The title, by the way, is a full sentence. (It's not imperative, either.)
Noun, verb. Value perverts. It changes the way you think about investing in very strange and dramatic ways. The realization dawned on me a couple of days ago as I watched my portfolio tick green for a change, and I found myself wishing to see red. A lot of red. Big red.
What kind of an idiot looks at a couple-percent increase in his net worth and wishes for a nice market freak-out instead? The kind of investor who's been perverted by value. Don't call us value pervs, please. OK, if you must. But try VP. It just sounds better.
Here's the thing: VPs love a sale price. There's nothing like making an easy buck when investors flee a good company. A briefly wounded elephant like Nokia (NYSE: NOK ) late last summer, or Select Comfortfalling and recovering from its bogus mold scare, changes your attitude. Once you've taken advantage of Mr. Market, you want to do it again and again.
Mr. Market is a freak
What's that? You never met Benjamin Graham's mythical Mr. Market? Let me describe him to you. At best, he's a fickle beast, prone to fits of dizzy optimism and periods of unwarranted despair. Some days, he'll ask you to pay 50, 60, or 100 times earnings for an unproven upstart of a company. Other times, he'll beg you to take something off his hands for less than eight times its earning potential, maybe even for less than liquidation value. I have an uncle who wears foil hats and thinks the government is controlling his mind with space rays. Mr. Market is the crazier of the two.
Casual investors think his fits are the primary danger in stock investing. Technical traders try to predict his upcoming moods and profit from the swings, and usually scatter entirely when he's feeling down. But VPs know that Mr. Market's fits are the best thing about investing.
A VP finds it unnerving when everyone else is happiest, when the market is aiming skyward. Yes, we all like to make money, but let's be honest, when everything's green for a year or two, a monkey with a dartboard can look like a stock market genius. And he might start to think he is a stock market genius. Those bloated investment egos that afflicted just about everyone in America before the last great crash? They were nurtured by a phenomenon like the one you see on the left side of this chart. As for the right side, that's when people figured out they were more lucky than smart.
VPs, on the other hand, learn to love the situation on the right side of these charts. That's because fear is the VP's friend, so long as he can control it when others won't, or don't.
The VP advantage
The VP is quite happy to line up against the world's financial heavies: the big institutions and the fund managers. It's not because the VP has a superiority complex. After all, his opponents in this game are smart people: MBAs, PhDs, CFAs, BMWs, and all that. The VP would be silly to think he had a brainpower or information advantage over these people. So what are his advantages? The same ones Buffett and other successful VPs have demonstrated over the years: freedom, baby, and self-control.
The VP might even pity the big institutional investors. Their skittery co-workers and clients judge everything they do on a daily basis, often in the context of bogus, short-sighted financial reporting. Some jabbering squawker on CNBC says it's time to get back into "the semis," and you can bet the fund will be feeling heat from people who don't understand why they aren't "playing the semis," too.
Keeping up with the manager down the hall or down the street leads to all sorts of silliness, like abandoning good businesses just because you think the other guy might do the same and you want to be the first one out. It also leads to abuses like window dressing. It's the end-of-quarter or year-end fund ritual that finds managers paying high prices in order to add popular highfliers like Apple to their portfolios, after the run-up. That way, no one can say "Skinner! Why weren't you in Apple?"
As a VP, you don't need to measure your results by anyone else's yardstick, and that's a major edge.
And this is just one of your advantages. Want to bet big on a shoo-in, like putting 10% of your portfolio in Home Depot (NYSE: HD ) when it was near $20 a stub back in early 2003? As a VP, you can do that. Not so for the fundsies, who have strict legal and institutional guidelines to follow. You think everything's too expensive? (Hey, I don't agree. Take a look at something like Pfizer (NYSE: PFE ) , for instance.) But if you do want to sit in 80% cash, you can sit in 80% cash waiting for bargains to come your way. Self-control is another advantage that VPs have over the Street.
Praying for the rapture
While Mr. Market and his jittery juniors usually ensure that there are bargains to be had, these days they seem to be tougher and tougher to find. Although the 52-week low list is getting longer and longer these days, if you're like me, you don't find much there of interest.
OK, maybe I'm slightly interested in Israeli women's underpants -- via Delta Galil Industries (Nasdaq: DELT ) -- but that's only because the company has a history of OK cash flows, sports a 5% yield, and trades below book value. Putting aside the ladies undergarments, let's just say that a lot of the companies trading at new lows look like they deserve to be there.
I'm sure there are values on the list. There almost always are. It's just that sorting the wheat from the chaff can be tough. You need to dig up a lot of financials, do third-grade math, make predictions based on incomplete facts, and also be prepared for the fact that you're likely to be wrong.
That's why I find it hard not to hope for one of those 20% market freak-outs. They make the pickins so much easier, just so long as you are ready to exploit VP advantages.
Nature of the beast
Remember, when the market has a major freak-out, the selling makes no sense. People start throwing away shares in very solid businesses because they're caught up in the panic. Even those folks who are smart enough to know better -- like our friends at the big funds -- have no choice but to do the same. When enough people start cashing in their fund coupons, the biggies have no choice but to go along and sell, because they have money to pay out. This only feeds the downward spiral. That's when VPs get excitable. The only thing better than an undervalued company is an undervalued world-class company. And often, you don't see those until the market goes nuts.
Take a look again at Home Depot circa February 2003, in the midst of a pretty heavy drop in the markets. This was one of earth's biggest retailers, a solid company that was still growing and had increased earnings per share (EPS) by 40%, 10%, and 17% in the previous three years. Yet it was thrown on the slag heap with everything else. If you look closely at that chart, you'll see that even after the Street learned that 2002's final EPS growth had come to 24%, the stock sold off yet again, so that it was selling for a price-to-earnings ratio (P/E) of around 15, something unheard of for a company with that kind of power and consistent growth.
As you can see, the Street came to its senses soon afterward, netting a near double for those brave enough to take advantage of the panic. (One of them, by the way, was our own VP, Inside Value's Philip Durell, who was arguing that the firm was a great buy and had the numbers to back him up.)
And no, the comeback can't be entirely explained by a market recovery. Home Depot doubled the S&P's return over the same period, and some other victims of March madness that year, McDonald's (NYSE: MCD ) , Caterpillar (NYSE: CAT ) , and Deere (NYSE: DE ) -- powerhouses clearly in the midst of turnarounds -- went on to do much better.
Foolish bottom line
There are some value investors out there who take the elitist view that you're either born with the value thing or you're not. Ridiculous. Everyone likes to make money, and the fact is, buying solid companies that are trading at low P/Es and low price-to-book ratios is the best way to do it. I realize that even though no one could call me a dyed-in-the-wool value investor. My portfolio has growth firms, clunkers, and good, cheap companies that I think are great values. But there's always room for more.
Yes, I could dig them up myself, or I could let Inside Value do it for me. But in the meantime, don't hold it against me if I also hold hope for a minor market catastrophe, the kind of thing that would, say, make a share of Berkshire cheaper than a fancy SUV. It's not my fault that I feel this way. I've been perverted by value.
For related Foolishness:
- Learn more about profiting from panic.
- How to get three $10s for a $20.
- Relive the golden age of value.
- See why value wins.
Seth Jayson is still hoarding cash, hoping for a crash. At the time of publication, he had long call options on Nokia, but no position in any other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.