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Investment Wisdom From The Original Global Guru

Sir John Templeton, who passed away at the age of 95 in 2008, was the original Global Guru. Templeton provided me with an introduction to the world of global investing when I picked up a book on Templeton’s investment philosophy many years ago in Amsterdam. While today you can buy a Brazilian or Malaysian or South African stock with a click of the mouse, the world was a very different place when Templeton began his global investing career. John Templeton: A Pioneer in Global Investing Born in 1912, Templeton hailed from the South (Winchester, Tennessee), graduated from Yale in 1934 and won a Rhodes Scholarship to Oxford. After studying law in England, Templeton embarked on a whirlwind grand tour of the world that took him to 35 countries in seven months. That tour exposed him to the enormous investment opportunities that exist outside of the United States. In the very first display of his famous contrarian streak, Templeton came to Wall Street during the depths of the Great Depression to start his investment career in 1937. Templeton soon borrowed a then-princely sum of $10,000 ($170,000 in today’s dollars) as a 26-year-old investor and bought shares of 104 European companies trading at $1 per share or less. This was in 1939, the year German tanks rumbled into Poland, launching World War II. Though dozens of companies were already in bankruptcy, only four companies out of those 104 turned out to be worthless. Templeton held on to each stock for an average of four years and made a small fortune. In 1940, he bought a small investment firm that became the early foundation of his empire. Templeton then went on to build an investment management business whose name became synonymous with value-oriented global investing. He launched the Templeton Growth Fund in 1954 – notably in Canada, which then had no capital gains tax. He made his company public in 1959 when it only had five funds and $66 million under management, and eventually sold his business to Franklin Resources for $913 million in 1992. Templeton focused his final years largely on philanthropy, endowing the Centre for Management Studies at Oxford. He also established the Templeton Prize in 1972, which recognized achievement in work related to science, philosophy and spirituality. His Templeton Foundation, which today boasts an endowment of $1.5 billion, distributes $70 million annually in grants to study “what scientists and philosophers call the Big Questions.” Past winners have included Mother Theresa, Billy Graham, Desmond Tutu and the Dalai Lama. John Templeton: Contrarian to the Core Templeton’s investment track record was impressive, although, given his deeply contrarian style, inevitably quite volatile. A $10,000 investment in the Templeton Growth Fund in 1954 grew to roughly $2 million, with dividends reinvested, by 1992. That works out to a 14.5% annualized return since its inception. Templeton was perhaps best known for investing in Japan in the 1950s when “Made in Japan” was synonymous with free toy trinkets found in cereal boxes. And like all great investors, Templeton was not afraid of big bets. At one point in the 1960s, Templeton held more than 60% of the Templeton Growth Fund’s assets in Japan. That kind of a concentrated position in a global fund would be illegal on Wall Street today. But Templeton also had the savvy to exit markets when they were overvalued, selling out of Japan well before the market collapsed in 1989. Central to Templeton’s investment philosophy was buying superior stocks at cheap price points of “maximum pessimism.” He diligently applied this approach across a range of countries, industries and companies. As Templeton noted in an interview in Forbes in 1988: “People are always asking me where the outlook is good, but that’s the wrong question. The right question is, ‘Where is the outlook most miserable?’ ” My favorite Templeton anecdote was his bet against the U.S. dotcom bubble in 1999. Templeton famously predicted that 90% of the new Internet companies would be bankrupt within five years, and he very publicly shorted the U.S. tech sector. I think it’s a terrific irony that John Templeton – a value investor known for sussing out little known global opportunities – made his quickest and possibly biggest fortune by shorting U.S. stocks. John Templeton: Lessons for Today’s Market With most global stock markets trading in bear market territory, you may find some comfort in John Templeton’s most famous piece of advice: ” To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward .” This advice is simple – but not easy to implement. Templeton also added a small refinement to this approach. He recommended that you initially take a small position in your investment ideas before rushing in. If it’s a truly great bargain, there’s no need to hurry. Finally, what I found most refreshing about John Templeton is his relentless optimism. Templeton once asked a journalist to write about why the Dow Jones Industrial Average might rise to one million by the year 2100. At first blush, “Dow 1,000,000” sounds absurd. Yet, it turns out that thanks to the miracle of compound interest, the Dow would only need to rise about 5% per year to hit that level in 86 years.

