After deliberating the issue for the last month, I decided to go ahead and deploy my cash balance and place 10% of my portfolio into global indexes boasting a low CAPE ratio. Today I executed the below trades, which places 10% of my portfolio into the five country indexes boasting the lowest CAPE ratios in the world:

Poland – EPOL – 36 Shares @ $27.245

Singapore – EWS – 39 shares @ $25.215

Brazil – EWZ – 23 shares @ $42.625

Russia – ERUS – 29 shares @ $34.0795

Turkey – TUR – 23 shares @ $41.935

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Growth doesn’t bring much to the party


Counterintuitive Findings

Prior to reading Deep Value by Tobias Carlisle, I always thought that the key in value investing was to find cheap companies that could grow fast.

Buffett even discussed the merits of combining growth and value in his 1992 letter:

Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

A key point of Tobias’ book is that growth is not how value delivers returns. The discount from intrinsic value and the closing of that gap is the key driver of return in a value portfolio.

De Bont & Thaler

He cites two studies in the book that are compelling because of how counterintuitive they are. They were both conducted by Werner De Bondt and Richard Thaler. The first study looked at the best-performing stocks and compared them to the worst performing stocks in terms of price performance. They found that the worst performers go on to outperform the best by a substantial margin.

They also looked at this in terms of fundamental earnings growth. They reached the same conclusion: the worst companies outperform the best.

A Simple Backtest

I decided to backtest more recent data myself to see if this still holds true. In an S&P 500 universe, I performed a backtest going back to 1999. I compared the performance of the 30 companies with the fastest growth in earnings per share to a portfolio of the 30 worst stocks, rebalanced annually.

Just as De Bont & Thaler determined before, the 30 worst companies continue to outperform the 30 best.


Keep in mind: there is no other factor involved here except for 1-year earnings growth. We’re not even looking at these stocks in a value universe: it’s simply the 30 fastest growers vs. the 30 worst.

Value Drives Returns

The evidence suggests that value alone is the best determinant of future returns. Growth isn’t nearly as powerful.

For instance, I also tested the performance of a universe of stocks with a P/E less than 10. This universe of stocks delivered an 11.69% rate of return since 1999. Within this winning universe, if you bought the 20 stocks with the best earnings per share growth then the return actually declined to 9.77%. Fast growing value stocks actually underperform the overall value universe.

The same is also true from a macro standpoint. Looking at the performance of the S&P 500 since the 1950s, the greater determinant of future returns is starting valuation, not actual business performance.


As you can see, the valuation of the market at the start of the decade (Shiller CAPE and the average investor allocation to equities – both valuation metrics are discussed in this blog post) are far more predictive of future returns than actual business performance.

Look at where the divergence is widest — the 1980s versus the 2000s.

The 2000s was a much better decade than the 1980s in terms of actual business performance. During the 2000s, earnings grew by 191%. In the 1980s, earnings only grew by 16.40%.

However, the 1980s witnessed a 409% total return for the S&P 500, while the 2000s actually clocked in a net decline of 9%.

Of course, there were macro events driving both markets. In the 1980s, returns were bolstered by interest rates declining from all-time highs once inflation was brought under control. At the end of the 2000s, we suffered the worst financial crisis since the Great Depression and the worst recession since the early 1980s, which negatively impacted stocks at the end of the decade.

With that said, the key factor behind the returns was the overall valuation of the market, not macro events or even business performance.

The undervaluation of the US market in the early 1980s was the true force that propelled the bull market forward.  In 1980, the Shiller CAPE for the US market was 8.85 and the average investor allocation to equities was only 23%.

In contrast, the overvaluation of the US market in 2000 was the key force that drove down returns over the next decade. In 2000, the Shiller CAPE was 43.77 and the average investor allocation to equities was 50.84%. Actual corporate results were impressive but that wasn’t enough. Valuation mattered more.


The conclusion is both simple and radically counterintuitive: valuation matters more than growth in predicting future returns for a single company stock or an entire market.

In the long run, growth simply doesn’t bring much to the party.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

A financial health check up for the S&P 500


Debt: The Best Measure of Risk

One of my core beliefs as an investor is that debt is the best measure of risk.

Academic attempts to define risk as the volatility of a stock price are ridiculous. Risk is the possibility of a permanent loss of capital. The risk that a company will go out of business is heightened through the use of leverage.

There is no perfect measure of risk, but I think that debt levels give the clearest signals about the risk of an investment. A company without debt can withstand incredible business problems, while a company in deep debt won’t be able to survive the slightest shake-up.

Debt levels are one of my chief concerns when I purchase a stock.

As a deep value investor, I focus on firms that are going through a tough time in their business or sector. Because they are going through difficulty, it is paramount that balance sheet risk is low. If they have a healthy balance sheet, then they will be able to survive whatever trouble they are mired in.

I try to find the firms that are still profitable and are still in a strong financial position so they can survive the temporary business setback.

Corporate debt at all-time highs!

Due to my views on the subject, I was alarmed when I read several articles indicating that debt is rising to all-time highs within the S&P 500. High leverage levels were one of the driving forces behind the crisis of 2008.

