Tag Archives: seeking

Should You Buy Value Stocks Today?

The third quarter was abysmal for stock markets. October has proven the pain short-lived. Growth stocks have outperformed value stocks. But value has the long-term track record of outsized returns. The typical investor is a notoriously bad timer at buying and selling. A good advisor helps limit emotion-driven mistakes. The third quarter is now on the books and it was an ugly one for stocks. The S&P 500 ( SPY , IVV ) fell 6.4% while the Russell 1000 Value ( IWD ), arguably one of the best indices to benchmark “value” stock performance, was down 8.4%. We commented last month, “We concede that there are plenty of reasons to hesitate, but we’re putting capital to work. The economic landscape in the U.S. remains favorable to equities and more importantly, ample long-term investment opportunities exist. … And that’s why we’re buyers.” At least for now, the recent turmoil has proved short-lived. The S&P 500 is up over 8.0% in October and the Russell 1000 Value has posted a similar gain. For the year, the S&P 500 has delivered a 2.5% gain, while the Russell 1000 Value returned negative 1.8%. Growth stocks are up over 6.0% in 2015. Value stocks’ year-to-date underperformance of growth stocks isn’t a new trend. It’s been a tough going for value for many years now. (click to enlarge) Since Black Cypress’s inception in the summer of 2009, over six years ago, growth stocks have outperformed value stocks by 23% — about 3.0% per year. Growth’s cumulative outperformance stretches back even further, all the way to the end of 2006 before the onset of the recent financial crisis. Growth has bested value by 5% per year for almost nine years. There are only two other instances in history where growth’s dominance reigned longer: the Great Depression (another financial crisis) and the technology bubble of the 1990s. Such multi-year value underperformance is unusual. Historically, it lasts a few years at most and growth’s cumulative gains are reversed over a one or two-year period. At least that’s the historical precedent. Since 1927, value stocks have returned an average 2.5% more per year than growth stocks. Academics call this historical outperformance of value over growth the “value premium”. And yet, while the value premium is a well-documented phenomenon, most investors fail to capture it. Owning an underperforming asset taxes one’s patience. Continuing to own it requires a deep conviction in one’s research as well as the emotional fortitude to withstand the frustration that comes with being at odds with the market. Most investors have neither. And therein lays the likely reason the value premium remains despite widespread knowledge of its existence: capturing it entails suffering through occasional periods of underperformance. Individual investors buy and sell at inopportune times, fund managers fear redemptions and hug their benchmarks, and advisors chase the hottest funds. And the value premium persists. One of the best studies to illustrate such bad investor behavior and its impact on performance is DALBAR’s Quantitative Analysis of Investor Behavior. This study doesn’t address the value premium in any way, but it is illustrative of investor actions and their effects, which makes it relevant to our discussion. The 2014 QAIB stated that over the last 30 years, investors in stock mutual funds averaged annual returns of 4.0%, while the S&P 500 averaged about 11.0%. That is, the very investors that were seeking equity market performance by buying stock mutual funds underperformed stock markets by over 7.0% per year. The culprit? Poor timing decisions. Investors — including individuals, advisors, and consultants — added to their stock positions at or near stock market peaks and sold near market lows. Investors also hesitated to invest again after markets bottomed. Investors are their own worst enemy. We choose to address these topics for two reasons. First, because we’re value-oriented investors and it has been one of the more inhospitable environments in history for our investment approach. In the last two years alone, growth stocks have outperformed value stocks by 9.0%. To say the least, it has been a challenge to provide outsized returns with our currently out-of-favor approach. And yet, despite the headwind of growth over value since our firm’s inception, our strategies have held their own with broad markets. Considering what we’ve been up against, including growth’s dominance as well as no opportunity to showcase our risk management practices in this ongoing bull market, we’re pleased with our results. And today, we think our portfolio is about as well-positioned against the market as it has ever been. Broadly, we like value’s prospects over the next five years. The second reason we delved into these topics is because one of the most important functions of an investment advisor is to provide a check on emotion-driven decisions. Coaching to buy, sell, and hold, and the timing of these recommendations, often goes overlooked in an advisory relationship. But it can be more important than security selection itself. Get an advisor you can trust if you’ve found yourself buying and selling for no other reason than emotion. You’ll save yourself some well-deserved self-ridicule and probably a lot of money too. Our portfolio is well-positioned to capture the value premium and to create excess value through our carefully selected individual company holdings in the years ahead. Is yours?

