These Markets Are Making Everyone Look Brilliant…except Value Investors

Markets keep going up.  Everyone keeps getting more and more confident in the markets.  It’s now to the point where when I hear someone say “Boy, this market is overpriced”, what they typically mean is “This thing is gonna fall 5-10% and it will be a great buying opportunity.”  Hardly the sign of overpriced.  That’s a run-of-the-mill market pull back during normal markets.

I am not a believer in that just because something has gone up for so many years does it mean it’s overvalued.  What makes something overvalued is that it is selling at a level that, based on history and fundamentals, is well above the normal range of valuations.  We are at levels, right now, that historically will produce break-even results INCLUDING DIVIDENDS over the next 10 years.  This historical accuracy is around 90%, based on John Hussman’s Weekly Market Commentaries.  This means that 10 years from now, we can expect the S&P 500 and Dow Jones to be 20% lower than they are today, on a nominal basis.  This is also the valuation metric that Warren Buffett has said is probably the “single most accurate measure of stock market valuations at any given time.”

Since 2000, we are only up 43% or so on the S&P, not including dividends.  That’s a mere 2.4% annual growth rate on the S&P 500, but what you need to remember is that valuations in 2000 were at all-time highs compared to history and we are NOW at valuation levels that are merely 10-15% lower than 2000.  Everyone thought that the markets would keep going up back in 2000 and 15 years later, we have only seen 2.4% capital growth on any dollar invested in the year 2000.  So let’s not forget that valuations DO matter.  There is a capitulation point for every market, good or bad.  No one remembers the bad times when things are good and no one remembers the good times when things are bad.

Could the party end again? Of course…and it will. When?  No idea.  I’ve been calling for it since 1500 or so on the S&P…that was many moons ago, and I admit that I was trying to fight momentum.

In late 2008 and early 2009, I was one of the few positive investors out there.  A lot of people have said “But you used to be so positive on the market! What happened?” Valuations happened.  My views on the market are based on historical valuation metrics that have proven to be highly accurate over time.  Clearly my timing has been off, but over the long run, these will prove to be true.  There will be a time in the next 5 years where I will be one of the few bulls out there talking about the incredible buying opportunities and low valuations.  Yes, when I make those calls, things will likely get worse and people will question me then like they question me now…but historical returns will eventually take grip then and a new secular bull market will take hold.

Unfortunately, this is all part of the process.  The excesses of 1982-2000 were so large that it will take a few ups and downs in the market for people to give up on stocks and, only then, will a new secular bull market be ready to take force.

I will wait patiently until valuations are at the right levels.  I have no idea when that will happen, but when it does, you will be able to read these posts and see that sound value investing can make someone look stupid for a while but brilliant later on.  I’m not hoping to look brilliant at the expense of others, but I am writing these words and showing that I will be putting my money where my mouth is.

What is a Value Investor?

I was just on CNNfn.com and I came across an article by Scott Fearon, CFA.  He is discussing what we can learn about investing by looking at the death of pay-phones (http://cfainstitute.tumblr.com/post/111879028236/what-investors-can-learn-from-the-death-of-the-pay). His point, in a nutshell, is that back in the last 1990s, he received “Buy” recommendations from analysts about inexpensive pay phone companies but they were inexpensive because they were a dying company. Now those are penny stocks, if they even exist. He said the value investor who cares about those metrics miss the forest for the trees…hmmm.

I don’t disagree, much, on that point about why pay phone companies were a bad buy in the last 1990s.  However, I would make two points.  1.) Most EVERY company that wasn’t a high tech high flying company was ignored in the late 1990s and had lower valuations.  Unlike today’s market, small and midcap companies were actually reasonably priced even during that late 1990s boom because the overvaluation was centered on high tech highly valued companies.  2.) He has no idea what a true value investor does.

Scott goes on to point out that value investors need to care about growth.  Uhhh.  We do.  That’s what he is missing.  A true value investor isn’t just looking for a “cheap” stock.  They are looking for an ignored stock or company, for whatever reason. Last year when I was buying Microsoft like crazy in the $25 range, everyone was telling me how stupid it was because Microsoft was dying…yet when I looked at their yearly revenue and profit numbers, every single year they were growing.  So here was a GROWING company who everyone was ignoring because they weren’t sexy anymore and therefore was selling at 8-9 times earnings. THAT is value investing.  I didn’t buy Radio Shack when it was dying.  I didn’t buy his example of JC Penney because it was dying and a true value investor isn’t looking for dying businesses.  They are looking for OVERLOOKED businesses.

Ironically, we see an article like this during a major bull market and at a time when valuations are through the roof.  I get it.  It’s easy to dismiss value investing when things are going gang busters.  Ironically, the best investors of all time tend to be value investors and they tend to do best when markets are dull and down.  That’s when they get the best deals.  When the markets are so far down that people don’t even want to buy the good companies at good prices, that’s what a value investor is looking for. Not the dying companies when markets are going great.

Patience Is A Virtue I Normally Do Not Possess

2014 finished in a way that was quite disappointing.  In terms of the stock market, I have missed out on the majority of the gains in the S&P 500 since it was at 1500 or so and I have even bet against Amazon and the entire market along the way.  Clearly I have missed the mark.

I was just scanning Yahoo Finance and came across an article where Bill Ackman is announcing that he is in the money on his short of Herbalife.  If you are not familiar with the story, please take some time and look into it.  Ackman shorted the company by calling it a “Ponzi Scheme” as many reputable investors (Carl Icahn and George Soros) praised the company and bought shares in it.  The stock climbed from the $30 range all the way up to $82 per share, and I believe he had lost about $1Billion at that point.

But he kept insisting he was right.  EVERYONE said he was wrong.  He said “Nope, i’m right. You’re wrong.” Now, granted, the stock isn’t done yet. It could bounce right back up but right now, he is not only making money but he also feels vindication I am sure.

I’ve been shorting Amazon (AMZN) for over 2 years now and have been “wrong” because the stock is above my original short price.  I’ve shorted the entire market as well and so far, I’ve been wrong.  But there are bright spots.  Amazon went from a high of $408 and now it’s sitting under $290.  Not quite the darling it was just a year ago.  The stock market, overall, has had many jumps and falls over the past six months which are typical during the topping process.

I hope, and I’m confident, that I will end up being right, but patience, my most lacking virtue, is what I need to stick with and what most investors have a problem with.  We need patience.  In my other businesses, I want things done yesterday, but with investments, you have to give the time to let things pan out if your analysis is correct.  Even then, you will be wrong sometimes.

Everyone forgets the tough times during the good times and the good times during the tough times. That’s why sound financial analysis is important at all times.  Be patient for the opportunistic times because that is when true wealth is built.