...the New Bore Port explains itself
ALEXANDRIA, VA (Oct. 5, 1998) -- For the next few portfolio reports, Alex Schay and I are going to talk about what we think of value. While we consider ourselves to be value-oriented investors, we have some real problems with the whole concept of value these days. And that's not the curmudgeon in me saying that about people who will pay more than one times book value for something -- that's the curmudgeon in me criticizing the investing cohort that thinks value is only attainable through buying crappy companies at discounts to liquidation value or net working capital.
Alex has more to say about this in the next few reports, but I think a particular comment of his sums it up nicely: If you're not looking for value, then you're not an investor. A company selling at a 50% discount to intrinsic value can still be priced at 100 times earnings and 4 times book. We know people have a hard time with that one, but it's entirely true. Well, rather than standing in Alex's way, I'm going to let him get started with "Value Philosophy, Part 1." We hope to see you on the message boards on AOL and on the web.
Value Philosophy, Part 1
The investing process is always reflective of one's epistemological leanings. That is, what you believe is reflected in how you invest -- and this is no short order. It's not so much that we need epistemological structure, but rather, the human brain naturally imposes this interpretive element onto our experiences. For instance, the bettor that wins a load of money the first time picking a horse falls danger to the premise that betting on horseracing provides easy money. Or the individual that wins big on their first hot stock tip falls prey to the belief that hot tips are good things.
We could begin with the premise that we're wired in such a way that a spatial, temporal order is an inherent feature of our collective condition. And overlay this with the notion that "categories" become the means by which we put an order and structure to our existence -- which has long since been vindicated by neuroscientists studying the features of the left brain's grand interpreter.
However, we're not talking neuroscience here, we're talking about stocks. We're talking about money -- but most importantly, we're talking about business. The purpose of public markets was never to create lottery tickets denominated in ticker symbols, or a great new forum for "legalized gambling." From the very beginnings of the joint-stock corporation, the idea was to give entrepreneurs capital with which they could build businesses. In return for the capital, the investor would receive ownership of a portion of that company. In order to facilitate the needs of various individuals who invested (primarily with respect to liquidity), an independent, secondary market developed where shares in companies could be bought and sold. And so it goes, the queer lineage of stock ownership continues today, defined not by a right of blood, but by financial transaction -- as all the responsibilities of ownership passing from one investor to the next.
Now, the fundamental premise by which we operate is that when we buy stock, we are buying a business. Whether you are buying the whole business or just shares in the business, approaching the problem as if you were buying the entire enterprise enforces the same discipline any true acquirer would use. If you were to really go out and acquire a business, you would undoubtedly pay careful attention to the price that was paid; you would want to know the underlying quality of the business and the makeup of the competitive landscape; you would concentrate on a business endeavor that made maximum use of your peculiar intellectual capabilities and understanding; and you would consider how long you intended to own the business. In other words, you would impose some kind of framework on the process for assessing the value of the business --giving you an idea of what it was worth.
While speculators concern themselves with what the share price of a company will do, independently of how its business will perform -- and that's fine if you're temperamentally suited to that kind of manic endeavor -- investors seek to get a handle on how a business will perform and what its stream of cash flows are worth, in effect letting the share price take care of itself. Our general view of the market can be summarized by the parable of "Mr. Market," as told by businessman Warren Buffett:
"Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
"Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game."
We tend to think Mr. Market is a little more stable than the parable suggests, but no doubt about it, he suffers from some emotional instability. Unlike many value-oriented investors, we believe it's amazing how efficient the market can be in the short run, pricing in new factors effecting the value of the company. But that doesn't mean the market does not make mistakes. It makes big ones.
If the market were perfectly efficient, it would be pretty hard to outperform the major indexes. Fast-growth companies with excellent economics would never trade deep discounts to their intrinsic value, as they occasionally do. Cruddy companies with horrible business plans, economics, and managements more interested in pumping up the value of their stock than running the company would never trade at ridiculous market caps. Faddish concepts like the conglomerate boom or the boom in roll-up strategies wouldn't fly. And temporary worries about excellent companies wouldn't push the price of such companies to incredibly attractive levels. But all of these things happen because market behavior is undeniably the product of human behavior, which does not conform to logical, knowable patterns 100% of the time. And thank God it doesn't.
More Wednesday in "Value Philosophy Part 2." Meanwhile, we hope to see you on the Boring message board for discussion.
Stock Change Bid ANDW - 1/8 13.44 CGO -1 1/2 24.50 BGP - 1/4 23.69 CSL -1 1/2 35.25 CSCO -7 7/16 48.31 FCH -1 5/8 21.00 PNR - 5/8 31.00 TBY - 3/16 5.94
Day Month Year History BORING -5.36% -8.64% -21.83% -1.63% S&P: -1.40% -2.80% 1.87% 59.02% NASDAQ: -4.85% -9.28% -2.14% 47.62% Rec'd # Security In At Now Change 2/28/96 400 Borders Gr 11.26 23.69 110.44% 6/26/96 225 Cisco Syst 23.96 48.31 101.68% 8/13/96 200 Carlisle C 26.32 35.25 33.90% 3/5/97 150 Atlas Air 23.06 24.50 6.25% 4/14/98 100 Pentair 43.74 31.00 -29.13% 5/20/98 400 TCBY Enter 10.05 5.94 -40.89% 11/6/97 200 FelCor Sui 37.59 21.00 -44.13% 1/21/98 200 Andrew Cor 26.09 13.44 -48.50% Rec'd # Security In At Value Change 6/26/96 225 Cisco Syst 5389.99 10870.31 $5480.32 2/28/96 400 Borders Gr 4502.49 9475.00 $4972.51 8/13/96 200 Carlisle C 5264.99 7050.00 $1785.01 3/5/97 150 Atlas Air 3458.74 3675.00 $216.26 4/14/98 100 Pentair 4374.25 3100.00 -$1274.25 5/20/98 400 TCBY Enter 4018.00 2375.00 -$1643.00 1/21/98 200 Andrew Cor 5218.00 2687.50 -$2530.50 11/6/97 200 FelCor Sui 7518.00 4200.00 -$3318.00 CASH $5750.59 TOTAL $49183.40