Tag Archives: past

True Value Investing Still Works

Value investing is on the ropes. At least, that’s what you’d think reading articles like this one that highlight how “value” has underperformed “growth” in recent years. I put those words in quotes, partly because the distinction between value and growth is somewhat arbitrary , and also because the critics of value investing tend to attack metrics that have no real connection to shareholder value creation. Patrick O’Shaughnessy did a great job of attacking this myth on his blog, The Investor’s Field Guide . He points out that, over the last ten years, investors that have bought the cheapest stocks based on price to accounting book value have significantly underperformed. As we recently pointed out , book value relies upon flawed accounting metrics, diminishing its usefulness for investors. Unfortunately, most of the “value” indexes that people reference, such as the Russell 3000 Value Index, are based primarily off of price to book. As O’Shaughnessy points out, the performance of value strategies varies greatly depending on which metric you use. If you picked the cheapest stocks based on earnings, you did poorly in 2015 but slightly overperformed over the last decade. Stocks with the cheapest price to sale ratios have done very well recently. Despite their superior recent performance, these metrics have their own problems. We’ve pointed out many times how price to earnings ratios are inherently flawed and have almost no relationship with actual value. The sales number is at least less easy for executives to manipulate, but it also ignores structural margin differences and the impact of the balance sheet. What’s The Solution? Investors looking for value need to take a holistic approach that measures a company’s ability to deliver economic earnings to investors and quantifies the expectations for future cash flows embedded in its current stock price. This is what New Constructs aims to do, and while that process is not easy, it can be rewarding, as shown by the long-term outperformance of our strategies . As you can see from Figure 1, over the past decade our Most Attractive Large and Small Cap stocks have outperformed a combination of the S&P 500 and Russell 2000 by 80%. Figure 1: Most Attractive Stocks Outperform Click to enlarge Sources: New Constructs, LLC and company filings. The diligence we do helps us to uncover hidden gems that might not show up in simplistic, traditional value screens, such as computer chip manufacturer NVIDIA (NASDAQ: NVDA ). When we highlighted NVDA as a long idea in September, it had a P/E of 24 and a P/B of 3. Hardly numbers that are going to make your “average” value investor salivate. However, a closer look showed that these numbers were misleading. For one, NVDA’s reported income was artificially depressed by a $60 million write-down hidden in the footnotes . Plus, the company earns a fantastic return on invested capital ( ROIC ) of 34%, demonstrating its competitive advantage and its ability to efficiently allocate capital. After making adjustments to determine the true earnings quality and quantifying the market’s expectations for future cash flows, we saw that NVDA had a price to economic book value ( PEBV ) of just 1.1, implying that the market believed the company would only grow after tax operating profit ( NOPAT ) by 10% for the remainder of its corporate life. For a company that had just doubled its NOPAT the year before, those expectations seemed awfully low. Sure enough, the market has adjusted its expectations for NVDA in the past few months, driving the stock up 25% even as the S&P 500 has fallen by 2%. When the markets get volatile, it’s the real value stocks, the ones with economic profits and low market expectations, that thrive. Meanwhile, the imposters get exposed. Avoiding Value Traps and Imposters Succeeding in a struggling market is as much about avoiding the bad stocks as it is about picking the good ones. Our research helps clients avoid “value traps” that seem like they might be cheap on the surface but are actually significantly overvalued when you look a little closer. One such value trap we warned investors about was Olin Corporation (NYSE: OLN ) back in June of 2014. The stock had a P/E of 13 and a P/B of 2 at the time, but those numbers were highly misleading. Hidden non-operating items boosted its reported earnings by $25 million. Plus, the company was facing obvious headwinds in the form of falling commodity prices for its chemicals division and an unsustainably high level of demand for its Winchester ammunition segment. Despite this fact, the market was expecting that OLN grow NOPAT by 5.5% for 35 years, an unrealistically long timeframe for such a weak and highly commoditized business. OLN was able to coast by on its inflated accounting earnings when the market was strong, but that all changed after the S&P 500 hit its peak in the spring of 2015. Since then, the stock’s been in free fall, and it’s now down 42% from when we made our Danger Zone call. Investors that pick stocks like OLN and ignore ones like NVDA due to simplistic metrics are not truly value investors. In a buyer-beware system like our market, you need to understand how to separate real value-investing research from the imposters. True value investing means performing your due diligence to understand the real economics of the underlying business and the profits it will have to achieve in the future to justify its stock price. Only by doing this hard work can investors uncover value and protect their portfolio. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. 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.