A Shopping List For Bargain Hunters

The old saying that “things can always get worse” seems to be an apt description for markets so far this year. A poor start to the year has snowballed into an environment in which investors are being paid to “sell the rallies.” Year-to-date global equity markets are down roughly 10 percent in dollar terms, as measured by Bloomberg performance data for the MSCI ACWI Index (NASDAQ: ACWI ). While a few markets, notably Canada and Mexico, are flat to nominally higher, several market segments, including U.S. biotech, China and Italy are down more than 20 percent since the start of the year, according to Bloomberg data for the Nasdaq Biotechnology index and the respective MSCI country indices. Against this backdrop, bargain-hunting investors are asking whether there may be opportunities. My take: Given that the sell-off is occurring in the aftermath of a multi-year bull market, stocks overall still aren’t cheap. That said, it’s not too early to begin compiling a shopping list of potential bargains that may be worth considering . While the selling has returned some value to equities, the best that can be said is that most markets now look reasonable. According to a BlackRock analysis using Bloomberg data, a global benchmark ( ACWI ) is trading at around 16.5x trailing earnings , down around 7.5 percent from last summer’s peak but roughly in-line with the 10-year valuation average. Global stocks look cheaper on a price-to-book ( P/B ) basis, but with the exception of emerging markets equities, they are only trading at a small discount to their 10-year average. If valuation is unlikely to put a floor under markets, there are two other scenarios that could help establish a bottom: signs of economic stabilization or a more aggressive, coordinated response from central banks. As I don’t view either as imminent , markets are likely to remain volatile in the near term. There’s value to be found if you know where to look However, for investors looking to bargain hunt, there are certain segments of the market that are trading at a significant discount. While it may still be too early to pull the purchase trigger, these two segments in particular are worth a closer look. 1. Emerging Markets. After underperforming for the better part of the past five years, emerging market stocks, as measured by the MSCI Emerging Markets Index, are one of the few, genuinely cheap asset classes. At roughly 1.25x trailing book value, emerging market equities are trading at a level last seen at their trough in early 2009. On a relative basis, using the MSCI World Index as a proxy for developed markets, EM stocks trade at nearly a 35 percent discount to developed markets, the largest such discount since the market bottom in 2003, according to an analysis of data accessible via Bloomberg. 2. Energy stocks . The other universally unloved asset class is energy. While assessing ” fair value ” is always an elusive exercise when discussing commodities, the recent plunge in oil prices seems to have created value in energy-related companies . With energy firms’ earnings still plunging, their price-to-earnings ( P/E ) ratios don’t look very appealing. However, based on P/B measurements, the sector, as represented by the S&P 500 GIC Energy Sector, is trading at the lowest level of the past twenty years and at about a 45 percent discount to the broader U.S. equity market. Even assuming future write-downs, the current discount looks large. Emerging markets and energy have another argument in their favor: Over the past several months, rising volatility has begun to chip away at the momentum trade. Long positions in biotech and tech darlings have already been hit. Downside momentum plays continue to work, but being underweight, or short, energy or emerging market stocks have become very crowded trades. Similar to what has happened to long-side momentum plays , such downside momentum trades are likely to violently reverse at some point. When that occurs, these two segments appear well positioned to benefit. This post originally appeared on the BlackRock Blog.