The narrative of the corporate debt scare articles goes like this: (1) the Fed made debt too cheap after the crisis, (2) companies are taking advantage of it and spending it on frivolous activities like buying back shares, (3) corporate debt is now at all-time highs and will trigger a severe credit contraction in the future.

The headlines are usually along the lines of “corporate debt is at all-time highs!”

Well . . . based on inflation alone, corporate debt should regularly hit all-time highs in raw dollar terms. Looking at the total dollar volume of debt issuance doesn’t make a lot of sense.

The Real Story

What, then, is the best way to measure the debt risks to corporate America? Many like interest coverage ratios . . . but I don’t like this, as interest rates can change on a dime for the better or the worse. I look at total debt relative to earnings and assets.

When I assembled the data, I was pleasantly surprised to see that the situation is actually not that bad. Corporate America is financially healthy. Despite record low interest rates, corporate America hasn’t gone on a debt binge. Quite the opposite. They have been deleveraging since the crisis.



This suggests that if we do fall into a recession, it won’t be the painful credit crunch we endured in 2008. Even though interest rates are at historic lows, corporate America is not taking the bait.

This also explains why the Fed has been able to keep interest rates near all-time lows. Few companies are actually taking advantage of the low rates.

Financial journalism is in the business of creating sensational click-bait headlines. They aren’t particularly useful. This is why individual investors need to do their own homework and think independently.

I think low corporate debt is also is a major reason that the economy isn’t growing more than 2% even though interest rates are rock bottom.

While it means less growth for the economy, it also means less risk for corporate America. That’s a good thing.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Macro is hard and probably a waste of time


Macro is probably a waste of time, but I can’t help myself

Everywhere I turn in discussions of the stock market, everyone seems to have made a similar conclusion: (1) The stock market is in a bubble, (2) the Federal Reserve created the bubble, (3) When the bubble bursts, we will be faced with financial Armageddon.

The mood among value investors looking at a historically high CAPE ratio is something like this:

giphy - Copy

I love talking and thinking about Macro, but I suspect it is mostly a fun waste of time and not entirely useful. Peter Lynch offered the following advice about these matters:

Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.

Nobody can predict interest rates, the future direction of the economy, or the stock market.  Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

I think living through 2008 might have polluted everyone’s minds, the same way 1929 poisoned the minds of a generation of investors and made them stay out of the market for life to their own detriment.

Unlike the 2000-02 meltdown, in 2008 there was nowhere to hide. This is because the 2000 collapse was driven by an overvalued stock market falling apart. 2008 was different because it was an economy-wide credit contraction that caused everything to decline.

This left investors with a kind of financial PTSD. As for myself, I had hardly any money at the time, so I wasn’t concerned about my financial assets going down, but I was still consumed by fear.

By day I am an operations nerd for a bank, so I was acutely aware of what was going on. I had very little savings (I was in my mid-20’s and had just started making decent money), a pile of debt and I was mostly worried about basic survival if I lost my job and faced a Depression job market. My main personal lesson from the crisis was about the dangers of being in too much debt and not having sufficient savings. Today I have zero debt and an emergency fund if I lose my job. I sleep better at night.

If anything, this is why the simple low-PE low-debt Graham strategy intuitively appeals to me. Financial problems facing a company or a person are always manageable . . . Unless you’re in heavy debt.

Post-crisis, everyone is consumed with trying to predict the next meltdown after getting burned so badly.

We look at investors who made the right call — people like John Paulson — and are in awe that they made the right call. They knew what was going to happen. We want to be able to predict what is going to happen. We become obsessed with finding tools that will help us prevent losing money.

Post-crisis hindsight also puts the permanent bears in a positive light. They are lauded for getting it right in 2008, but how much money has been lost listening to them since then?

Prediction is Hard

As small investors, I think we may have to just accept the fact that if we want equity-sized returns, we need to take equity-sized risks. A 25% drawdown a couple times a decade is pretty standard. A 50%+ drawdown 3 or 4 times a century is also typical. The average person lives about 80 years, so when they see these events happen a couple of times it looks extraordinary in the context of our lives and permanently affects our thinking. In the grand scheme of things, these events are not uncommon and we should expect them.

Charlie Munger gave this great advice about the subject:

This is the third time Warren and I have seen our holdings in Berkshire Hathway go down, top tick to bottom tick, by 50%.  I think it’s in the nature of long-term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%.  In fact, you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.

We can’t invest like 1929 or 2008 are going to occur tomorrow. It’s not a useful long-term strategy for building wealth. We need to accept the fact that we will face those kinds of drawdowns and face the fact that there will be more minor drawdowns frequently (or the 20-25% variety) and don’t give into our emotional need to panic. If we constantly live in fear that a big drawdown is imminent, then we should stay out of the market and won’t earn equity sized returns.

Using valuation tools to time to the market

There are tools to predict future market returns (like the CAPE ratio, the average equity allocation, market-cap-to-GDP, etc.) that give us clues as to where we stand in the cycle, but timing the market using those tools isn’t particularly effective either. I’ve talked about them on this blog.

You can use these tools to predict market returns 10 years out, but it doesn’t tell you if a correction is going to happen tomorrow and they are not particularly useful for timing the market.

