Category Archives: Historical Lessons

Graham, Buffett, and The “Superinvestors”

Collectively, mutual fund managers have a very poor track record. But while the pros struggle mightily to beat their benchmarks, that doesn’t mean that beating the market is impossible, Validea CEO John P. Reese writes in his latest Seeking Alpha column.

“In a 1984 speech he gave at Columbia University entitled ‘The Superinvestors of Graham-and-Doddsville’, [Warren] Buffett examined the remarkable track records of a small group of investors who studied under Benjamin Graham, the man known as “The Father of Value Investing,” Reese writes. “He explained that from 1954 to 1956, there were four ‘peasant level’ employees working under Graham at the Graham-Newman Corporation (David Dodd and Jerome Newman were among the firm’s other directors). Three of those ‘peasants’ (Walter Schloss, Tom Knapp, and Buffett himself) established easily traceable track records after leaving the firm, Buffett said — and all of those track records were tremendous.” Buffett concluded that this was no coincidence, and that there must be something to Graham’s techniques.

Many other great investors were inspired by Graham’s value-focused approach, Reese notes. In recent years, however, value stocks – which over the long haul have significantly outperformed more expensive stocks – have struggled. “But these periods of underperformance are where great value investors like Graham and Buffett do the hard work that lays the groundwork for future gains,” Reese explains. “When others bail on good stocks that are having short-term dips, those focused on the long term can swoop in and pick up the bargains left behind. It’s hard to do, because in the short term your portfolio can include some very unloved, declining stocks. But, as Graham, Buffett, and other ‘superinvestors’ have shown, over the long haul value and fundamentals win out. Stay disciplined, and you tilt the odds greatly in your favor.”

Reese looks at a handful of stocks that get high marks from his Graham- or Buffett-inspired Guru Strategies. Among them: industrial firm Mettler-Toledo.

 

To Avoid Value Traps, Get Multi-Metric

Value traps can ensnare even the best value investors. But in a recent piece for Canada’s Globe and Mail, Validea CEO John P. Reese offer some advice on how investors can limit the impact these traps have on their portfolios.

Reese says there is a key step investors should take to protect from value traps (that is, a stock that appear to be cheap at first glance but whose value proves to be a mirage): Use multiple valuation metrics. “Yes, using a single valuation metric can lead to outperformance over the long haul,” Reese says. “But for a given stock at a given time, a single valuation metric can be very misleading. For example, a company whose sales have been declining may still be squeezing more and more earnings out of those sales by delaying needed capital improvements or making some crafty accounting manoeuvres. In such cases, the company’s P/E ratio is likely to be artificially low, and its price-to-sales (P/S) ratio may be a better gauge of true value.”

Other times, companies can use dangerous amounts of debt that boost earnings and sales in the short term, but make for serious long-term headwinds that will detract from future earnings, Reese writes. In such cases, the EBIT/enterprise value metric can give a better sense of the stock’s true valuation.

“A stock doesn’t have to look cheap using every value metric – you simply aren’t going to find many technology companies with low P/B ratios – but it should look cheap using more than one,” Reese says. “By using multiple valuation metrics within your investment strategy, you make it less likely that you will walk into a value trap.”

Reese uses his Guru Strategies, each of which is based on the approach of a different investing great, to find stocks that impress using multiple valuation metrics. Among those he highlights: blue-collar staffing firm TrueBlue.

 

 

 

 

 

 

 

 

 

 

 

O’Shaughnessy: Timeframe Is Most Investors’ Biggest Mistake

James O’Shaughnessy’s What Works on Wall Street is something of a bible for quantitative investors, and in a recent Investors Podcast, O’Shaughnessy talked about what his vast amount of research has taught him.

O’Shaughnessy says it is critical to understand human nature if you want to succeed at investing. While his book detailed how dozens of quantitative strategies have worked over several decades, he says he wasn’t worried that disclosing the information would lead to hordes of investors piling into the best strategies, and thus ruining them. He “knew that, human nature being what it is, that they might get very excited about it but the moment it stopped working, they would abandon it. I mean, I’ve seen this time and time again. I’ve had investors who have been with me for years, getting great performance, and then suddenly we have a bad year or a bad couple of years, which we’ve told them about ahead of time, right, because we can always show them that nothing works all the time,” and they still bail.

Basing their decisions on short-term results is in fact the biggest mistake investors make, O’Shaughnessy says. Most investors don’t realize that even three years is too short a time to judge a strategy, he says. He also says that, while he pays attention to macroeconomic factors, he does not include them in his stock-selection models.

O’Shaughnessy also talks about rebalancing, saying that he has found that a monthly approach – that is, revising his portfolios each month so that they contain the highest rated stocks according to his models – works best when all factors are considered. And he talks about how he combines value and momentum in his portfolios.

As for where he is finding value now, O’Shaughnessy says he still sees plenty of good US stocks with high shareholder yields. He also sees a lot of value in emerging markets and international stocks, which he says are extremely cheap. But he warns that investors need to have a five-year time horizon if they’re going to invest in those areas.

 

Why Graham-Style Value Investing Isn’t Dead

While value investing has had a difficult run, Validea CEO John P. Reese says not to give up on the discipline that Benjamin Graham created.

Since February 2007, U.S. value stocks have lagged the most expensive U.S. stocks by 2.6 percentage points annually, Reese writes. “The eight-year, seven-month stretch of underperformance is the longest losing streak on record, going back to 1926.” Does that mean good old-fashioned Graham-style value investing has gone the way of the dodo bird?

