next year, we will be a little smarter about what worked and what didn’t in the upcoming twelve months :wink:

Lower valuation metrics work only all else being equal, and the all else includes R, required rate of return (based on interest rate and risk) and G, expected growth. This derives from the dividend (D) discount model.

  1. P = D / (R - G)

In the real world we adapt, and one important adptation is use of E (earnings) in lieu of D. It’s a fictious assumoptipon that all earnings accrued directly to shareholders who opt to reinvest some or all back into the business. Therfore . . .

  1. P = E / (R - G)

Solving for P/E . . .

P / E = 1 / (R -G)

In 2015, expectations of rising interest rates and risng risk were conspicuous.That raises R, thus pushing P/E down. Unless offset by rising G, stocks decline.

Value strategies that don’t effectively capture rising G expectations and/or diominishing risk (often translates as increased Quality) have to have sufferred last year.

Marc,

Nice. When will declining growth expectations–independent of quality–start to affect the equation and many of the growth companies? Or do you see this happening?

Near-term estimates are already starting to come down but it’s too ear;ly to tell how sustainable a trend that will be.

What’s interesting – and a big reason why investing is so challenging – is that R and G often pull the equation in different directions. R is most likely to rise due to the interest-rate component – as G rises (the reason why rising rates do not have to push stocks downward, although it undoubtedly will in the early stages since there’s a large portion of investors who were still toddlers that last time we had sustainable rising rates and were raised on the combination of Sesame Street and the belief that stock can’t go up unless rates fall). What makes it even more challenging is that assuming R rises because G is going up, at some point there may be a self balancing aspect as risk is perceived to diminish. So with things in the same equation and even the same variable pointing different ways, that’s where the “science” of investing sits down and the “art” takes over. The latter involves identifying which of the various influences is making itself most felt at a particular point in time. For me, I think it’s the interest-rate component of R and that’s why I’m cautious at the moment. The risk component probably ranks 1B (see, e.g., oil, China).

Thanks Marc. Interesting.

Marc, I have a feeling that all of the investors on Tom’s list are looking at their investments in a different, albeit related, light. I think they depend more on what Mr Market has missed or overlooked and not on the theoretical underpinnings of all stock prices. I think both approaches try to find the same thing, undervalued assets, but from completely different directions.

The theory doesn’t necessarily describe what they’re looking at. It describes the mechanism through which factors (company specific and external) influence stock prices – and lately, those factors have provided a strong headwind into which value strategies have had to fly.

Generally speaking, a successful value strategy is about information arbitrage. Value is not about low ratios. It’s about ratios that cause stocks to be mis-priced by the market in light of what one thinks G and R (and their respective drivers) are likely to be; i.e. security mis-pricing based on the difference between what is likely to be versus what the market presumes (openly or implicitly) is likely to be. Mis-pricing occur all the time. remember from the seminar that P <> V. It’s P = V + N.

I’m sure everyone on the list would agree with this although they might use different language to describe it. I know Buffett’s approach pretty well and know he’d agree. Note that he doesn’t consider himself a pure value investor. If anything, he thinks of himself as a growth investor (the thing he says most often is that he emphasizes growth in book value). The value label is really just something that got attached to him. He’s quality (stability, predictability, managerial competence, etc.) first and value second. You might call it QAAP (Quality at an Acceptable Price). Others call it “Betting against Beta” (not against the theory but in favor of an aberration in which low beta stocks often outperform high beta because the market fails to correctly appreciate the workings of the risk/quality component of R. But again, Buffett uses different verbiage; he’s so anti academic jargon, he’d probably dump a Dairy Queen fudge sundae in the lap of anyone who said Beta to his face. :slight_smile:

Bill Ackman, Feb 2010: “As a result of overdiversification, their returns get watered down. Diversification covers up ignorance.”


Makes me feel a bit better. Over the past 14 months, I’m down less than 1%. Watching my account is like watching paint dry.

Walter

Diversification! I should have known. I thought it might have something to do with all the man hours squandered getting personal about one stock. Silly me.

Walter 1% down the last 14 months in this market is a good result.

Ackmann could not be wrong more! One of my best strats has 100 Stocks and does very well!
Buy hey, he can not buy micro caps I guess, since his size should be bigger :-), poor guys that
have so much size, they can not use the size effect anymore :wink:

I get an error from acrobat reader (“file not supported or damaged”) when trying to open the original pdf from Tom.

Not sure if it is just me - but would anyone who has been able to access and open it kindly repost?

Thx

Jerome