The 10-year S&P returns predicted by valuation tools don’t happen in a straight line. My favorite indicator (the average equity allocation), suggests a 10-year rate of return for the S&P 500 of 3.34%. With the 10-year treasury yielding only 2.361%, that actually makes sense. We are likely in store for a decade of low returns across all asset classes. “Low returns over 10 years” does not mean “We are facing Old Testament biblical meltdown.”

(Hell, if we were facing an Old Testament Mad Max kind of situation, what good is your 401(k) going to do you anyway?)

You can use market valuation tools to get a fair understanding of what returns will look like, but it is not a crystal ball. It doesn’t predict if a crash will happen tomorrow or what the road to those returns will look like.

Current valuations are basically where we were around 1973 and 1998. The 10 years after ’73 and ’98 were not particularly good for the indexes . . .  but they were great for value investors, the indexes still delivered a small return, and the world didn’t end. Value stocks had an excellent bull market from 2000-2003 and 1975-1978.

The difference between the two eras is that in 1973-74, value stocks went down with everything else before their bull market in 1975 and in 2000-03 value experienced a bull market during the decline of everything else.

This happened because the 1973-74 event was caused by a real economic shock, while the 2000-03 meltdown was the stock market coming back down from crazy valuations. The 2000-03 collapse was unique in that the market caused the economy to contract, while most meltdowns (like ’73-’74 and ’07-’09) are the economy causing the market to contract. The stock market wasn’t overvalued in 2008, the real estate market was. The decline in real estate caused the economic contraction, which ultimately impacted stocks.

Whether the current situation is like the ’70s or the early 2000s is tough to predict. I suspect that it will be more like the ’70s (value will go down in the bear market with everything else, but then perform nicely). Hopefully I’m wrong and it pans out more like the 2000-03 event. This is discussed in depth in this blog post.

It’s also tempting to short stocks in this environment, but that’s not something I do. You shouldn’t do it, either (unless your name is David Einhorn). Shorting is a dangerous game. For instance, tech shorts in 1999 were correct in their analysis. Even though they were right, most were completely wiped out when tech stocks doubled in 1999. They were ultimately vindicated but, as Keynes warned us, markets can stay irrational longer than you can remain solvent.

It’s tempting to try to time the market with macro valuation tools. I found a great post at Tobias Carlisle’s blog exploring this issue of timing the market using CAPE ratios. You can read the post here and here.  The conclusion is simple: timing the market using valuation tools is a waste of time. He makes the following point:

The Shiller PE is not a particularly useful timing mechanism. This is because valuation is not good at timing the market (really, nothing works–timing the market is a fool’s or genius’s game). Carrying cash does serve to reduce drawdowns.


Japan in the 1980s is the common comparison among bears to today’s market. There was a similar sentiment among bears in the late ’90s.

In the 1980s, the success of Japanese firms combined with an easy monetary policy caused a massive asset bubble. There was a widespread perception that Japan was going to take over the world.

Easy monetary policy and rising asset prices are where the comparison ends, however. Valuations in late 1980s Japan were genuinely insane. In 1989, the real estate around Japan’s imperial palace was worth more than all the real estate in the entire state of California.

During the 1980s, the Nikkei rose from around 6,600 in 1980 to 38,000 by 1989. Everyone thought that Japan had figured it out: their management was superior, their workers were better, their processes were more efficient. The zeitgeist was captured in the Ron Howard movie “Gung Ho.”

Like all bubbles, the Japanese bubble collapsed. The Nikkei fell from its high of 38,000 in 1989 to 9,000 in 2003. This is the nightmare scenario that the bears fear will happen to the United States stock market.

Valuation puts this in context. Today’s investors fret of a Shiller PE around 30. In Japan circa 1989, the Shiller PE was three times that at 90. Indeed, there is no comparison between US stocks today and Japanese stocks in the 1980s. Valuations today suggest bad returns in the future for US stocks. Valuations in Japan indicated that a complete collapse was inevitable.

Lost from the typical talk of Japan’s lost decade is a discussion of its actual economy. The focus is solely on the markets. Japan’s economy continued to chug along despite the complete meltdown in markets. Its central bank scrambled to contain the collapse, but likely merely prolonged the pain as the market was destined to return to a normal CAPE. Their unemployment rate has never even gone above 6% during the meltdown!

It took nearly 20 years for Japan to go from a Shiller PE of 90 to a more normal Shiller PE of 15. Markets are worth what they’re worth and they will eventually fall to normal levels of valuation. That’s what happened in Japan. Very little changed in their real economy, it just took a long time to work off their crazy 1989 valuations.

Value in Japan

Even if the US is in a Japanese style asset bubble (even though it is nowhere near those levels), I was curious how a value strategy performed in Japan during their asset meltdown if this were the future for the United States.

It’s encouraging that value-oriented strategies actually performed very well during the Japanese market collapse. In James Montier’s epic The Little Note That Beats the Markethe observed that Joel Greenblatt’s magic formula returned 18.1% from 1993 to 2005 in Japan. EBIT/EV alone returned an excellent 14.5%.

This suggests that as long as you stick to a value framework, even in a market that is in long-term decline, a value strategy should hold up over a long stretch of time.


