FAQ

The newsletter is called Quant Value and has a separate website.

Information can be found under the following links:

About the Quant Value Newsletter

Quant Value newsletter track record

Is there a place similar to the EDGAR database for European corpanies?

This is a problem I also struggled with. Unfortunately there is no simple solution as there is no there is no central financial statement database for all European Union or even Euro countries.

What you must keep in mind is that European companies have all the information in their annual reports. Not like US companies where the annual report is more like a brochure and you have to go to the SEC document to get the numbers.

You can try this website: https://www.orderannualreports.com

And if that doesn’t work just search company name along with the word “investor relations”. For example, Linedata investor relations

Many people throw around the term value investing without an exact definition of what really it means.

Since value investing has become so popular some funds will now call themselves value funds and be nothing of the sort. Some “value” funds own high p/e technology stocks that Benjamin Graham would have never considered anything remotely close to value stocks.

Of course the fund manager will say even at a 50 p/e the stock is still “undervalued”, this argument can be used to say any stock in the world is a value stock.

So the question is what really is value investing?
The first school of thought in value investing believes that there is no simple formula to investing.

With thousands of analyst covering the big cap stocks like MRK (Merck) and KO (Coke), you would not be getting more value by buying Merck at a P/E of 8 vs Coke at a 20 P/E.

This theory largely agrees to the Efficient Market theory, which states that the market incorporates all data immediately, and therefore you cannot beat the market. Many value experts including Bruce Greenwald, Seth Klarman among many others subscribe to this notion.

Seth Klarman in his book Margin of Safety states

“The financial markets are far too complex to be incorporated into a formula. Moreover, if any successful investment formula be devised, it would be exploited by those who possessed it until competition eliminated the excess profits. The quest fora formula that worked would then begin anew. Investors would be much better off to redirect the time and effort committed to devising formulas into fundamental analysis of specific investment opportunities.”

This value approach does not employ the classic low P/E, P/B, P/CF, high dividend yield etc. for security analysis.

But wait does that mean these investors believe in the efficient market theory, isn’t value investing a contradiction to the theory?

Of course they don’t agree completely with it, but they agree partially.

These value investors believe that you cannot gain an advantage by looking at big cap stocks followed by thousands of analysts. These investors believe the best way is to not fight the crowd but to look for value situations with high margins of safety in obscure places.

These include spin-off’s, bankruptcies, risk arbitrage and small cap stocks in general. These are situations where analysts are not covering and many institutional investors are not interested in and sometimes legally obligated to sell (e.g. some funds are obligated to sell any stock that goes under $5).

The theory sounds good but does it work?

The answer is a resounding yes.

Many of the most outstanding investors have handily beat the market for many decades using this approach including Seth Klarman and Joel Greenblatt.

Greenblatt states that spin-off’s on average have beating the market by a 2-1 margin.

Furthermore, he states that if you look for special value situations which occur in many spin-off’s you can earn much higher rate of return. Greenblatt employed some of these methods returning spectacular 50% annualized returns for over 10 years.

What is the the other school of value investing? I would call this the contrarian investing approach made most famous by David Dreman.

This approach believes that the stock market (especially in the short term) is driven by psychology.

The best value is in stocks with low P/E, P/B among many other methods to investigate whether a stock is over or undervalued. All this information is publicly available and is true for both small cap and large cap stocks.

So why doesn’t everyone just look for stocks with low P/Es and high dividend yields which can easily be found on a stock screener?

The reason is investors overreact and place too high a P/E on stocks that have experienced recent earnings growth in recent years.

High P/Es are also placed on certain sectors that are expected to do well over the coming years such as technology. When these stocks don’t match the earning estimates (or even if they match the estimates but investors are no longer willing to pay such a high premium for them since they fall out of favour), they can decline heavily in value.

Does this method also work?

The answer is yes, Jason Zweig in his commentary on the Intelligent Investor by Benjamin Graham states that over the 30 year period ending in 2002 utilities outperformed technology stocks.

Stocks with low P/E and P/B ratios have outperformed higher P/E and P/B stocks over long periods of time not only in America but in virtually every stock market in the world. The reason is that people think alike across the world. Amazon is a lot sexier than Altria, which is constantly stigmatized by lawsuits and laws restricting tobacco use, yet Altria has far outperformed Amazon over the past ten years.

Both value investing approaches are legitimate and provide an investor the chance to outperform the market.

Although by using the contrarian approach it is easier to find stocks that are potential investments, both require full analysis of financial statements.

The first approach is harder but most times the returns are much higher.

The most important thing to keep in mind about value investing is to always be disciplined and not driven by emotion, devote time to analysis before investing and to invest in undervalued securities with high margins of safety.

