FOOL ON THE HILL
An Investment Opinion
Are "Value Investors" Fools or fools? Bill Mann (TMF Otter)
January 26, 2000
These are tough times to be an investor who concentrates on such pedestrian concepts as earnings. In an age in which a company with a good story and a dotcom can be valued at 158x sales (Yahoo!) or some other of the multitude of "New Era Valuation" metrics. Messrs. Graham and Dodd are most certainly spinning in their graves right now with the tremendous market value being granted many concept companies. Their most famous disciple, Warren Buffett, has seen the share price of Berkshire Hathaway (NYSE: BRK.A) decrease by some 30% at the same time that the Nasdaq Composite has made a run for the hills.
Certainly these are strange and unique times. Certainly the Internet has fundamentally changed how we interact with one another. Most certainly individual investors hold much more power than ever before in sway of the valuation of companies. So what's up with these "value investors"? Have they lost their minds? Did they not get the memo? Are they just flat out wrong in working so hard to find companies that are "undervalued" in regard to future prospects? And are these people Fools, or just anachronisms?
Yesterday a Fool named fferarra produced a piece de resistance in the Eyes On the Wise message board in regard to his recent ditching of a particular Value Fund (Oakmark) because the managers spent all of their time focusing on businesses that were "cheap." Meanwhile, their investors ended up holding a roster of crappy businesses that, in most cases, were depressed in price for good reason. This post, as beautiful as it was, brought about a litany of spleen venting about value investing in general, with one poster asking how to retrain value investors into Fools.
Oops. I draw the line right there. There is no embargo against being a Foolish value investor. The two are not mutually exclusive. Once again, I think the long-standing run that we have enjoyed has skewed perception, in particular of those investors who are relatively new to the market, that those who take on more risk are somehow superior investors.
In 1999, with the exception of a few worthless pieces of dreck, almost every high beta stock's returns were to the upside of the overall returns on the market. (Beta is a measurement of share price volatility relative to the general market. So, for a company with a beta of 2, for every percent the stock market moves, up or down, on average that company's share price moves two percent). In such an environment, the dice rollers are by and large going to be rewarded handsomely for their investments, while the more conservative investors' returns will pale by comparison.
This doesn't mean that "value investors" as a species, somehow blew it. Part of the problem may be one of nomenclature.
There is a grave difference between a value investor, one who looks for any company that has a price below intrinsic value, and what Ben Graham called a "cigar butt investor." A cigar butt investor looks for companies that have been shelled on the market, regardless of the quality level of the underlying business, and seeks to derive that last little bit of life out of them. These businesses don't have to be quality ones, they may be ones that are in fact obsolete. But if there's a good chance they'll rebound even a little bit, this investor is interested.
I believe that the majority of "value" type mutual funds are really manifestations of this type of investing, where such fallen beauties as Bethlehem Steel (NYSE: BS) and Venator (NYSE: Z) are their primary targets. Cigar butt investors, like mutual fund managers, are looking for short term rebound moves, the proverbial "last puff." These are a type of value investors, but they are as representative of the whole as day traders are to "growth investors."
A "value investor," for example, can certainly, and with intellectual honesty, determine that some of the more highly valued companies, say, NOW 50 company Sun Microsystems (Nasdaq: SUNW), is valued below its fundamental potential for growth. The logic gets more and more strained as you move into the companies that have negative net revenues, and even more so when you consider companies that have next to no revenues. What a value investor will not do is buy a concept. They want to see numbers, a pattern of or a potential for growth, and a tenable business plan. As such, they by and large can be colored as lower risk investors, and in our current environment, the lower the risk, the lower the return. But is this "unFoolish"?
No. In fact, hell no. You see, what is true about value investors (as opposed to momentum investors) is that they elect to focus upon that long laugh they get at the end of the road for an awfully large number of laughs in between. The best value investors do the exact same thing that Fools do -- they focus upon the best companies in existence. Moreover they tend to focus upon those great businesses that are within their circle of competence.
The best value investors, just like Fools, do not focus upon the little price movements of a stock. They find companies that are undervalued to a degree that they have a significant level of safety. And then they wait. They wait until the voting in the market stops and the weighing begins. And if the past is any guide (and by the way, the past should always be studied as a guide), only those companies that earn profits have the potential for long-term share appreciation.
This is a fundamental rule that cannot, over the long term, be broken. Sure, we can look at the money flows, look at who's buying what, invest in concepts, study technical moves, whatever. But in the end, nothing matters more than a company's ability to bring home the bacon. People on message boards can tout stocks, companies can skyrocket based upon future potential, industries can become the darlings of the investing world. But nothing replaces earnings and the potential thereof, not over the long run. This is the motto, the creed, and the manifesto of value investors.
One must only go back and look at the 30-year performance of Berkshire Hathaway to recognize the fact that value investing has retained relevance in a multitude of markets. Warren Buffett missed Cisco (Nasdaq: CSCO). But he also missed the Nifty Fifty, the advent of globalism, the first computer companies, telecommunications, and all of the other huge growth stories of the last 30 years. And yet there is no investor, growth, value, cigar butt, or momentum, who can touch his rate of annual return. Warren Buffett is a patient man operating in a current environment that does not reward patience. I doubt that he's all that happy with his return on investment at this moment, but I doubt he's losing much sleep, either. Just keeping his powder dry (Berkshire Hathaway has a $33 billion dollar cash war chest), waiting for the next top-notch company to present him a buying opportunity.
That is value investing. It is time tested. It is relevant. It emphasizes a lower risk profile than is currently being rewarded in the markets.
And it is very Foolish.
Bill Mann, TMFOtter on the boards