I found a wonderful article on the famous and enormously successful value investor Howard Marks that I thought would be helpful to pass on to you. The current stock market is filled with media and speculator darlings such as Tesla, 3D Systems, Facebook and LinkedIn. There are numerous other stocks trading at absurd earnings multiples and valuations. A great example of the froth in the M&A market is the recent $19 billion acquisition of WhatsApp by Facebook. This is a company that hardly generates any revenue and has only losses to show for itself. Small cap stocks in particular are trading much more expensively than historical averages.
In this market, we at T&T Capital Management (TTCM) have taken a very different approach. Six of our seven largest positions trade below book value. Our top two positions trade below the even more conservative metric, tangible book value, which is a proxy for liquidation value in many cases! Our utilization of cash-secured put selling actually serves to further reduce the risk and will allow us to dollar-cost-average if the market were to decline. The point of this article is that there is no safety in doing what everyone else is doing. We take concentrated positions in businesses that we understand thoroughly and that possess a significant margin of safety because of the bargain prices that we are acquiring them at. At some point, there will be a reckoning for all of the speculation that is out there. Year five in a bull market is not the time to get on the bus but instead is the time to focus on the few areas that are highly undervalued and are likely to experience earnings and margin growth. These are the stocks that we are invested in and are a primary reason why I believe that our out performance is likely to accelerate over the next 3-5 years. Time will be the ultimate measuring stick but I’d urge you to carefully evaluate your exposure to long-only mutual funds, as their past performance over the last five years is not likely to repeat itself and will likely be quite disappointing in my opinion!
“When Marks joined Citibank in 1969, the company — along with other big New York banks like Chase and JP Morgan — practiced ‘Nifty 50′ investing, he said. They emphasized buying the stocks of the 50 highest-quality, fastest-growing companies in America, which at the time included Xerox, IBM, Kodak, Polaroid, Merck, Textron and Coca-Cola. “The official dictum was if you were buying the stock of a good enough company, it didn’t matter how high a price you paid.” But it did matter, Marks noted, and people were paying about five times what the stocks were worth. “By 1973, the people who held those stocks had lost 90% of their money.” The Nifty 50 stocks eventually became an often-cited example of unrealistic investor expectations.”
“What his career experience so far had told him was that with its Nifty 50 policy, Citibank had invested in “the best companies in America and lost a lot of money.” Then it invested in “the worst companies in America and made a lot of money,” Marks noted, adding that “it shouldn’t take you too long to figure out that success in investing is not a function of what you buy. It’s a function of what you pay.” An asset of high quality, Marks pointed out, can be overpriced and be a bad investment; an asset of low quality can be bought cheaply and be a good investment.”