About the Author:
Jacob Wolinsky is a business major at Farleigh Dickinson University. He lives with his wife and daughter in Monsey, NY. He can be contacted at [email protected]

My portfolio composition to date has been quite simple. It consists of 25 to 30 positions, all more or less equally sized accept for cases where I bought more at a lower price.

In spite of studies showing that 15 positions eliminate 80% of company specific risk in a portfolio I arbitrarily chose 25 to 30 positions as I knew my selections were not perfect and I wanted a bit more diversification.

I hardly ever have more than 30 positions in my portfolio, as that is the maximum number of companies I can comfortably keep track of.

When doing research for this article I remembered a very good presentation Zeke Ashton of Centaur Capital Partners gave on portfolio composition and concentration at the Value Investing Congress in May 2007.

Zeke graciously agreed to let me use his presentation for this article.

Great value fund portfolios

The table below shows the composition of the portfolios of noted value mutual fund managers:

Source:www.morningstar.com as at 10 Aug 09

As you can see the portfolio concentration differs but they are all relatively concentrated with high percentage bets, up to 22.5%, in one company. This differs substantially from the 100 plus securities in most mutual funds.

Common Value Investor Portfolio Models

The following are several common ?portfolio models? used by successful value investors:

Ultra-Concentrated Portfolio Model

Definition

Fewer than 10 stocks with large position sizes routinely comprising 20-25% of portfolio assets and larger.

Practitioners

Chieftain, Eddie Lampert, Tom Brown

The 10 Stock Model

Definition

Standard position size of around 10%, though there may be one or two larger positions, and a handful of smaller positions for a total of 12-20 ideas.

Practitioners

Clipper, Mohnish Pabrai until the end of 2008, he now uses the 20 stock model below

Standard 20-Stock Model

Definition

Standard position size for a good idea is about 5%, though best 2-3 ideas may be modestly larger and many ideas are somewhat smaller. Total portfolio of 25-40 ideas.

Practitioners

Many of the value mutual fund managers in the above table: Robert Hagstrom, Bill Miller, Wally Weitz, Longleaf Partner, Tweedy Brown Value, etc.

20-Stock Model (Super-sized)

Definition

Essentially the same as standard 20-stock model, but two or three best ideas are ‘super-sized? to 10-15% of the portfolio, and there are fewer sub-5% positions. Total of 20-30 ideas.

Practitioners

Tilson Focus, Fairholme, Sequoia, Oakmark Select

The Centaur Capital Partners Portfolio Model

LONG POSITIONS

?

SHORT POSITIONS

The Reliability Pay-off

• Portfolio structure is not about reducing volatility, it’s about increasing reliability.
• You want enough ideas to ensure that your sample size is big enough to reward skill and absorb the occasional bad outcomes, bad decisions, bad timing, or bad luck.
• Adding in a mix of five to ten short ideas further improves reliability.

Maxims Regarding Position Size

• The goal for all investors should be to get the most value out of your best ideas without risking significant capital loss if you are wrong.
• Concentration isn?t a constant – it is idea and environment dependent.
• Your philosophy on selling will determine to some extent how many positions you hold at any one time.
• The more concentrated you are, the more rigorous you have to be and the more good ideas you have to reject.
• The more ideas you have, the harder you have to work.
• Diversification in terms of the valuation factors (Price/earnings or Price/book) also known as Factor diversification can be a good thing as it further diversifies your risk.
• Sample sizes matter. A certain minimum number of ideas is required to protect skilful investors from the capriciousness of luck and unexpected bad outcomes.
• If you can?t sleep well at night, either you don?t own the right stocks or you are running too concentrated a portfolio.

Practical Questions to Ask Yourself

• What type of portfolio is consistent with your portfolio and personal risk / stress tolerance?
  • Can you sleep at night if you have -10% months? or 25-30% peak-to-trough declines?
• What are your goals?
  • Maximum returns (with the assumption of significant volatility) or satisfactory returns within a certain risk profile?
• How many ideas can you process and maintain?
• What kind of ideas do you prefer?
• How stable is your capital base?
  • Are your investors prepared for significant volatility?
  • Do you have safeguards in place to protect your capital from fleeing at the worst possible time?
• Do you work best alone or do you prefer a team environment?
  • A team is going to generate more ideas than a solo practitioner.

Final Thoughts

?Confronted with the challenge to distil the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.?

Benjamin Graham, Intelligent Investor

Why is having a margin of safety important?

• Valuation is an imprecise art
• The future is inherently unpredictable
• Having a margin of safety provides protection against bad luck, bad timing, or error in judgement.
• We believe that the principle of ?margin of safety?is just as applicable to portfolio construction as it is to individual investment selection.

The positions in my portfolio has all, more or less, had the same weighting. Zeke’s article has however changed my view.

