Latest memo from Howard Marks: Something of Value

[Wildreamz]

https://www.oaktreecapital.com/docs/defa...-value.pdf

If asked about possible silver linings to this pandemic, I would list first the chance to spend more time with family. Our son Andrew and his wife and son moved in with Nancy and me in Los Angeles at the beginning of the pandemic, as they were renovating their house when Covid-19 hit, and we lived together for the next ten weeks. There’s nothing like getting to spend months at a time building relationships with grandchildren, something we were privileged to do in 2020. I’m sure the impact will literally last lifetimes.

As I’ve previously reported, Andrew is a professional investor who focuses on making long-term investments in what the world calls “growth companies,” and especially technology companies. He’s had a great 2020, and it’s hard to argue with success. Our living together led me to talk with him and think a great deal about subjects on which I hadn’t previously spent much time, contributing a lot to what I’ll cover in this memo.

I’ve written before about how the questions I’m asked give me a good sense for what’s really on people’s minds. These days, one I frequently field is about the outlook for “value” investing. “Growth” stocks have meaningfully outperformed “value” for the last 13 years – so long that people are asking me whether it’s going to be a permanent condition. My extensive discussions with Andrew led me to conclude that the focus on value versus growth doesn’t serve investors well in the fast-changing world in which we live. I’ll start by describing value investing and how investors might think about value in 2021.

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A refreshing change of pace.

[ghchua]

Don't mind I side track a bit.
1. There are a significant number of valuebuddies with engineering or computer science background.
2. Relatively, valuebuddies posted much less in Tech stocks than non-tech.
3. Obviously, SGX lack tech stocks (other than few famous high tech precision engineering counters like MM) would be the reason why there are not so much discussions on Tech stocks.
4. Obviously, those high growth Tech stocks exist and there might still be some worth looking aka not buying now but watching for the right time to buy.

And, I'm spending my time in this area now.
The first one I brought is GME (divested).
The second one I brought is PLTR (accumulating).
I'm looking at a third one which I can't decide whether to buy the steady mother company or her fast growing daughter or both?

I don't think it is the lacking of tech stocks on SGX that resulted in not much discussions here. But rather, this is a value focused forum and tech stocks are mostly trading at higher valuations. Therefore, there is not much interest here.

I think you have to careful when you choose which tech stocks to invest. Ossia is a stock that is trading below book value, profitable and pays a dividend. Whereas the list of stocks that you have listed here seems to be Meme stocks to me. Are GME, PLTR even profitable companies? Do they pay a dividend? Are they trading below book value? If not, then in what ways do you think that these stocks that you mentioned are attractive, in applying value investing methodologies?

[weijian]

Don't mind I side track a bit.
1. There are a significant number of valuebuddies with engineering or computer science background.
2. Relatively, valuebuddies posted much less in Tech stocks than non-tech.
3. Obviously, SGX lack tech stocks (other than few famous high tech precision engineering counters like MM) would be the reason why there are not so much discussions on Tech stocks.
4. Obviously, those high growth Tech stocks exist and there might still be some worth looking aka not buying now but watching for the right time to buy.

And, I'm spending my time in this area now.
The first one I brought is GME (divested).
The second one I brought is PLTR (accumulating).
I'm looking at a third one which I can't decide whether to buy the steady mother company or her fast growing daughter or both?

I don't think it is the lacking of tech stocks on SGX that resulted in not much discussions here. But rather, this is a value focused forum and tech stocks are mostly trading at higher valuations. Therefore, there is not much interest here.

I think you have to careful when you choose which tech stocks to invest. Ossia is a stock that is trading below book value, profitable and pays a dividend. Whereas the list of stocks that you have listed here seems to be Meme stocks to me. Are GME, PLTR even profitable companies? Do they pay a dividend? Are they trading below book value? If not, then in what ways do you think that these stocks that you mentioned are attractive, in applying value investing methodologies?

hi ghchua,

GME could actually once be classified as a value stock (a business in a sunset industry but with a lot of cash on hand, and also able to continue to raise more cash by actually reducing its working capital - inventory and retail stores). Our favorite Michael Burry owned it before it was reddit-fied. Of course, because of its current price, it isn't a value stock anymore.