German ETFs Hurt As Business Confidence Falls

German ETFs took a beating yesterday as reports indicated a fall in business confidence in Europe’s biggest economy for the first time in four months . The Ifo Institute revealed that business climate index declined to 108.2 in October from 108.5 in September. At the beginning of this month, ZEW Center for European Economic Research in Mannheim also revealed that its index of investor confidence decreased to 1.9 in October from 12.1 last month. This is the seventh consecutive decline, attributed to Volkswagen’s ( OTCQX:VLKAY ) emission rigging scandal and sluggish growth in emerging markets. Further, Germany’s exports declined at the fastest pace in August since the financial crisis in August 2009. As per German Federal Statistics Office, the country’s seasonally adjusted exports tumbled 5.2% to €97.7 billion ($149.7 billion) in the month, from July. This certainly doesn’t bode well for an economy highly dependent on exports for growth. Meanwhile, Germany’s economics ministry data showed that manufacturing orders ebbed 1.8% while industrial output slid 1.2% in August after a revised increase of 1.2% for July. The blame for all these goes largely to the slowdown in China and other emerging markets, those being the key export markets of Germany. The weak global growth led the German government to lower its economic growth forecast for 2015 to 1.7% from its previous level of 1.8%, but it kept its 2016 growth outlook intact at 1.8%. However, the German Chambers of Commerce, or DIHK, predicted growth of only 1.3% for the next year. On October 26, some of the major German ETFs such as iShares MSCI Germany (NYSEARCA: EWG ), iShares Currency Hedged MSCI Germany (NYSEARCA: HEWG ), WisdomTree Germany Hedged Equity ETF (NASDAQ: DXGE ), and First Trust Germany AlphaDEX ETF (NASDAQ: FGM ) ended their sessions in the red. EWG fell 0.04%, DXGE dipped 0.3%, while both HEWG and FGM declined 0.4% on the day. Despite the fall, there are rays of hope that could cause the ETFs to rebound in the near term. The Ifo Institute revealed that in spite of the knockdown from the Volkswagen scandal, Germany’s automobile industry is optimistic about their present business environment and trade outlook for the next six months. Moreover, the indication of a fresh monetary stimulus for the Eurozone by December given by the European Central Bank president Mario Draghi and the cutback in interest rates by China to revive economic growth in the region are upsides to the prevailing economic scenario. These will definitely define the future movements of these ETFs. Original Post

The Two Definitions Of Net-Nets: Net-Net Working Capital Versus Net Current Asset Value