My apologies if this post is a bit of a mess, but it summarizes many of the things that have been on my mind lately.  To summarize my conclusions:

  • It is probably best for most investors to not obsess over macroeconomics. The smartest people in the world are playing that game . . . and they’re bad at it. We cannot do any better.
  • Market valuation tools are useful for predicting returns over the next decade but aren’t particularly helpful in predicting short-term market moves.
  • The United States is not in a Fed-induced, Japanese-style asset bubble. Our market is high, but a definite return is still likely over the next 10 years.
  • Even if we were in a Japanese style asset bubble (which we’re not), a disciplined value-oriented strategy should still perform very well in the United States.
  • 50% drawdowns 3-4 times a century and 25% corrections are standard. They’re the cost of earning equity returns. If equities went up by their historical 8% average every year in a straight line, they would eventually stop delivering those returns. If you can’t handle corrections of that magnitude, you shouldn’t invest in stocks.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.



Q3 2017 Performance Update


I had a nice run this quarter after underperforming for most of the year. We will see if it lasts.

Interestingly, nearly all of the gains occurred in the last month. A month ago, I was down 2.72% for the quarter and the portfolio then staged a resurgence. Even after the resurgence, I still lag the S&P significantly by 8.8%

For most of the year, richly valued large-capitalization growth stocks dominated the market, and cheap stocks have lagged. This appears to have reversed in the last month, but we will see if the trend can be sustained.

As explained in a previous blog post, value stocks have lagged the market in the United States for the longest period of time since World War II. The trend will ultimately reverse itself, but there is no telling how that will take. I expect my portfolio to perform in a more exaggerated fashion to a standard value portfolio due to my concentration in 20 stocks. It should keep up with value as a group but it will be more volatile. This should lead to bigger gains in the long run with periods of pain and volatility.


While staying put for most of the year, I traded a bit this quarter. The sales are below.


The first trade was in STS (Supreme Industries) on August 9th. A buyout was announced at $21 per share. I sold for $20.95, securing a 31% gain from my purchase price. Buyouts are one of the key drivers of performance in value stocks. I think once the buyout is announced, it makes sense to sell rather than capture a tiny gain. All that can happen after a deal is announced is the deal falling through or a bidding war. A bidding war didn’t seem likely in this situation.

The next trade was in Sanderson Farms (SAFM). I have a weird temperament: I get nervous when a stock goes up too much, and I don’t really care when it goes down. I got out of Sanderson Farms because the valuation simply got too high and I already secured a 59% gain. Nevertheless, the rally continued with the stock going up another 12.9%. I probably should have let the momentum continue.

I feel the same way about TopBuild (BLD) in which I am up 71%. To avoid a repeat of the Sanderson Farms situation, I am going to let that position continue to run. When it looks like the momentum has faded, I will sell. I will indeed sell at the end of the year when I do my complete portfolio rebalance.

This is the chief drawback of deep value investing. Time is not on your side. You’re buying businesses when they look dead (or they’re just so tiny that they’re being ignored) and selling when they’ve had a modest improvement in their outlook, which leads to a massive increase in price because the market was so downbeat in the first place.

Deep Value vs. Buy & Hold

I am not a “buy and hold” investor. Contrary to popular belief, neither was Benjamin Graham. Buy and hold forever was Phil Fisher’s idea, which Warren Buffett later picked up on. Phil Fisher recommended buying stock in excellent companies and then keeping them forever. This is advice that Warren Buffett then picked up when he shifted his investment philosophy from the purchase of undervalued cigar butts to investing for the long term in good companies

In contrast, Graham’s recommendation was to hold a stock for two years or after a 50% gain, then sell. In other words, buy undervalued stocks and sell them when they reach fair value. While most value investors moved on from this philosophy, Walter Schloss stuck to it and delivered impressive results throughout his career.

One of the drawbacks of a deep value approach (contrasted with the Warren Buffett approach) is that, as Warren Buffett likes to say, time is the friend of the good business and the enemy of the bad business. I am not buying the Coca-Cola’s of the world: I am buying ignored, hated, beaten up stocks in which a problem caused Wall Street to throw the baby out with the bathwater.

I like this approach for three reasons.

1) I’m not as smart as Warren Buffett and Charlie Munger to evaluate how “good” business is. Most of the people trying to emulate Warren and Charlie aren’t either, despite their claims to the contrary. Buffett and Munger have a genius at identifying companies with strong returns on capital that have an economic “moat” which allows them to sustain those high returns on capital. This looks easy in retrospect, but it ‘s hard to pull off in practice. Most of the Fortune 500 from 1950 is gone today. Most of those businesses thought they had a “moat” of some kind, but the relentless pressure of competition made it wither away.

Buffett’s 1987/1988 purchase of Coca-Cola looks like a slam dunk in retrospect, but hindsight is 20/20. Coca-Cola had just made some blunders. They were steadily losing market share to Pepsi in the early 1980s, which lead them to change the formula of Coca-Cola which caused an incredible public relations backlash. Buffett also bought Coke in the wake of the 1987 stock market crash, when many in the investing public suspected that the US may go through another Great Depression.

