Diary

Joel Greenblatt on the markets
Market Folly has an article on Joel's presentation from the value investing congress. Here were some of this observations:

A week ago, the Russell 1000 had average FCF of 9.2% (in the 94th percentile toward cheap!) Looking backwards, cheaper than 94% of periods over the last 20 years and that correlates with a 15-20% return over next one year (market up 5% over week since slide finished) "on only 10-15% left, but still pretty nice."

Also worth noting:

Arguments against stocks being cheap (playing devils advocate): one argument is that we are at peak operating margins, but he showed a graph that indicated it is unclear what the real mean operating margins should be. The second argument is return on tangible capital continues to climb. In addition, outsourcing of factories, moving to a service economy, so tangible capital may not be the right way to look at it, and again it's unclear where the mean level is. He also showed a graph of tangible capital per dollar in sales is declining to 35 cents from 50 cents, 20 years ago.

One company he mentioned in the value 1000 was Gamestop (GME) - the UK equivalent would be GAME (GMG) - which has been "doing the rounds" lately. The implication was that GME was a buy (together with Hewlett Packard) because of the possibilities of assymetric returns.

Interestingly, Jim Chanos also did a presentation at the conference on "how value investors can avoid value traps", in which he declared GME a short. (I think it's worth remembering that Whitney Tilson declares that his greatest shorts are faltering companies with weak balance sheets - the kind that a typical value investor might be inclined to buy - rather than overpriced companies with a lot of momentum behind them). On the positive side, Chanos states:

Value Stock Traits: Predictable, consistent cash flows, defensible business, don?t need superior management, low/reasonable valuation, margin of safety, reliable transparent financial statements, "analyzable."

What he says to be shorting themes are:

• booms that go bust, debt-driven asset inflation
• cyclicals that ceome secular, e.g. autos, airlines
• overly dependent on one product e.g. renewable energy
• illegal does not equal value - "they often look deceptively cheap". Online poker (oh dear)
• consumer fads
• technological obsolescence "probably killed more value investors in last 20 years than any other". Minicomputers, Eastman Kodak, Video rental. The cash flows drop off faster than you think they do. At some point, cash flows hit a tipping point, and drop precipitously.
• structurally flawed accounting. Be "triply careful" whenever management pulls out some metric that they define - such as cash flow. Be careful when they keep pointing to a metric they like.
• selling $1for $2
• rapid prior growth. "Law of large numbers" Telecom build out example. When tech shift occurs, old metrics that value investors use are totally irrelevant
• marquis management - new CEO as saviour
• famous investors: in every disaster, there is usually a great investor in it all the way down
• growth by acquisition
• buiying low growth low PE businesses with expensive high PE stock - huge red flag. Be careful when you see big write-down because management is claiming to be conservative

Read the full article for why he doesn't like some integrated oil, Gamestop, and educational stocks. I like his take on GME: "Will appear cheap all the way down".

What readers will find interesting is that Carnevale, on 02-Sep-2011, at Seeking Alpha, issued a bullish statement on some of the stocks (or at least themes) that Chanos thinks are shorts candidates.