Summary There are two definitions of net-nets: Buying stocks at below two-thirds of net current asset values (NCAV), and purchasing stocks trading under net-net working capital, a revalued version of NCAV. I offer some general principles and caveats that apply in the case of both low P/NCAV net-nets and low P/NNWC net-nets. My exclusive research service, Asia/U.S. Deep-Value Wide-Moat Stocks, provides watchlists and profiles of net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. Defining Net-Nets Two different “versions” of net-nets have evolved from the teachings of Benjamin Graham in his two books “Security Analysis” and “The Intelligent Investor.” The first definition of net-nets involves comparing the net current asset values (current assets – total liabilities) (NCAV) per share of stocks against their share prices and buying them if the P/NCAV ratios are below two-thirds. The second definition of net-nets, more commonly known as net-net working capital (NNWC), makes an attempt at “revaluing” NCAV with the following adjustments: +100% of cash and short-term investments +75% of accounts receivables +50% of inventories -100% of all liabilities Both definitions of net-nets try to incorporate a margin of safety for the collectability risk of accounts receivables and the salability of inventories to a certain extent (the former through an arbitrary discount assigned to the net current asset value; the latter via specific discounts for accounts receivables and inventories). Most deep value net-net investors tend to use the first definition of net-nets, P/NCAV, in their search for potential investment candidates, as the screening for low P/NNWC stocks is more difficult in reality (compared with low P/NCAV stocks). Firstly, there is a greater likelihood of data services providers getting the calculation of accounts receivables wrong since a significant number of companies tend to lump accounts receivables and other receivables and may not provide the necessary disclosure to differentiate between them. If one incorporates all receivables (including non-operating receivables) in the calculation of low P/NNWC net-nets, he or she may be overstating the value of NNWC. Secondly, simply taking 100% of cash and short-term investments at their face values may not be the wisest thing to do since the market values of short-term investments will fluctuate and not all cash are unencumbered and excess in nature. Thirdly, the 25% and 50% discounts assigned to accounts receivables and inventories respectively may not be appropriate for all companies. For example, some companies may have customers which are MNCs or government-linked where the probability (and history) of defaults is close to zero, so even a 25% discount for accounts receivables is considered harsh. On the other hand, for companies which sell products with short lifecycles and shelf lives and are witnessing growing inventory days, a 50% discount for inventories may be simply too little. The second definition of net-nets, buying at less than two-thirds of NCAV tries to solve this problem by assigning a blanket 33% discount to all the current assets on the balance sheet. Stocks Trading At Low P/NCAV But High P/NNWC Continuing from the discussion above, it will be intuitive to conclude that stocks trading at low P/NCAV ratios but high P/NNWC are likely to have lower margins of safety since the “quality and quantity” of assets are questionable. I provide two examples of such stocks for illustrative purposes below. I focus on assessing the margin of safety for the stock (comparing net current asset value against net-net working capital) rather than the stock’s investability as a net-net. STR Holdings (NYSE: STRI ), a provider of encapsulants to the photovoltaic module industry, appears on the net current asset value screen as a net-net trading at 0.32 times P/NCAV, but it will not qualify as a net-net if one considers its P/NNWC ratio of 1.5. This is because STRI’s current assets include income tax receivable and other current assets amounting to $8.3 million and $4.7 million respectively, which I do not include in the calculation of NNWC. Hong Kong-listed Xinjiang Tianye Water Saving Irrigation System Co. ( OTC:XJGTF ) (840 HK), a company engaged in the design, manufacturing and sales of drip films, PVC/PE pipelines and drip assemblies used in water saving irrigation system, is valued by the market at a P/NCAV of 0.64 times, but its P/NNWC ratio exceeds 2 times. This is largely due to the fact that inventories and accounts receivable contribute 63% and of 16% of Xinjiang Tianye Water’s current assets respectively and are therefore heavily discounted based on the net-net working capital formulae. The full list of 75 U.S. and Asian low P/NCAV (less than 1) net-nets trading at high P/NNWC (greater than 1) ratios, which should warrant greater attention to their underlying asset values, is available exclusively for subscribers of my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service in a separate bonus watchlist article. Assessing The Real Margin Of Safety For Net-Nets There are some general principles and caveats that apply in the assessment of the margins of safety for both low P/NCAV net-nets and low P/NNWC net-nets. One of them is the collectability risks relating to accounts receivables. Accounts receivables are near-cash in nature as long as they do not become bad debts i.e. customers default on payment. One can assess the collectability risk of accounts receivables for a specific stock in terms of the trend in accounts receivable days, the credit payment terms for customers, the credit strength of major customers, the adequacy of current provisions for bad debts and the potential for further write-downs on the receivables. Another point to take note of is the salability risk of inventories. Under normal conditions, the costs and selling prices of inventories are relatively stable. In reality, rising raw material costs, changing customer preferences and lack of bargaining power with suppliers and customers could lead to overstocking, loss-making finished products, and eventually write-downs on inventories. Similarly, cash and short-term investments are not always as “safe” as they appear to be. The accounting values of short-term investments such as stocks, bonds, hybrid securities, structured products are typically mark-to-market with huge volatility in their prices and values. In addition, not all of a company’s cash balances are unencumbered and excess in nature since some cash may be set aside for security deposits or working capital purposes. Also, if a net-net is loss-making, the market may be discounting the future cash burn into its share price. For readers interested in learning more about the background of net-nets and specific Asian names, they can refer to my articles on Hong Kong net-nets and Japanese net-nets here and here respectively. Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks get full access to the watchlists, profiles and idea write-ups of deep-value investment candidates and value traps, which include net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.