Buffett also had the insight to buy Coca-Cola at the right price. There is no such thing as a “good company at any price.” Coke made sense in its 1987/1988 price. It didn’t make sense at its 1998 price.

Once Wall Street and the investing public caught on to Coke’s greatness, Coke surged throughout the 1990s, reaching a peak P/E ratio of 50 in 1998. From there, it proceeded to plunge 44% in the bear market of 2000-2002. Coke didn’t change: it was still a great company, just as it was when Buffett first bought it. Since the 1998 peak, the stock price is only up about 9% (although it has consistently paid dividends over that time).

Not only did Buffett have the genius to recognize Coke’s natural moat and economic advantages: he had the talent to identify the right price to pay for Coke. That isn’t something that I can do.

The good news is: it’s not something I need the capacity to do because I’m not a billionaire. Buffett was forced into this style of investing when he became too big. Buffett’s best returns were actually when he was buying and selling cigar butts of the net-net and low P/E variety in the 1950s and 1960s. He had to stop doing that because he became too big. He was so big that he had to buy controlling interests in net-nets, which caused a lot of pain on his part. Trying to run bad businesses is not fun.

In fact, Buffett had this to say in 1999:

“If I were running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

Now, I sure as hell can’t make 50% a year, but it seems absurd to me that most people try to invest like a billionaire when they don’t have to. An average person like me can operate in the small and micro-cap corners of the market and buy screaming bargains, then sell when they’ve had a modest improvement.

2) The other reason I prefer the deep value approach is because it is quantitative. I don’t have to visit management, I don’t have to have profound insights into the economy or future of the business, I don’t have to understand the “culture” of the firm, I don’t have to figure out if there is a moat.

It’s all right there in the annual reports and the quantitative signals from the stock. I look for a variety of signals: low P/E, cheap price/sales, bargain Enterprise multiples. I don’t need to have incredible insights into the operation and future of the business. I buy companies that are priced like they’re going to die and they are not for obvious reasons a) they don’t have a lot of debt and b) are still profitable.

Peter Lynch once pointed something out that is so obvious and so grounded in common sense that it eludes the smartest investors: “Companies that have no debt can’t go bankrupt.”

I think the leading “edges” that will exist in the future are behavioral. There is nothing more behaviorally challenging than deep value investing. You’re buying businesses with “stories” that make the stomach churn. You’re suffering short-term volatility and underperformance. Over the long run, however, the rewards will compound.

This is why I have an aversion to buying and holding great businesses, growth investing and momentum investing. It’s behaviorally easy. If it’s easy, it is eventually going to be arbitraged away. Buffett-style investing requires a stroke of genius that most people simply do not have.


3) Every value investor is trying to be the next Warren Buffett. “Wonderful companies at good prices” is a crowded game that I’m not interested in playing because everyone else is playing it. Deep value, in contrast, is a niche. As long as it stays a niche, it should outperform over the long term.

Warren and Charlie make it look easy. It’s not.

Anyway, I’ve gone off on a tangent. Back to the portfolio!


It also appears that I made a mistake with these two stocks. They are both well run Florida insurance operations. I bought them last year in the wake of hurricane Matthew related losses. I figured that they were a great value and if Florida avoided a massive hurricane, they should do well.

When hurricane Irma was barrelling towards Florida, I got scared and sold both stocks. This looked like a smart move at the time, but both have recovered nicely.

One of the points that Tobias Carlisle makes is that models outperform humans in most fields.  In fact, simple models outperform experts when equipped with the model. The tweaks that the experts bring to the design usually create a drag on performance.

For instance, if you have a model indicating when someone will go to the bar for the evening, you should be able to override that model if the patron has a broken leg. The research suggests the opposite: you are better off going with the model.

I think I should have done this with UIHC & FNHC. I let my emotions make me frightened during the hurricane, and I sold both at a loss for the year. Both stocks completely recovered from the Irma sell-off and are back to where they were before.

I let my emotions get the best of me. Hopefully, I can control this a bit better in the future and let the statistical cheapness of the portfolio work over time.

Global Low CAPE Indexing

I wrote a blog post earlier in the month discussing the idea of buying indexes for countries with low CAPE ratios. I still haven’t decided to pull the trigger on this idea. I still hold a lot of cash, (about 17%). I deployed some of it this month in two incredibly cheap stocks: Foot Locker & Game Stop. I still haven’t decided on whether or not I want to pull the trigger on this idea.


I increased my bet on the physical retail space. I initiated a new position in Foot Locker and increased my position in Gamestop. Both are ridiculously cheap by all metrics. Foot Locker trades at a P/E of 8 and Gamestop trades at a P/E of 6. They are similarly cheap on an enterprise multiple and price to sales basis. They both have clean balance sheets: little financial debt relative to their assets and earnings.

Retail stocks have an inverse relationship with Amazon’s stock this year, which has been on fire. This is due to the ubiquitous narrative: physical retail is dead and Amazon is taking over the world.

I believe that investors have overreacted to Amazon’s success. They have bid up Amazon to an insane multiple (242 times earnings as of this writing). Amazon is a good company, but as I stated earlier in my Coca-Cola 1998 example, there is no such thing as a company so good that it is worth any price. Meanwhile, physical retail stocks have been hammered down to levels not seen since the Great Recession even though their financial situation is better than it was back then.