Thinking back there was definitely a few companies that deserved a larger position due to their undervaluation and business quality.

I am however still comfortable with my 25 position portfolio as, in spite of by best efforts and thorough analysis, I was still wrong on a few companies. This was in spite of what I thought was a high probability winner.

I will elaborate on this experience in a future article about my worse investment mistakes and what you can learn from them.

As Zeke mentions above, valuation is an imprecise art and the future is unpredictable.

Value Investing is the strategy of choosing shares that are trading at less than their intrinsic value. In other words, Value Investors look for stocks they believe have been undervalued by the market.

They believe the market overreacts to both positive and negative news, resulting in stock price movements that do not correspond with the company’s long-term fundamentals. The result is an opportunity for Value Investors to profit by buying when the share price is low.

Estimating intrinsic value

The central problem for Value Investing is how to estimate intrinsic value as there is no universally accepted way to obtain this figure.

Most often intrinsic worth is estimated by analysing a company’s fundamentals, particularly their financial statements. Look in particular at its debt ratios (debt levels should be low) and look for good cash flow. A company with manageable debt and good cash flow is worth getting to know better, regardless of how the market is treating the share price.

Some Value Investors only look at present assets/earnings and don’t place any value on future growth. Other Value Investors base strategies on the estimation of future growth and cash flows.

Despite the different viewpoints Value Investing means buying stock at a price less than its inherent worth. Value Investors thus select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields.

Margin of safety

A crucial aspect of Value Investing is “margin of safety”. This just means that you buy at a big enough discount to allow some room for error in your estimation of value.

What does a Value Investor look for in a stock?

The Value Investor looks for stocks with strong fundamentals – including earnings, dividends, book value, and cash flow – that are selling at a bargain price, given their quality.

The Value Investor seeks companies that seem to be incorrectly valued (i.e. undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation.

Value Investors look for value

Value Investing doesn’t mean just buying shares in a company where the price is declining and therefore seems “cheap” in price. Value Investors must research the company thoroughly and must be confident that the share is undervalued for some reason. It is therefore only ?cheap? in relation to its inherent value, or worth.

It’s important to distinguish the difference between a value company and a company that simply has a declining price. For example, if a company’s shares have been trading at about $35 for a year, but suddenly drop to $15 per share, it does not automatically mean that the share is a bargain. All you know at this stage is that the company’s shares are trading at a much lower price than a year ago.

This drop could be attributable to the market reacting to good or bad news (such as the appointment of a new CEO), or it could reflect a fundamental problem in the company.

To be a real bargain, this company must have healthy fundamentals and its inherent value must be more than $15. Value Investing always means comparing the current share price to intrinsic value, not to historic share prices.

Buying the business, not the share

The Value Investing approach is to view a stock as the means by which the shareholder becomes a part owner of a company. Value Investors make their profits by investing in quality companies, not by trading in shares.

Look at the worth of the asset, and don?t get distracted by external factors such as market volatility or day-to-day price fluctuations. These factors are not inherent to the company, and therefore don?t have any effect on the value of the business in the long run.

Example of Value Investing

One of the greatest investors of all time, Warren Buffett, has proven that Value Investing does work. He took the stock of Berkshire Hathaway from $12 a share in 1967 to $70,900 in 2002, thus beating the S&P 500’s performance by about 13.02% on average annually!

Other interesting Value Investing articles can be found by clicking here

PS If you would like to get quality value investment ideas each month take a look at my newsletter.

PPS It costs less than a cheap lunch for two each month and if you do not like it you get your money back, why not sign up right now while its still fresh in your mind?

My track record has moved but can be found by clicking on the link below:

Track Record

We do not have a fixed source of investments. We try to remain as open as possible to new ideas.

In the past my ideas have come from:

• The screening of stock markets world-wide using time tested investing criteria such as low price to earnings, high return on equity, low debt and low operating profit to enterprise value.
• Interesting companies read about in books, magazines or internet
• Unusual companies mentioned by family and friends
• Following investments of fund managers we admire
• Discussions with fellow investors and newsletter readers

We however know our limits and do not invest in companies we do not understand.

Once we have identified an interesting company we conduct a financial analysis which consists of the following:

• Analise the company using a minimum of five years of financial data

• Work through a check list of more than 20 points which we have put together over many years of reading and practical experience

• Check list allows me to quickly identify where we have to dig deeper into the financial statements of the company

• We focus strongly on cash flow as it is less prone to accounting manipulation and is the real life blood of any company

• We avoid companies with high levels of debt preferring companies that are not capital or asset intensive that generates a lot of free cash flow

• Should a company pass our checklist we read through the annual, interim and quarterly financial reports to get to know the management and the business of the company

Only once we are satisfied with all of the above do we invest