I read this book “Invest Like a Dealmaker” by Christopher Mayer some time ago. It is a book on value investing, and goes through the standard value investing concepts
- Think about the whole business, not just the stock price.
- Think about cash flow, not earnings.
- Use EV/EBITDA to get a snapshot on value.
- Think about asset values (tangible assets are more precisely valued and provide investors with greater protection from loss).
- Focus on your downside.
- Margin of safety of 25% to 40%
- Characteristics of funds that beat the market (Mauboussin)
- Low portfolio turnover
- Portfolio concentration
- Value style with attention to price paid
- Geogrphic location not near Wall Street
- Limited time on macro forecasting
- A few big winners can overcome nasty big losses (Murray Stahl from Horizon Asset Management)
- Have a long holding period (Ron Muhlenkamp recommends a minimum time horizon of 3 years for the long-term dynamics of stocks to work in your favour).
- The market worries about the short term, that can be exploited to buy stocks with temporary setbacks but solid longer-term prospects.
- The way to win is to make very few mistakes. You play not to lose.
- When there’s nothing to do — do nothing (Dolce far niente).
- It’s all about the price you pay.
Some other points below.
On Top-Down Investing
The book had two good quotes from Seth Klarman:
There is no margin of safety in top-down investing. The top-down investors are not buying based on value; they are buying based on a concept, theme or trend. There is no definable limit to the price they should pay, since value is not part of their purchase decision.
Paradoxically, a bottom-up strategy is in many ways simpler to implement than a top-down one. While a top-down investor must make several accurate predictions in a row, a bottom-up investor is not in the forecasting business at all.
On Insider Transactions
It mentioned some good points about insider transactions that I thought would be good to note down:
- Management can be the last to know that there is something seriously wrong with the company (e.g. the CEO of Countrywide Financial was giving bullish remarks till the last few moments 0f the company’s demise. From all accounts, he was genuinely shocked by what happened).
- Insiders sell for all sorts of personal reasons, the key is to look for divergence from normal behaviour.
- Be excited when insiders are buying at higher and higher prices.
- Insiders can’t predict the future (an example was given where Warren Buffett in May 1996 issued a statement in Berkshire’s B Shares prospectus, that the stock was not worth buying at that price, and the stock proceeded to double in two years).
It also mentioned a book by George Muzea called “The Vital Few versus the Trivial Many”, I should read it when I get some time
On How Companies Create Value or Wealth
Martin Whitman gave 4 ways:
- Growth of earnings from operations
- Free cash flow thrown off from operations
- Resource conversion activities (e.g. involves using your assets and liabilities in new ways).
- This includes M&A, changes of control, management buyouts, massive share repurchases, major financings, refinancings, restructuring, converting assets to higher uses, hidden assets can be sold, spinoffs, investment in new ventures in othe rindustries, corporate liquidations).
- Most investors analyse companies as a going-concern continuing its current activities and failed to recognise resource conversion activities.
- Access to capital markets on a super-attractive basis
- E.g. selling shares, using its high priced shares for acquisitions, borrowing money at very low rates
Theory of Slack
Chris Mayer has a theory that says owning companies that have lots of capacity — whether in excess cash or excess assets — and low amounts of liabilities — whethre in debts or pending litigiation or growing pension obligations — is a great way to make big profits in stocks. This slack is in and of itself a valuable commodity.
My thinking is that how valuable the slack is depends on whether the company is able to utilise the slack to realise value. There may be inherent difficulties such as Buffett’s lament that even though See’s Candies’ ROE is high, they cannot inject cash into the business and achieve the same ROE, hence See’s excess cash still needs to flow to Berkshire for other investments.
On How Contrarian Value Investing Makes its Money & Market Timing
See my previous post here.
On Hunting Grounds
Where to look for investments:
- Look at what the greats are doing.
- Use the Net Tangible Asset Value (NTAV) screen
- Market cap greater than $150M (to screen out micro-caps)
- P/E > 1 (to screen out companies losing money)
- P/B < 1
- D/E <= 0.3
- NTA >= Market cap
- Use the screens in the Value Line investment survey
- Stocks with widest discount to book value.
- Stocks with P/E and P/NWC that are in the bottom of the Value Line universe.
- Spin-offs
- Read WSJ, Barron’s
- Look up the holdings of Claymore/Clear Spin-Off Exchange Traded Fund (CSD)
- Greenblatt’s Magic Formula
- Insider buying (see section on Insider buying above)
- Distressed investing during market crashes
- Stocks with decreasing shares outstanding
- A paper by Bali, Demirtas, and Hovakimian titled “Corporate Financing Activities and Contrarian Investment” found that you can beat the market by buying the cheapest 20% (by P/B) of the market whose shares outstanding are also falling. This would give a 5.5% edge per annum over the years they studied (1972 to 2002).
On When to Sell
Ralph Wanger of Columbia Acorn Fund (author of A Zebra in Lion Country)’s advice is to make the reason you buy a stock specific enough so you know when it is no longer true. Keep checking back with your reason, and sell when it is no longer true.
On Competitive Dynamics
Bill Miller talked about a book Nature: An Economic History by Geerat Vermeij, which found that efficiency in nature can be trumped by “aggregation of power”. The parallel to economics, is that small and efficient companies can often be crushed by bigger but less efficient companies. Greater profits with lower margins may be more valuable because the inherent size has certain advantages you couldn’t get otherwise.
Bill Miller drawing from Increasing Returns and Path Dependence in the Economy by W. Brian Arthur also highlights that the market shares in the technology world can be remarkably stable for mature applications. Wall Street has a tendency to overestimate competitive threats.
On Shorting
J. Carlo Cannell highlighted that while stocks as a whole tend to rise, there are some sectors that have not made money for investors, on average, for years. These present opportunities for short sellers, e.g.
- Airlines (-6.5% annual returns)
- Computer hardware manufacturers (-13% annual returns)
- Semiconductor equipment manufacturers (-4% annual returns)
- Restaurants (-4% annual returns)
David Babson’s 5 Essential Truths
- Markets are unpredictable and ill suited to forecasts.
- Long-term fundamentals are key.
- Investor emotion leads to volatility.
- Valuation discipline should guide investment selection.
- Perspective and patience are rewarded.
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