There is certainly some truth to the rise of Amazon, but I think investors are overreacting. This is why retail stocks now comprise 25% of my portfolio. If you want to outperform the market, you have to do things that are different than the market.

The popular perception is that most shopping will occur online, but the fact of the matter is that 91% of all retail sales still take place in a store. E-commerce has increased at a relatively steady pace since 2000, gaining a little less than 1% a year. This means that in 10 years, 80% of all retail sales will still occur in a store. The revenues spent on retail sales will also be higher than they are today through normal economic growth.

There will also be a peak to online shopping. There is only so far you can go with shipping products. There is only so much you can reduce prices and still maintain economies of scale. I don’t think e-commerce will eat into physical retail’s market share forever. At some point, the two will probably reach an equilibrium. Whether that’s 50-50 or 80-20 is yet to be seen.

Retail is a declining market and some operations will go out of business, but this is an opportunity for the physical retail stores that survive. As companies like Sears and K-Mart go out of business, their less indebted competitors should benefit from their demise. The goal is identifying the retail operations that will survive and whose stocks have been unduly punished in the current shake out.

All of the retail stocks that I own have common characteristics: they all are profitable, and they all have very little debt. I’m betting that they will survive the shake-up and the slightest glimmer of hope should cause their stocks to appreciate nicely.

Or maybe I’m just crazy. That is altogether possible!

In any case, we’ll see how this continues to shake out in Q4 2017. Hopefully, the value resurgence continues.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Walter Schloss: Superinvestor

I came across this interview with Walter Schloss and it was packed with interesting quotes and insights.

Walter Schloss started his career on Wall Street in 1934 as a runner at the age of 18. He read Graham and Dodd’s Security Analysis and later went to work for Graham in his partnership. When Graham closed his partnership, Schloss went on to manage money himself. He managed money from 1956 through 2003 and delivered a 15.3% rate of return.

Here is what “Adam Smith” had to say about him in the 1972 book Supermoney:

“He has no connections or access to useful information. Practically no one in Wall Street knows him and he is not fed any ideas. He looks up the numbers in the manuals and sends for the annual reports, and that’s about it.”

Buffett had this to say about him:

“He knows how to identify securities that sell at considerably less than their value to a private owner: And that’s all he does… He owns many more stocks than I do and is far less interested in the underlying nature of the business; I don’t seem to have very much influence on Walter. That is one of his strengths; no one has much influence on him.”

While others deviated from the Grahamian value approach, Schloss stuck to it for the rest of his career. He started off buying net-nets. When net-net opportunities dried up and his capital expanded, he focused his attention on low price-to-book names.

Here are some great quotes from the interview:

  1. Ben Graham: “In the ’20s he had a deal where he took 50 percent of the profits but he took 50 percent of the losses. And that worked great until 1929 when the market went down and obviously, his stocks were affected, too, and he was not only affected by that, but many of these people then pulled out because they needed money for their own purposes or they had lost a lot of money other places. So, he figured out how he could possibly never have this happen to him again. he was very upset about losing money. A lot of us are. So he worked on a number of ways of doing this and one of them was buying companies below working capital and in the ’30s there were a lot of companies that developed that way.”
  2. Work at Graham-Newman: “Anyhow, at that time my job was to find stocks which were under valued. And we looked at stocks selling below working capital, which was not very many.”
  3. Increasing positions in beaten up stocks: “Well, a lot of people don’t like it if you buy a stock at $30 for a customer and then they see it at $25. You want to buy more of it at $25. The guy doesn’t like that and you don’t like to remind him of it. So, one of the reasons I think that you have to educate your customers or yourself, really that you have a strong stomach and be willing to take an unrealized loss. Don’t sell it, but be willing to buy more when it goes down, which is contrary, really, to what people do in this business.”
  4. More on undervaluation: “Basically we like to buy stocks which we feel are undervalued and then we have the guts to buy more when they go down.”
  5. Why the “superinvestors” who worked for Graham succeeded: “I think number one none of us smoked. We were all rational. I don’t think that we got emotional when things went against us and of course Warren is the extreme example of that.
  6. On buying foreign stocks: “Well, my problem with foreign companies is I do not trust the politics. I don’t know enough about the background of the companies. I must tell you, I think the SEC does a very good job and I feel more comfortable holding an American company.”
  7. Selling: “Sell is tough. It’s the worst, it’s the most difficult thing of all and you have an idea of what you want to sell it at and then you sometimes are influenced by the changes that take place. We owned Southdown. It’s a cement company. We bought a lot of it at 12 1/2. Oh, this was great. And we doubled our money and we sold it at something like $28, $30 a share and that was pretty good in two years. When next I looked it was $70 a share. So, you get very humbled by some of your mistakes. But we just felt that at that level it was, you know, it was not cheap.”
  8. Shifting from net-nets to low price-to-book: “Yes, it’s changed because the market’s changed. I can’t buy any working capital stocks anymore so instead of saying well I can’t buy em’, I’m not going to play the game, you have to decide what you want to do. And so we decided that we want to buy stocks if we can that are depressed and have some book value and are not too, selling near their lows instead of their highs and nobody likes them.”
  9. Q: Tweedy Browne is very quantitative, and Buffett’s more qualitative. Where are you in that spectrum? A: “I’m more in the Tweedy Browne side. Warren is brilliant, there’s nobody ever been like him and there never will be anybody like him. But we cannot be like him. You’ve got to satisfy yourself on what you want to do. Now, there are people that are clones of Warren Buffett. They’ll buy whatever Warren Buffett has. Fine. I don’t know, I don’t feel too comfortable doing that and the other thing is this. We happen to run a partnership and each year we buy stocks and they go up, we sell them and then we try to buy something cheaper.”
  10. Why he didn’t pursue Buffet-Munger style concentration: “Psychologically I can’t, and Warren as I say, is brilliant, he’s not only a good analyst, but he’s a very good judge of businesses and he knows, I mean my gosh, he buys a company the guy’s killing himself working for Warren. I would have thought he’d retire. But Warren is a very good judge of people and he’s a very good judge of businesses. And what Warren does is fine. It’s just that it’s not our — we just really can’t do it that way and find five businesses he understands, and most of them are financial businesses, and he’s very good at it. But you’ve got to know your limitations.”
  11. Selling short: “We did it a couple times and we’re always very upset after we do it. So I’d say not anymore.”

