The Best Investor You've Never Heard Of - God Bless

One of the finest value investors in the world passed away yesterday in New York city. Walter Schloss, was surrounded by family and passed at the age of 95. If you have not read about Walter's investing style ( and superb track record ) and about the kind of person he was, then I strongly suggest that you do. My investment strategy has been heavily influenced by Schloss' investment framework over the years. He was truly a good guy of wall street. God Bless Walter.

Slowing Down The Game

To invest successfully you need an edge, some kind of advantage over the market. While this "advantage" will not guarantee results every year, it will, if effective, produce good results over a long period of time.
Value investors are often asked what their edge is. After all, value investors don't have complicated computer trading systems, don't check stock prices every minute and many (including me) don't even use a calculator or an excel spreadsheet. So what's a value investor's edge: patience, patience, patience. Value investors understand that the value of a business fluctuates much less (generally speaking, barring some major fundamental change) then it's own stock price. This idea flies directly in the face of the Efficient Market Theorists (EMT), that postulate that a stock is always perfectly priced. It's probably fair to say the markets are pretty good at pricing stocks most of the time, but not all of the time. But there is big difference between always and most.
A picture is worth a thousand words, see below:


So value investors are willing to step when a company's share price is significantly less than the intrinsic value (IV) of the company. Then, you must be willing to wait, perhaps several years, for the market to recognize the undervalued situation and re-price the shares to reflect the company's true IV. It's the waiting period that most investors can't deal with. After all we live in a short-term world, where high frequency traders (HFT), some argue, are responsible for 70% of the volume on major exchanges. A world where mutual funds are ranked daily, and therefore can't focus long-term for fear of losing assets the next guy who "was better last week". The average holding period for these HFT's is 22 seconds. Yes, 22 seconds. Their job is to provide liquidity and capture a small ( 1/3 of a cent or so ) profit with each trade. Sounds way too stressful for me - how do they take a nap? The other one third of the market holds stocks for an average of only 7 months. The "new" long-term for most investors is one year. Consider the following (approximate numbers, source: FT):

Decade                                      Average Holding Period

1940's                                                     7.0 years
1950's                                                     7.0 years
1960's                                                     7.0 years
1970's                                                     5.0 years
1980's                                                     <2.0 years
1990's                                                     <1.0 year
2000's                                                       7 months

Owning a stock for just a couple of months presents many problems. Firstly, you will likely never capture the closure of the gap between price and value of a company. Therefore, you won't make any money, and you'll take on a lot of risk if you didn't buy cheap. Also, this approach would require you to make dozens of correct decisions a year as your portfolio turns over many times. Your trading costs could eat up much of the profit you might make from your short-term trading activities.

So investors would benefit greatly by "slowing the game down" and allocating their hard earned capital to undervalued investments that offer little risk and significant upside, but will take some time to work out. Remember, you want to be able to sleep at night (or take nap) or take a vacation without your Blackberry to check your stock quotes. Investing is a marathon not a sprint.

This discussion reminds me of  a couple of my favorite Warren Buffett quotes:

" lethargy, bordering on sloth, should be the cornerstone of any investment style"
" I'd be a bum on the street with a tin cup, if the markets were efficient all of the time"

Just in case you are wondering, my average holding period is approximately 4 years, with my largest and longest holding at 9 years. My trading cost for 2011 amounted to 0.17% of the value of all portfolios. I don't get a Christmas card from my broker.

Andre

Approaching Intrinsic Value (IV)

I have recently reduced my position in Ensco PLC (ESV) by another one third @ $55.15.  Ensco continues to perform well, but is now close to being fully priced. My conservative estimate of ESV is around $60/share ( the intrinsic value of a company is moving target and can't be calculated with precision ) and I generally like to start selling as the price reaches 90% of IV. I'll continue to hold the last 1/3 of my position for now and monitor the Pride International merger and adjust IV accordingly. Also of interest, day rates for rigs are rising and that may explain the recent run for the drillers. We'll see if that lasts....

My initial purchase of ESV was @ $38.20 in 2010.

Car Parts For Xmas

With all the uncertainty swirling around the markets combined with December tax-loss selling, prices are down and value ideas continue to pop-up here and there. I have initiated an opening position in Magna International (MG), the car part giant @$34. MG is a wounded giant that is out of favour. Being a consumer discretionary industrial exposed to Europe is not helping MG right now. MG has suffered from problems with some European operations, reduced margins due to high commodity prices (steel and resins) and poorly priced contracts written during the last few years. However, there is good news:

- margins may improve if commodity prices fall. MG purchases $3billion/year in steel and resins.
- under performing operations are being fixed or sold, writedowns taken accordingly.
-car sales are strong even with the global economic uncertainty. 13.6 Mill units in Europe, 13.0 Mill U.S.
-new contracts with Asian OEM's, diversifying revenue base.
-expanding plant capacity in emerging markets like Brazil and China.
-OEM's are reducing there supplier base, signing deals with larger more stable suppliers like MG.