That said, VB.com is a place where we talk and discuss about fundamentals. Regardless of stock price or actual company profitability, every company is still open for a discussion of their fundamentals, isn't it? As such, we should more than welcome if ¯|_(ツ)_/¯ brings about his fundamental analysis for those companies he mentioned under the respective relevant threads.

The only red line that we don't cross, is the talking purely about price (eg. "XXX will reach XX price soon!") or trading signals.

Moderator

[ghchua]

That said, VB.com is a place where we talk and discuss about fundamentals. Regardless of stock price or actual company profitability, every company is still open for a discussion of their fundamentals, isn't it? As such, we should more than welcome if ¯|_(ツ)_/¯ brings about his fundamental analysis for those companies he mentioned under the respective relevant threads.

Moderator

Hi weijian,

Fully agreed with you. Because ¯|_(ツ)_/¯ mentioned about these two tech stocks in this Ossia International topic and his decision to invest in them over Ossia, my questions include asking whether they are trading below book value and in what ways he thinks they are attractive over Ossia in applying value investing methodology. It is not about stock price or profitability or dividend only.

And if he is applying other fundamental methodology over value, he should state clearly too. Because he seems to be looking at high growth tech stocks which is not what Ossia is offering. Here, we are talking about undervaluation and dividend.

[weijian]

hi ghchua,

You probably haven't been well acquittanced with his style which may drift here and there a bit

In anyways, different people have different strokes. So it is indeed hard to compare! And at times, comparison is always the root cause of all evils, isn't it?

It will be good to continue any more fundamental analysis in the relevant threads.

Moderator

[¯|_(ツ)_/¯]

Thank you moderator, you know me so well. 

Thank you Shifu Chua too. 
Your selfless sharing of all the value, growth, cyclical and dividend stocks is 2nd to none. 

Innovation would be keen to further success.

I'm still learning and I do appreciate the questions that you asked regarding my value investing methodology and fundamental analysis.

I must confess that I'm not a financial analyst nor business analyst.

I had a computer science background and I'm just applying my education, training and professional knowledge when I am investing in stocks... value, non-value, fundamental, non-fundamental, growth, non-growth, dividend, non-dividend is definitely part of the decision process.

However, strangely or not, when I look at my favorite stocks such as Bestworld, Micro-Mechanics, PIL etc, I don't use these methodology to trigger a buy.

There are a few reasons why I did not use these methodology to trigger a buy.
Says Bestworld, it used to be a favourite stock by a famous author and financial trainer. When he was sharing his fundamental analysis of Bestworld, it met all the ticks.  I don't really care. I just put a remarks to pay attention later.

Later, when Bestworld losses it's shine eg. due to tax in Indonesia and halal issues and many other reasons, I took a closer look again and realised that the price had dropped below 18cents which I just buy and buy and buy like no tomorrow.  
I only stopped buying because the price picked up due to Sam Goi buying.

That kind of explain the reason why I says that Ossia met all the ticks but I'm going to let it cool down by a few months before I look at it again.

Another reason why I don't use these methodology to buy is because they change.
Says PIL.
PIL is an exceptionally good stocks due to Jeffrey and James. Of course, everyone knows that PIL passed all the ticks too and obviously it's in my parking lot for a longest time. 
Then the dividend was not up to expectation and even stopped at one time.  With that I take a keen interest in PIL.  I track it's two Qtr results when it' was 20+. I stubbornly refuse to put the trigger despite it's good two Qtr performance and I wait patiently for the 3rd Qtr result to be out. It was not a peaceful wait as PIL price inching upward everyday before the 3rd Qtr result came out. I bite my nail waiting patiently. (Fundamental analysis shows that 20+ is an excellent buy but I did not buy). The day when the 3 Qtr result was out and I confirmed that FY result would be good, I just buy and buy and buy.