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


Going Global with Value Investing


Holding Cash in a Euphoric Market

I have a problem. 26% of my portfolio is in cash. I hate cash. It earns nothing. My preference is to be fully invested at all times. I prefer not to try to time the market.

But . . . I am frightened by the valuations present in the U.S. market right now. I don’t believe in market timing, but with a Shiller CAPE around 30, average equity allocation at 42% (probably higher now), and market cap to GDP at 132% . . . it definitely feels like the market is primed for a fall. Usually, value stocks tumble with everything else (except for the early 2000s).

This conflicts with my belief that investors shouldn’t time the market. If you own cheap stocks, it shouldn’t matter what the general market is doing, they will eventually realize their intrinsic value. The CAPE ratio or any valuation metric for that matter isn’t entirely predictive. Just because stocks are expensive now doesn’t mean that the market is necessarily going to crash. Valuations may even be justified if interest rates stay low. That seems like wishful thinking, but we’ve gone through long stretches before where interest rates stay very low (as they did in the 1930s and 1940s). You just don’t know. No one has a crystal ball.

Whether it is stocks or companies, all that you can do is put the probabilities in your favor.  Expensive stocks and markets can get more expensive. Cheap stocks and markets can go down. As a group, though, this is unlikely. Buying cheap stacks the odds in your favor.

International Net-Net Investing

The prudent course seems to me to expand outside of the United States for diversification. It is also a way to make sure I am not overly correlated with the US market. The most tempting way to do this is to buy net-nets in foreign countries.

Net-net investing involves buying companies at sub-liquidation values. In the most basic form, you take all current assets and subtract all liabilities to arrive at the net current asset value (NCAV). No value is given to long term assets like plant, property, and equipment which might be more difficult to sell. Graham advocated buying a net-net at 2/3 of the NCAV value and then selling when it reaches full value (thus securing a 50% gain). Graham remarked about net-nets: “I consider it a foolproof method of systematic investment . . . not on the basis of individual results but in terms of the expectable group outcome.”

Studies show that net-net investing is the best way to earn the highest returns. Buffett’s best returns were when he was investing in net-nets in the 1950s and 1960s. Joel Greenblatt created his original “magic formula” with a net-net strategy in 1981. He devised a strategy of buying net-nets with low P/E’s and demonstrated that you could earn 40% returns.  The period he studied was after the market crash of 1973-74.

Those net-net opportunities were eliminated during the bull market of the 1980s and 1990s, which is why he didn’t stick to that strategy. Net-net investing is also hard for professionals investing a lot of money (i.e., over $10 million or so), as the stocks usually have extremely low market caps. It’s only something that individuals like me can pursue who are dealing with relatively small sums of money.

The strategy I pursue during frothy bull markets is Graham’s low P/E strategy that he devised in the 1970s. Graham demonstrated that this strategy delivers 15% rates of return over the long run. 15% returns are incredible but not nearly as exciting as what you can make investing in net-nets which amp up returns to the 20% level. I look at other value factors (price to sales, EBIT-Enterprise Value, relative valuation), but I try to stick to Graham’s rules (low debt to equity ratio and an earnings yield that doubles corporate bond yields).

While Graham’s P/E strategy is my base during bull markets, I look at other value factors (price to sales, EBIT-Enterprise Value, relative valuation). I like to see multiple signals that a stock is cheap but I try to stick to Graham’s rules (low debt to equity ratio and an earnings yield that doubles corporate bond yields).

I would much rather invest in net-nets than the low P/E strategy, as the returns are better, it is easier to calculate intrinsic value, and it is easier to determine the appropriate selling point (you sell when the stock hits the net current asset value). Unfortunately, in the United States, there aren’t enough net-nets available to make it viable. Net-net returns are higher than any other strategy, but a net-net is also more likely to go bankrupt than a normal company, so diversification is paramount. When Graham bought net-nets for his partnership, he would buy them in bulk. I read once that he would own nearly 100 net-nets at any given time.

