On behalf of our Chief Investment Officer Tim Travis… In a world where data of just about any kind is literally seconds away with a few strokes from your fingertips, it is not hard to get swallowed up in the hysteria of short-termism, in relation to your investment approach. The term “investing” means purchasing a security with the reasonable belief that it will be worth more in the future than it does in the present, based on your analysis of the facts. Benjamin Graham distinguished between the investor and the speculator with the following:
“The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.”
In a bull market, many market participants view themselves as investors when their practices are far more speculative in nature. A perfect example is buying stocks that have surged in value based on a “hot” technology and little basis on fundamental investment principles. 3D Systems (DDD) is a great example of a glamourstock that traded at a P/E of 100 for a period when speculatorscouldn’t get enough of the stock; the stock has since fallen off dramatically, with the potential to dive much deeper. To really invest successfully, it is important to think about what the world will likely look like in 3-5 years and attempt to buy securities that trade at very large discounts to what their intrinsic value is due to short-term problems. This practice is known as a “time arbitrage.”
Looking at the market right now, we have a very average to below average economy, while Europe is in much worse shape. Slow growth companies in various industries such as Consumer Staples or Pharmaceuticals trade at above average price to earnings ratios based on the hunt for yield in a low interest rate environment. Bonds are as unattractive as they have been in the last 300 years, yet buyers still flock to them because of a lack of investment opportunities. Social Media stocks are another glamourarea with a variety of companies trading at 10-15 times sales, prices at which an incredibly small amount of companies have been able to justify such a valuation historically. These speculative strategies designed to take advantage of price fluctuations may or may not work, but the odds generally lean towards permanent losses of capital when the balloon pops.
Alternatively, we live in a world where many of the largest and most important financial institutions in the world can be had at a discount to their net assets. The majority of these firms’are overly-capitalized, but have been hit by a deluge of lawsuits and penalties from an administration that clearly has an agenda to squeeze as much out of the big banks’as is possible. Increased regulatory costs and higher capital ratios have diminished returns on equity, while a bureaucratic regulatory process has forced companies to hoard capital, at the expense of dividends and stock buybacks. Looking three years out, many of these issues will be in the past. There will be a new administration in office and most of these lawsuits that relate to securities sold 7-9 years ago, will be distant memories. These institutions will be dramatically increasing their dividends and buying back stock, as improved returns on equity and robust capital ratios will easily allow it. If interest rates rise, net interest margins and investment income will improve, providing a further tailwind towards generating higher returns on equity. All of these factors lead to a very real likelihood of dramatically higher stock prices and a low likelihood of permanent losses of capital.
Another example of an attractive opportunity in the market is what is occurring with Russian stocks, due to the political upheaval in the region. Now don’t get me wrong, Russia has absolutely massive issues and war is a possibility. With this said, many of the most important companies in Europe that are headquartered in Russia, trade at 2-3 times earnings with 6-8% dividend yields that are easily covered by free cash flow. Russia’s corporate governance issues preclude us from making these huge portfolio positions, but the fact is that not a lot has to go right to make a lot of money on these stocks! Of course, they will be volatile and I assure you that I have no aptitude at picking the bottom, but distressed investing is one of our core competencies and nothing is more distressed than Russia currently.
A lot can change in three years and while I don’t have acrystal ball, investing in companies that are deeply undervalued based on short-term issues has been a key to success for us and many other value investors. It certainly takes courage, discipline and a strong stomach, but the rewards can be quite rich. Never forget that we are investing money with the full knowledge that there will be wars, there will be political chaos and there will be recessions. Markets will drop 20-30% at some point and many stocks will drop by 50% or more each year. When the value investment discipline is competently employed and as long as investors don’t panic based on news headlines, I’m confident that the next three years can provide quite attractive returns to us, despite the fact that I don’t believe the equity or bond markets in general will perform very well over that same period of time. Time will tell.
If you would like a free portfolio review to see where things stand with assets held outside of T&T Capital Management, I’m happy to personally provide that service and can be reached at 949-630-0263. Thank you very much!