How To Pick Value Stocks

I find it ironic that more research is being done today than at any point in time in the past, yet a lot of value investors are failing to beat the market. Ironically, the mountain of articles on popular investing websites just aren’t helping. Part of the problem might be due to the “more brains” problem Graham cited years ago. Since everybody on Wall Street is so smart, all those brains ultimately cancel each other out. This glut of brain power, investment research, and investors clamoring for bargains does not mean that you can’t beat the market. But, knowing how to pick value stocks is a key requirement, along with having a good strategy and being prepared to do things that most other investors aren’t. Where You Should Hunt When Picking Value Stocks One core piece of the puzzle is leveraging your biggest competitive advantage as a small investor: your size. Let me explain… Professional money managers manage billions of dollars each year. In fact, the entire mutual fund industry in the USD in 2012 amounted to $13 Trillion and the size of the average mutual fund was a staggering $1.72 Billion. Legal regulations make owning more than 10% of a single company, or having a single company make up more than 5% of assets, a real burden for a fund company. Given that managers want to keep positions below 5% of their fund, the pool of investment candidates open to money managers is tiny. These restrictions essentially limit a manager’s universe of stocks to firms that are $860 Million in market cap or larger. That means focusing on roughly 500-600 of the largest companies in the US. With that much money sloshing around the markets, small, medium, and large cap companies are, understandably, extremely picked-over. This suggests a powerful advantage that small investors can leverage: investing where the pros aren’t investing. That really comes down to investing in micro cap and nano cap companies. It’s in this universe, among the thousands of tiny publicly traded companies available, that a small investor can pick the most promising value stocks. What Value Stocks to Concentrate On 15 years of experience in investing has taught me a few very valuable lessons. The first is that, despite your research, you’re probably not as important to the end result as you’d like to think you are. Sure, you can conduct an analysis and your stock can go up just as you predicted, but it may not have advanced for the reasons you thought. Sometimes the stocks that you assume that will work out well… don’t. And, at other times, the stocks you thought were real dogs will advance in price. Another core insight I’ve had over the previous decade is that I (and likely you, as well) am not Warren Buffett . Small investors can’t bring the same amount of skill and experience to investing as he does, and blindly following how he invests today is what I call falling into the Warren Buffett trap . Luckily, a small investor doesn’t have to have Buffett’s investing prowess to know how to pick value stocks and succeed as an investor. Investing is a probabilistic exercise, and I’ve found leveraging a statistical investment strategy (i.e. “Mechanical” investing style), extremely rewarding. Leveraging them means being able to earn the same investment returns that drew you to value investing in the first place… without you having to be an investing guru. By simply buying a basket of stocks that are undervalued relative to some value metric, you can leverage those statistical returns to propel your portfolio to large profits. What Sorts of Strategies am I Talking About? The sorts of strategies that I’m talking about fall into the “classic value investing” or “deep value investing” categories. These are the value strategies that Benjamin Graham talked about years ago when he taught his students how to pick value stocks. These strategies have been extensively tested, and used successfully in practice for decades. Low PE – One of these strategies is the classic Low Price to Earnings strategy. This strategy has been employed successfully by contrarian managers such as David Dreman , whose funds returned 16-17% per year over decades. In general, as reported by Tweedy Browne , a Low PE strategy is good for an average annual return of 16%. Low PB – Low Price to Book value is another classic value metric that yields market beating results. Using the strategy investors should expect to bag a CAGR as high as 14.5%. That’s a fat 45% in excess of the market return over the course of your life. Low PC – One of the more recent classic value strategies, and focuses on finding stocks low relative to Cash Flow. This strategy performs a bit better, recording a CAGR of just over 18% . High Dividend Yield – Mario Levis at the University of Bath conducted a study called, “Stock Market Anomalies: A Reassessment Based on the UK Evidence.” He found that the highest dividend yielding stocks returned 19.3% on average. Not bad for a basket of cheap stocks! Net Nets – But the king of these strategies is Ben Graham’s famous net net stock strategy. This strategy has consistently beaten the market both in studies and in practice by roughly 15% per year. That amounts to a 25% CAGR, and you can achieve even higher returns with a basket of net nets by screening for other key characteristics . And, my own portfolio has done very well using this strategy. Of course, the catch is that while you can always find enough stocks to fill a portfolio using the first 4 strategies, during bull markets domestic net nets dry up, making it almost impossible to use the strategy. At least, that’s what popular websites will tell you — which tripped me up years ago. By expanding your universe of investment candidates to include friendly international markets you can fill your net net stock portfolio under all market conditions. How to Pick Value Stocks Once You’ve Nailed Down a Core Strategy This is where hunting for tiny stocks comes into play. When picking value stocks, you’re going to find your best opportunities within the universe of small companies. I’m going to come at this from the perspective of a net net stock investor, since this is where I’ve chosen to specialize. That being said, the process is the same for any statistical value strategy. As it turns out, not only do small stocks offer the best opportunities for value investors, but statistical portfolios of the smallest value stocks also offer the best portfolio returns. When it comes to net net stocks, Xiao & Arnold found that a portfolio of the smallest net nets returned significantly more than the largest net nets studied, 30.6% per year vs. 17.2% per year. That’s a staggering difference in return. The same trend is found among other sorts of classic value stocks. Tweedy, Browne found that the smallest 1/5th of Low PE stocks outperformed the largest, 19.1% to 13.1%. So, no matter what strategy you use, go small. Go tiny, in fact . This is where major investing websites really start to trip up investors. The focus on large investing sites is almost always on large stocks, and that causes small investors to give up a much more promising universe of investment opportunities in favor of trying to compete against the pros. Plus, you can only take advantage of a net net stock strategy if you’re buying tiny companies. Once I’ve narrowed down my list of possible investment candidates to the smallest, I like to look for additional metrics that are highly correlated to outperformance versus the benchmark. For net nets, one of those characteristics is a Debt to Equity figure below 20%. Companies with low Debt to Equity ratios drastically outperformed the benchmark in Tweedy, Browne’s study, What Has Worked In Investing , recording a CAGR of nearly 35% compared to their universe of net nets which returned 28.8%. That’s 6% per year of extra return! I also avoid firms with major Chinese operations, due to the flood of reverse merger scams , as well as resource exploration companies, pharmaceutical companies, real estate companies, and companies in regulated industries such as finance. None of these make for the highest quality net nets, and I’m after the highest possible returns. In the end, you have to stick to the most promising industries, and this usually means focusing on your domain of competence. How to Craft Your Portfolio If you do a good enough job using additional criteria to screen out the less promising candidates, building a portfolio really takes care of itself. At the end of the process you should be left with a very manageable number of firms. From there, spend time ranking the firms from most to least promising and then spend an equal dollar amount on the 20 most promising investments. That’s it. ….sort of. There are also nuances in portfolio construction and management that can really impact your returns, but that’s not the focus of this article. I’ll write that article at some point in the future. By now, you should have a great idea of how to pick value stocks for your own portfolio. Investing is really not as difficult as you think it is but, ironically, a lot of people try to make it more difficult than it needs to be. The hardest part is really sourcing the investment ideas and then narrowing down the pool of investment candidates you pick from. At Net Net Hunter, we start with over 450 statistical international net nets but then narrow the pool down to the 30 most promising, which gives you some idea of the amount of work to do if you want to buy the best investment opportunities. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.