Three buckets
There's a couple of interesting posts I want to touch upon. Valuhunteruk
wrote:
To state it simply, it isn’t about just buying stocks with low P/Es or P/Bs. We have to keep an eye on risk and the fundamental quality of the business we are buying into.
My response was generally along the lines that it's a contradiction in terms. Aswath Damodaran sums it up perfectly: the PE ratio is a combination of the risk-free rate, the expected growth rate, and the risk. In other words, TCG (Thomas Cook) isn't on a PER of just over 1 because the market somehow forgot the ticker symbol, it's on a PER of 1 because the economy is going into the tank, it's making losses, business is expected to decline, and it has being trying to prevent breaches in its banking covenants. So the question isn't so much "is it a business with a good fundamental quality", but "is it underpriced". The first question is easy to answer: no, it's a rubbish business with deluded rubbish managers. The second question is harder to answer. For all I know, the intrinsic value of TCG is zilch nada, making the share overpriced rather than underpriced.
Expecting Value also did a
review of his value portfolio in December, and found underperformance. He sums up:
The fact I think the market is mispricing these companies is evident by me purchasing them; I wouldn't do it otherwise. Since it mispriced them then, there's no reason to think that me buying them will magically reconcile the price with the true value; that could take years.
Value investor Richard Beddard also
expressed his frustration recently. His T30 (Thrifty 30) invests in micro-caps. In the period from 09-Sep-2009 to 01-Dec-2011, his performance is a whisker ahead of the All-share. I hope Richard doesn't take it the wrong way when I say that, so far, his theory that micro-caps are under-researched and hence should produce a higher return hasn't been a convincing one so far. I'm also worried that he hasn't properly adjusted for the high spreads that are inherent in micros.
More bad news for value investors comes in the form of Stephen Bland (aka Pyad) over at The Motley Fool. I can't find the link, but at the latest update, he was underperforming the indices. I used to think that Stephen was an excellent investor, but he has decreased in my estimation considerably.
"OK Mr. Smartypants, how are you doing so far this year?", I hear you ask. My response is "Stay tuned". I'll write about it in another post.
I'm now tending more and more to think of the stock market as consisting of 3 buckets: a "value bucket", a "defensive bucket", and a "growth bucket" (my experiences with insurers and banks is particularly solidifying my view - but like I say, it's for another post). Out of mathematical necessity, one bucket has to underperform the averages, whilst another has to outperfrom. So far this year, we've certainly seem that the defensives have outperformed value, with growth being amongst the outperformers, too.
My view now is that in order to outperform, you either need to own the right bucket, or you need to pick the right companies within your chosen bucket. There are advantages and disadvantages with both approaches. "The right bucket" requires two things: that the bucket is wildly mispriced, and you can know it is mispriced. If you can settle that question, then you merely have to choose the contents of the bucket at more-or-less at random. It doesn't matter what you choose (within reason, of course), you just need to choose a selection of them. This is the easy approach. It requires little imagination, and the worst that will happen is that you'll underperform the market somewhat. If in doubt, just choose the value bucket, or possibly the defensive bucket. The other approach is to choose the right companies in whatever bucket is your preferred one. The problem here is that you'll need to be a genius-level Mike Burry insight with Aspergers to do that (don't leave out the Aspergers, that's your structural advantage!). Very, very, difficult, as the people I've mentioned above have discovered.
We've still got a question to answer: which bucket should I choose now? Well, it's tricky! Value has taken a pounding lately, so it's plausible to answer that they'll be a dash for trash, and you should choose the value bucket. I see that Barclays and Lloyds are up nearly 2% today (did you guys buy those banks?) despite all the doom and gloom surrounding the financial situation in the Eurozone. Some of the really beaten-up stuff is making a strong recovery (Pace is up 30% over the last week or so, and it's up over 5% today).
But I don't think value is the right way to bet at the moment, despite this. I'm thinking of two factors here. For starters, take a look at AAPL (Apple). It is trading on a PER of 14. It has cash of £26bn against a market cap of £363bn, a forward PE of 10, massive returns on equity of 41%, and net income margins of 23%. That such a large, strong, profitable growing company is trading at these kinds of multiples suggests to me that growth is very cheap, and that we should buy growth. There actually seems to be some gross mispricings in the US markets, more obvious even than in the UK markets. MSFT (Microsoft) is on a PER of 9, yet it too has massive returns on equity, and even better margins than AAPL. I'm not saying that MSFT is a better growth company; but I seriously doubt investors will do badly buying into these kinds of companies. BRK (Berkshire Hathaway) is on a PBV of about 1, the lowest its been in way over a decade.
The second factor (all of the above was just the first factor, believe it or not), is simply an elaboration of the point above. In a previous
post, I concluded that the relative PBVs of value and growth shares put the odds in favour of growth - with the caveat that I might have misinterpreted Grantham's method of measuring the values. In another
post, I also said that the combination of VIX and the CBOE Put/Call ratio indicated that growth would be the more successful strategy - again subject to the caveat that I had misinterpreted information.
I'm also mindful of the fact that if economic conditions deteriorate, as is looking increasingly likely, then value is going to be the worst place to be. It's not all a one-way bet, of course, because the problems are well-understood, and if the Euro manages to magic away the problem "until next time", it's likely that all the junk will rise to the top.
Good luck one and all. I hope no-one has taken offense. If it's any consolation, it's been no picnic for me either. Happy investing, and let's hope Santa brings us a nice rally.
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