MG is trading at <6X pre-tax earnings power and close to tangible book value. The balance sheet is super strong with no net debt and $6.50/share in cash. A dividend yield of 3%. Some overhang has also been removed with the elimination of the dual class share structure at MG, a longtime criticism of the firm. The downside appears to be limited with MG.

MG's Canadian competitors include Linamar (LNR), EXCO (XTC) and Martinrea (MRE) and as group trade at a premium to MG with average an P/Book of 1.2X, P/S 0.5X.

MG's American competitors include Johnson Controls, BorgWarner, TRW, Meritor, American Axle, Dana and Superior Industries. These companies, many of which are debt laden, trade at and average P/Book of 2.0X and P/S of 0.6X.

MG is worth somewhere in the low $50's and should produce a fine investment result over the next 2-3 years.

Good News Gone Un-Noticed - Canam Group

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Stay The Course

An old French Proverb: "buy on the cannons, sell on the trumpets"


I was recently asked "where is the market going?". I have no idea. Nobody knows. What I do know is, that if you own a basket of undervalued assets with a margin of safety, then you will do well over time. For the last 3 years, we have witnessed an almost unprecedented level of uncertainty/chaos in global markets. Many have extrapolated what has happened recently ( last 3 years ) far out into the future. Many believe the problems that face the Greece, U.S., Europe and the world will continue forever. These problems will get solved, but the medicine will be hard to swallow for many. On a recent Canadian business news network call in show, a private investor called in and proclaimed "doomsday". He completely liquidated his RRSP, paying the associated fees and penalties, and invested all the proceeds in gold and silver bars to keep at home. To me this is a kin to financial suicide and ringing a "buy bell" at the bottom of the market. When the "herd" are so negative and can only look backwards to recent events, with no regard to valuations or the future, then it's time to be invested. I suspect, looking 3 years out, this investor will be very disappointed with his gold and silver bar rate of returns.

In the mean time, as I've outlined before, it's time to be invested with a nose for value. If you overpay, then you can get hurt - I can attest to that. However, the cross-currents in the markets do provide opportunity, if you look around. I recently added to my position in Big Lots (BIG) which just reported their Q3 results. Analysts, had already taken down their estimates for BIG' s Q3, accounting for losses on a recently acquired retail chain in Canada ( Liquidation World ). BIG, fell short of analyst's estimates by $0.02, yes only two cents a share. The market turned on BIG, upset by the short term losses on their new retail chain, and proceeded to bid down BIG's shares by almost 10% in one day. The market shaved $220 million off BIG's market value, for a $15 million shortfall, as compared to last year ( even though management raised guidance for the rest of this year ). Who says the markets are perfectly efficient? I stepped in at $36.04 and added to my BIG position by 10%. There are other opportunities out there - BAC, CSCO (<17), LOW (<23) or MSFT (<24.50), but it will be a bumpy ride.

Research In Motion And Book Value

RIM and "book value" (BV) are three words that you generally don't hear in the same sentence, until now. There has been much ta-doo, regarding the fact the RIM is trading below it's "book value". Many are now assuming/saying that RIM is a buy. For RIM to be a buy, we have to figure out what it's worth. The mere fact that RIM is trading around BV tells us little about what RIM is really worth - or it's intrinsic value (IV). Many confuse BV with  IV.  BV is what has been put into a business and IV is what can be taken out of a business over it's life. Book value, depending on the business, can be a good starting point in an exercise to figure out what a given company is worth. However, you have to closely examine what makes up BV. There can be a lot of fluff in the numbers. In the 1970's, the Pennsylvania Railway Co. had on it's balance sheet "assets" which included tunnels through mountains and old useless rail cars. While these "assets" contributed to the BV of the company by normal accounting conventions, they provided little in the way of value to the owners/shareholders of the business. This kind of fluff is not unusual. Thousands of companies maintain goodwill and intangibles on their balance sheet that, in many cases, offer little or no value. A quick review of RIM's financials show the following;

as of August 2011...

Assets               13.9B
Liabilities            4.0B
Equity/BV          9.9B or $18.70/share

However if you strip out goodwill and intangible assets od 2.9B ( yes, their brand and patents may have some value, but how much?) you now shrink RIM's owners equity or BV to 7.0B or $13/share. So, at $19/share, RIM doesn't look like such good value. For me it's easy pass. It is difficult to figure out what RIM is worth, as IV is dependent on many factors including a company's competitive position, growth, future prospects, asset values, management and earnings power. Many of these are extremely uncertain for RIM right now. This one is on the "too hard" pile.

Disclosure: No position in RIM