Another reason why I don't use these methodology to buy is because of volume.  
We all know that these (under-)value stocks are always lack of interest and trading volume is extremely low.
So, my stories goes to Micro-Mechanics.  When I first brought Micro-Mechanics at 40+, it was above (normal) valuation aka it was not a value stocks. 
I brought it because of it's extremely prudent management practices.  The company does not look like a Singapore or Asean or Asia company.  I look left and right and it has a heart (human-touch) of an American company with exceptionally Chinese (hard working) style of business attics. 
So, my assessment at that time was it was not a value stocks aka I know that I am over paying but I don't mind over paying.
I was rather crazy that the usual price was 43cents and out of the blue, I just hit the seller price of 48cents.  The next day triggered a tsunami of sell orders that I just mopped up everything I could at 43 cents.

Summary: what I really wanted to say is I did use these fundamental analysis to scan for a opportunities but the trigger point almost always go beyond these so called fundamental analysis. Most of the time, my trigger point came with MOS but sometime it's above (normal) valuation. I hope this is clearer.

Back to your questions on the meme stocks.
I roughly extracted your questions to give inline reply.
Your first question is an excellent questions.

1. Are GME, PLTR even profitable companies?
GME is happy trigger. I just wanted to buy and get some realtime experience of investing in a meme stocks. My holding period was less than one week. So, I do not know whether GME is profitable or not. 

PLTR is very different. I had yet done my due-diligent on PLTR but I had read the first few pages of IPO before I pull the trigger.  I mean, I had saw PLTR product demo in youtube and I saw first hand how PLTR platform and it's fascinating UI looks like. In my mind, it's second to none. 

I can answer you question because I read it's financial result before I pull the trigger too.
Yes, you are right, it is not a profitable company.
This is actually a excellent question. Why would I buy when a company is not even profitable?
Two thoughts came into my mind:
Firstly: If PLTR had not been a profitable company for the last 20 years (yes, it is not a young company, it had been operating since 2003), then why isn't it close down?
What is the thing behind PLTR that keep it continue operating for last 20 years.
What is the story behind? (you might get a different answer than me)

Secondly: I use Grab (taxi) services back in 2012 when it was first released.  I found the technology amazing. It has Geo-Spatial data, GPS and tiny little yellow taxi icon moving around ... sometime off road into the drain too.  Of course, the real taxi is on the road but the icon go off-grid.
In my mind, is Grab profitable now? (you might get the same answer as me)
And obviously, my next question is: if Grab going for IPO in SGX, will I buy? (again, you might get the same answer as me).
Last but not least, why would someone invest in a non-profitable Grab in SGX?

With this I don't think I need to answer the rest of your question on PLTR. The answer is obvious.
Do they pay a dividend? 
Are they trading below book value?

If not, then in what ways do you think that these stocks that you mentioned are attractive, in applying value investing methodologies?



Stay home and stay safe, everyone.

[weijian]

Dear VBs,

I think there might be a potential robust and healthy discussion of value investing on stocks selling abive NAV or not profitable.

I thought Howard Marks actually had a very good memo that talks about this a couple of months back. As such, i am moving some of the discussion from the Ossia thread here.

As investors, we surely expect most of the companies that we invest, in to keep up with innovation and disruption. So it is fair that we demand the same for ourselves. While the methods change, the principles of value investing doesn't. Our selection of the array of methods of course, is dependent on our own temperament and strength. But I feel the bottom line is that we owe it to ourselves to get a little better, each and every day, and evolve to become a better investor.

Moderator

[Wildreamz]

Interesting decision Weijian. Looking forward for more discussions on growth and tech.

Just a few comments, GME is not a "tech" stock nor a "growth" stock. It's a meme stock, which stock price is driven mainly by market mechanics: (1) fund managers, investors that is betting on it to fall, hence the high short ratio and (2) longs that are betting on it to rise from short/gamma squeeze.