Should REIT Investors Only Use A Buy And Hold Strategy?

Using REITs as an example I respect Brad’s expertise and experience in identifying the better choices of long-term, income-growth REITs. I have no such credentials. So I took his choices as listed in his report, and only included those where my special information could contribute. What I bring to the party is the daily updated next few months’ price range forecasts of market-makers [MMs] for over 2,500 widely-held and actively-traded equities, including hundreds of REITs. Their forecasts are derived from their hedging actions (real money bets) taken to protect firm capital required to balance buyers with sellers in filling volume block trade orders of billion-$ fund management clients who are adjusting portfolio holdings. Those forecasts are forward-looking additions to the reward/risk challenge, providing explicit downside price exposure prospects, as well as comparable upside gain potentials. Conventional risk/reward evaluations usually are based on only one forward-looking dimension: EPS and its growth potential. Everything else is drawn from history. Past P/E ratios and past price behaviors. Worse yet, the downside guess is typically a symmetrical measure (standard deviation) of price change, including upside differences from a mean value as well as downside ones. And the longer-term historical periods measured assume that neither the size of the variances nor their upside to downside balance varies over the time period. The assumption is that “risk” is static. Do today’s market prospects look like they did six months ago? Or a year ago? We also use history as a guide. But we try to make more sensible comparisons, because we have the information at hand to do so. We can look to the history we have collected live as the market has evolved daily in the past 15+ years since Y2K. We know what was being estimated by those arguably best-informed pros in the market, in terms of their stock-by-stock, day-by-day real money self-protecting actions. Real behavioral analysis of folks doing the most probable “right” things, not everyday man making errors of perception. We look to see how prices actually changed following prior forecasts that had upside-to-downside balances like those being seen today. And recognizing that today’s competitive scene continues to evolve, we limit our look back to the most recent five years, 1,261 market days. How that looks for this sample of REITs Click to enlarge This table has columns of holding periods following the date each forecast was made, increasing cumulatively up to 16 weeks of five market days. It has rows showing the annual rates of change (CAGRs) in each of the holding periods, for the forecasts counted in the #BUYS column. Those forecasts are a total in the blue 1: 1 row, so they are the average of the several REITs. The row above the blue row includes about half of the total sample, counting all forecasts where the upside prospect was twice the downside, or better. The next higher row includes only those forecasts where the upside was three times the downside. That process continues to the top row where only the forecasts that had huge positive upside balances, or had no downside at all, existed. The bottom half of the table below the blue row is just the inverse of the top half. In some ways, it is the more interesting part of the table. It shows that for these REITs the MMs pretty well identified the points in time where price problems were upcoming. It also shows that those issues would eventually recover, and at a later date probably be part of the forecasts shown in the upper half of the table. It also justifies the notion that if time is not a problem for the investor (he/she has adequate financial resources to deal with current retirement needs or sufficient time remaining before retirement to get there), then buy and hold works for them as a strategy in these cases. But if time is closing (or has closed) in on the retiree, then an active investment strategy of moving away from troubled REITs and into more favorably positioned ones can provide capital gains, along with the payout income of the alternative. It takes work and attention that is not required with B&H. But the CAGRs that can be added are not trivial. The REIT illustration has broader application Brad makes a strong case that, focused as he is on REITs, they should make up only a minor part of the investor’s portfolio. The table he uses from asset manager 7Twelve, showing year-by-year returns for various asset groups is instructive. Here is a copy of that table: Click to enlarge It has to be enlarged to be readable, but it is worth the effort. The yellow-highlighted years of best asset performance HOLLER * for attention to active asset-class portfolio management if you expect to beat the “market” average. The simple arithmetic average of the best asset gains each year was +31% and the worst averaged -14%. What typically is taken as the “market” average year was +5% simple, but the CAGR for the S&P 500 over the 15 years is about zero. *(A little Maine human: I had an Uncle who sometimes referred to advertising “written in letters large enough that you had to holler to read ’em”). Robyn Conti’s survey of investors in retirement showed that only 55% of them had over $200,000 portfolios. Of that 55, 31% had over $1 million. Some 5% admitted to less than $200,000 and the other 40% may have none. Trying to live better than social security and what a 401(k) plan may provide is pretty tough from even an 11% yield on $200,000 if it all was in REITs at the above table’s average. But as Brad makes clear to all nest featherers, we should use several baskets. Trouble is, the varied asset classes all present active-management alternatives if you have the insights. Here is how the Dow Jones stocks have fared over the past five years, based on MM forecasts: Click to enlarge Clearly, over the last five years, there have been hundreds of instances in these 30 stocks where substantial lasting capital gain advantages could be had, and as many or more where major capital calamities could be avoided. And these are the most closely watched stocks. Bigger and more frequent increments are being offered regularly elsewhere. Conclusion For many retirees, (the 31% in Robyn Conti’s survey with over $1 million portfolios and some of the 24% slightly less well-heeled), where REIT investments are concerned, buy and hold is a well-earned and satisfying strategy. But both her report and Brad Thomas’ advice open the consideration of earning more comforting resource reserves by the investor taking an active part in building and maintaining a more rapidly growing portfolio. We are particularly sensitive to the problems of those within 15 years of retirement who, by buy and holding SPY or similar market-average investment, may have lost any opportunity for growth over the last 15 years. They probably can’t afford to repeat that experience without a love for a future greeter role at the local Wal-Mart.