Reese doesn’t think so. “The idea of buying undervalued, fundamentally sound stocks still makes plenty of sense, and there’s no reason that such an approach should cease to work over the long haul,” he writes, saying that he believes several temporary factors are driving value’s underperformance. They include:

  • The trauma of the 2008-09 financial crisis has caused many to become extra sensitive to any sign of danger in the market, likely leading many investors to avoid value plays, which tend to have short-term problems hanging over them.
  • Weak global growth has likely led investors to reach for growth wherever they can find it–even if it is in overpriced growth/glamour stocks;
  • The basic materials and energy sectors, which tend to be laden with value stocks, have been pummeled by the commodity collapse of the past year-and-a-half;
  • The Federal Reserve’s extended period of ultra-low rates, which may well be distorting the growth/value cycle.

Reese says that often after going through rough periods, good strategies rebound with a vengeance. Because of that, he’s paying close attention to his Graham-inspired Guru Strategy, which is based on an approach Graham laid out in his classic book The Intelligent Investor. Reese looks at how this model works, and he examines a handful of stocks it is currently high on. Among those he highlights: clothing and apparel retailer Genesco.

Bogle’s Long-Term Projection Formula

As we move into 2016, just about every pundit in the world is offering his or her prediction on how stocks will fare over the coming year. But in a recent piece for Canada’s Globe and Mail, Validea CEO John Reese says those predictions are essentially worthless.

“That’s because so many factors go into short-term market movements that no one has found a way to reliably predict them,” Reese writes. “Not that they haven’t tried. In his 1984 classic Super Stocks, Kenneth Fisher wrote that people have attempted to divine market movements using astrology, demographic studies, sunspots, economics, technical analysis, tea leaves, and even ‘the skin of a dried lizard at sunset cast to the wind.’ But, Mr. Fisher said, while a forecaster might have a good of couple years, no one has found a way to consistently predict short-term market movements – and that still holds true.”

But, Reese says, longer-term projections do have some benefit. “Legendary Vanguard founder Jack Bogle, for example, has found that just three factors go a long way toward predicting where the market will be 10 years out,” he writes. “The first two of Mr. Bogle’s factors are dividend yield and corporate earnings growth, which comprise what he calls the ‘investment return,’ because they are determined by fundamentals. The third is ‘speculative return’ – that is, the change in what investors are willing to pay for each dollar of earnings (in other words, whether the market’s price-to-earnings ratio is rising or falling).”

Right now, that projected investment return is about 7%, Reese says, though he notes that a percentage point or two could be clipped from that if valuations come back down to historical norms. Reese takes a look at three stocks that he thinks are offering better-than-average opportunities. Among them: RV maker Thor Industries

 

When It’s Okay To Chase Hot Stocks

“Don’t chase hot stocks” — time and time again, investors are warned not to jump on the bandwagon of a red-hot stock. But in his latest for NASDAQ.com, Validea CEO John Reese says that there are plenty of exceptions to that rule.

“Generally it’s good advice — throughout history many investors have been pummeled because they tried to ride the momentum wave, and jumped on hot stocks just before the wave crashed. (Just ask those who went headlong into tech stocks around 2000.),” Reese writes. “But the ‘don’t chase hot stocks’ advice is, in fact, incomplete,” he adds. “The full version should be more like this: ‘Don’t chase hot, expensive stocks’.”

Reese says that distinction is an important one. “High-flying, overpriced stocks often lose steam and then come crashing down from great heights,” he says. “But high-flying inexpensive stocks can continue to fly high for some time — and they don’t have as far to fall if their momentum wanes. If used alongside valuation metrics, momentum can thus actually be a very helpful part of your stock-picking approach.”

Reese talks about three investment gurus who combined value with momentum in their stockpicking approaches: James O’Shaughnessy, and Tom and David Gardner. He also looks at a handful of stocks that get high marks from his Guru Strategies, which are based on the approaches of O’Shaughnessy, the Gardners, and other investment greats. Among them: temporary staffing firm TrueBlue Inc.

How To Deal With All Those Conflicting Investment Opinions

With so many financial news outlets offering so many often conflicting headlines and opinions, how is an investor to know what to do? That’s a question that Validea CEO John Reese looks at in his latest column for Canada’s Globe and Mail.

“In an arena as complex as the stock market, there are always two sides to an issue – and sometimes many more – and you can almost always find data to support any of those sides,” Reese writes. “So, as convincing as they may be, a particular headline and article can lead you into big trouble if you let them guide your investment decisions. That doesn’t mean you should ignore the financial news. Information is still power. But how you use the overabundance of information that exists today is key.”

Reese offers a few tips for how investors can find their way through the thick forest of conflicting opinions. He cites the research of Dr. Philip Tetlock, who has performed extensive research on the issue of forecasters and forecasting. “Dr. Tetlock, a psychologist and management professor, did find that some types of forecasters are better than others,” Reese says. “Using terms that philosopher Isaiah Berlin used to describe two broad types of thinkers, Dr. Tetlock said that “foxes” did better than “hedgehogs.” “The better forecasters were like [Berlin’s] foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability,” Dr. Tetlock told Money magazine. The less successful forecasters were like hedgehogs, which “ ‘know one big thing,’ toil devotedly within one tradition, and reach for formulaic solutions to ill-defined problems.”

To think like a fox, Reese says investors should gather much information as they can before making a decision, particularly information representing opposing viewpoints. “When you have an opinion, ask yourself, ‘How might I be wrong?'” he says.

To read all of Reese’s tips, click here.

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