NAV usually has little to do with intrinsic value of high quality growth companies (though, if net cash on book is quite significant, it sometimes make sense to back out cash during valuation; if debt is significant, it sometimes make sense to consider debt; hence, enterprise value is much more frequently used to value/price growth stocks nowadays); from the words of Warren Buffett itself (1998 Shareholder meeting):

Buffett said Japanese stocks were bound to sell at a lower price-book ratio than U.S. stocks because "Japanese companies are earning far less on book than American companies." He went on to add:

"And earnings are what determine value, not book value. Book value is not a factor we consider. Future earnings are a factor we consider. And as we mentioned earlier this morning, earnings have been poor for a great many Japanese companies."

Source: https://www.gurufocus.com/news/1441219/h...st-returns

[specuvestor]

Berkshire Annual Report consistently use Book Value as an indicator of worth

It is actually not Book Value per se but the GROWTH of Book Value

And 2nd order how it compounds vs opportunity cost and in Berkshire case they look at S&P500. I frequently hear people say "at least it's profitable". Make $1 over $1m capital is also profitable

Main function of this compounding is of course the PRICE you pay for the Book Value. Simplistically if you pay 2X Book but the earnings is 20% is equivalent to paying 1X Book earning 10%. But a very frequently forgotten variable: timeline. If the 20% is over 5 years and the 10% is 1 year it is not the same thing

So tech stocks that grows 30% this year but goes to 10% next year and even negative year after. So that's when analysis of the company comes into play forecasting the earnings. Hence Buffett prefers one that just grow consistently ~10% every year. That's why Buffet says he is a "growth" investor

Conversely in a loss making company it is the decline in Book Value. So how much cash flow can the investor get from this before the last puff is the key. And often the timeline is limited. Hence your cigar butt investing. But sometimes you get a white knight to turn things around who has access to cheaper capital or synergies. Howard Marks specialise in this with an army of accountants and lawyers.

And if we read even deeper it is not even accounting earnings per se but more the cashflow that the subsidiaries send to Berkshire that's the key...

[Wildreamz]

Berkshire Annual Report consistently use Book Value as an indicator of worth

..

In the past, Book Value has been used by Berkshire as a rough (quick and dirty) proxy of it's intrinsic value. 

2000 Shareholder meeting (https://finance.yahoo.com/news/warren-bu...49202.html):

In our case, when we started with Berkshire, intrinsic value was below book value.

Our company was not worth book value in early 1965. You could not have sold the assets for that price that they were carried on the books, you could not have -- no one could make a calculation, in terms of future cash flows that would indicate that those assets were worth their carrying value. Now it is true that our businesses are worth a great deal more than book value. And that's occurred gradually over time. So obviously, there are a number of years when our intrinsic value grew greater than our book value to get where we are today...

As Berkshire's business and portfolio change over the years, its intrinsic value's correlation with book value has drifted further and further apart. 

2018 Shareholder's letter (https://www.gurufocus.com/news/1319777/b...ires-value):

The fact is that the annual change in Berkshire's book value which makes its farewell appearance on page 2 is a metric that has lost the relevance it once had.

Three circumstances have made that so.

First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.

Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.

Third, it is likely that over time Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes the per-share intrinsic value go up, while the per-share book value goes down.

That combination causes the book-value scorecard to become increasingly out of touch with economic reality."

A simple demonstration why Book Value is a poor indicator of Tech and Growth companies in general. Amazon's book value in early 2016 was approximately $15bil and net income was $1.1 bil; market cap was $300bil (20x price to book).

Today it earns around $27bil TTM net income on book value of $103bil. 

Most analysts' linearly extrapolated projections would have missed the mark by a large degree. But analysts who understood exponential growth rates, market strength (near monopoly), and TAM of it's retail, ads and AWS businesses would have understood why it was valued that way.