VWELX: This 86 Year Old Fund Is Still An Ideal Choice For Retirement

Summary Vanguard Wellington is the first balanced fund in the U.S. having launched in 1929. The fund has ranked in the top 10% of its Morningstar peer group over the past 5-, 10- and 15-year periods. The fund has a beta of 0.65 compared to the S&P 500 while outperforming the index over the long term. Wellington held up remarkably well during the 2000 and 2008 bear markets. In a world where there are literally thousands of funds and ETFs available that cover almost every niche, sector and style available, sometimes it’s the most tried and true investment vehicles that still remain the best choices. In the case of the Vanguard Wellington Fund (MUTF: VWELX ), we’re talking about literally the oldest balanced mutual fund in the country. Launched all the way back in 1929, Wellington looks to maintain a balance of roughly two-thirds of assets in conservative large cap stocks and one-third of assets in a mix of high quality bonds. It’s this type of asset allocation that makes for an ideal core holding in many retirement portfolios. Historically, Wellington has provided exactly what retirement investors should be seeking – above average returns with below average risk. With a current beta of 0.65, you’d expect the fund to return about two-thirds of the SPDR S&P 500 Trust ETF’s (NYSEARCA: SPY ) return but over the past 20+ years that hasn’t been the case. VWELX Total Return Price data by YCharts Looking at the past 2+ decades of history is especially appropriate because it takes into account both bull and bear market environments. The fund has performed about how one would expect – outperforming the S&P 500 in a down market but trailing in an up market. The fund’s risk minimization strategy proved especially effective during the Nasdaq bubble providing a relatively steady market performance given the economic environment. While the chart above doesn’t illustrate Wellington’s performance during the financial crisis particularly well but you can see below how well the fund held up. VWELX Total Return Price data by YCharts While the S&P 500 dropped around 55% from its 2007 peak, Wellington was down about 35%. That’s roughly what you’d expect considering the fund’s 60/40 allocation but the fund’s long term performance has been exceptional. Over the last 10 years, the overall performance of Wellington and the S&P 500 has been almost identical. Using a more apples to apples comparison, Wellington has also outperformed the Vanguard Balanced Index Fund (MUTF: VBINX ) – a fund with a 60/40 stock and bond allocation – during the same 10 year period. Morningstar drops Wellington into the Moderate Target Risk bucket. While the fund has returned 8.2% per year since the fund’s inception, it has consistently ranked at the top of its peer group. Wellington ranks in the top 6% of its peer group over the past 5-year and 10-year periods and ranks in the top 4% in the past 15-year period. It’s this type of risk-managed performance history that retirement investors should be seeking out. Retirement income investors will also appreciate the fund’s 2.43% yield. The fund has a few dividend champions among its equity holdings and the bond holdings are almost entirely high quality corporate and Treasury securities ensuring that the fund’s dividend is secure and reliable. Conclusion I’m a firm believer that in the case of most retirement investors, simpler is better. Sophisticated investors may feel comfortable building a more complex portfolio using stock, sector ETFs, etc. but for those who want an all-in-one long term holding that they can just establish and forget about, it’s hard to imagine someone doing much better than Vanguard Wellington. The combination of strong long term performance, risk minimization and low costs make this an ideal core retirement holding even if it’s not as exciting as some of the newer niche products hitting the market today.