We live in a different world. To put it in perspective, there are about 9 net-nets in the United States right now. Of these 9 choices, they aren’t of the best quality and most of them can only be bought on OTC exchanges.

Net-nets become available in bulk in the United States during market meltdowns like 2008 and 2009. There were also a lot of them in the early 2000s during the tech crash. During both periods, net-nets performed exceptionally well.

There are quality net-nets available internationally, but the problem I have with buying them is that I don’t trust my ability to read foreign financial statements or research companies. I can’t go into Edgar and read an annual report for a Korean net-net, for instance.

I don’t even know where I can run reliable screens to hone in on the right opportunities. Unforeseen tax consequences would also plague me by investing in individual foreign stocks. While I wouldn’t owe US taxes because this is an IRA account, I would still owe taxes in the foreign countries on any gains. For those reasons, I am not keen on buying individual stocks outside of the United States.

Another reason I prefer buying individual companies in the United States is the SEC. I’m happy that the SEC is active in the US market. The SEC misses quite a bit, but it’s still better than what exists internationally.

For all of these reasons, I don’t want to buy international net-nets even though I think the returns are probably substantial and it would allow me to diversify outside of the frothy United States market.

I will shift to net-nets when they are available in bulk quantities (as they were in 2008 and 2009) during the next market meltdown and I can buy at least 10 quality choices. Unfortunately, that’s not an option in the current market.

A Possible International Solution

Thinking about the issue, I thought of something I once heard of listening to a Meb Faber speech from 2014 at Google. He discussed a really interesting idea: applying Robert Shiller’s CAPE ratio internationally.

Meb Faber has done a great research (available on his website) about this topic. He has empirically demonstrated that countries with a low CAPE tend to deliver higher returns (as a group) compared to those markets with higher valuations. Just like individual companies with low valuation metrics, this occurs as a group and it’s not an iron clad rule of prediction.

The CAPE ratio isn’t the best valuation metric for a market, but it’s good enough and it’s readily available for most markets.

This brings me to a possible solution: buying international indexes via ETFs for countries posting low CAPE ratios. This would allow me to avoid the tax consequences of international investing in individual stocks, remain consistent with a value approach, and provide adequate diversification. I will also be able to lower my correlation with the US market in a manner consistent with a value template.

I found a decent list of countries by CAPE ratio. The cheapest market in the world right now is Russia. The reasons for Russia’s low valuation is obvious. Oil has been crushed in recent years and Russia’s economy is very oil dependent. They are also under international heat and sanctions. For these reasons, Russia has a CAPE ratio of 4.93. Russia is hated by international investors. Of course, that is music to my ears: the best investments are the ones that everyone hates.

If it’s not behaviorally difficult to buy, it’s not really a bargain.

To give some perspective on how low Russia’s CAPE ratio is — there were only a handful of times that the US has a CAPE ratio that low — the early 1920s, the early 1930s, World War II, the early 1950s, the early 1980s. All of these were exceptional times to buy stocks. Even in March of 2009, the CAPE ratio for the US market only went down to 15.

In the early 1920s, early 1930s and the early 1980s – people hated stocks, which made them the best times to buy them.

Business Week ran a cover in 1979 called “the death of equities”. This was right before the greatest bull market in history from 1982-2000, which took the Dow from below 1,000 to over 10,000. The reason people hated stocks in the early 1930s is obvious. In the early 1920s, people in the United States hated stocks because the country suffered a severe but short Depression, which everyone forgets about because it is overshadowed by the Great one in the 1930s.

It’s true for individual companies and it’s true for entire markets: buy them when everyone hates them, sell them when everyone loves them.

Possible Investments

I haven’t decided if I’m willing to pull the trigger on this idea just yet, but I am curious to hear anyone’s thoughts.

I was considering putting 10% of my portfolio into two of the below ETFs:

iShares MSCI Brazil Index (Ticker: EWZ).  Brazil currently has a CAPE ratio of 10.4.

iShares MSCI Russia Capped ETF (Ticker: ERUS).  Russia currently has a CAPE ratio of 4.9.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


I sold my positions today in UIHC and FNHC today.

Both are Florida based insurance companies. I bought them last year because they were cheap in the wake of Hurricane Matthew. They are both well-run insurance companies and all they had to do to realize their value was for Florida to avoid another hurricane. With a category 5 hurricane on a direct course for Miami, it seemed prudent to sell both positions.

Last year after Hurricane Matthew, FNHC dropped 25% and UIHC dropped 35%. I’m down in both positions, but I decided to cut my losses short as catastrophic insurance losses in Florida seems very likely.

I got out of FNHC at $14.28 this morning. This was a good price because it later plummetted to $12.82 as investors realized the magnitude of the losses it is about to face. I got out of UIHC at $14.43. It closed at $14.77.

This brings my cash position up to $12,800.99, or 26.4% of my IRA. I evaluated my screens this weekend and couldn’t find anything that really excited me. It is a bit frustrating as my preference is to be fully invested. We’ll see if something comes along, otherwise, I’ll wait til I do a major rebalancing in December.

I’m also considering paring back my position in TopBuild, but I decided to stay put for now.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.