Tag Archives: value investing

Fishing for Value

Is investing like fishing?

Photo: João Pacheco. Source: Picjumbo

In 1653 Izaak Walton published “The Compleat Angler,” a short treatise on fishing. In this little book he explains that fishing is a pursuit that can never be truly mastered. When you go fishing, there’s always a new lure or a new location or some other shiny new toy to try out. “But he that hopes to be a good angler,” Walton continues, “must not only bring an inquiring, searching, observing wit, but he must bring a large measure of hope and patience.” He describes fishing as a perfect combination of contemplation and action.

I would agree. I grew up fishing in Minnesota. Times spent on a lake or stream have been relaxing and contemplative, punctuated by short bursts of energy where quick thinking and decisive action are necessary. Nothing quite matches the thrill of bringing in a “lunker” after a long and careful pursuit.

Photo: Doug Tengdin

It’s the same with investing. Investors need inquiring minds, hopeful dispositions, and patience. It can take some time for a disciplined investment approach to produce results. At the same time, we need to be diligent to make sure that the main idea behind our investment thesis hasn’t changed. We can’t allow ourselves to be whipsawed by every new fad or fashion that appears – but we can’t ignore the fact that circumstances change over time. And nothing quite matches the thrill of buying a “ten-bagger” – a ten-for-one winner.

Good investing is both art and science. It’s a science as it applies to investments, but an art as applied to the investor. Every investor is unique, with unique objectives and limitations. Applying the right investment in the right circumstance at the right time is something that – as Walton would say – is satisfying in the result, but also in its application. Investing, like fishing, is a reward unto itself.

Douglas R. Tengdin, CFA

Price, Quality, and Value

Which is more important: price or quality?

Photo: Victor Hanacek. Source: Picjumbo

Ideally, you’d like to have both. But there’s an old saying in business: quality is remembered long after the price is forgotten. This quote is frequently attributed to Aldo Gucci, the founder of the Italian fashion company, but it had been a marketplace maxim long before he was around. It presents a bit of business common sense: people often forget how much they paid, but how a product performs is in their face all the time.

The same is true with stocks. How much you pay matters. It matters a lot. Getting in at the top of a market, during enthusiasm and mania can depress your returns for years to come. But the quality of what you buy matters more. If a firm is on its way to bankruptcy, no entry price is low enough. There was never a good time to buy Enron, Worldcom, or Lehman.

But a high-quality company can overcome a bad entry point. A lot of great firms have stumbled over the years: Coca-Cola, Johnson & Johnson, Microsoft. In each case, the strength of their management team and their resources allowed them to work through their troubles and resume growing.

But how do we measure quality? I look at three things: management strength, financial performance, and the actual products they sell. Analysts often seem to ignore that if someone sells junk to their customers, eventually those customers stop buying their products.

These factors aren’t foolproof, but they give us a sense of how resilient a firm will be when hard times come. Because if you can buy good quality at an attractive price, that’s real value.

Douglas R. Tengdin, CFA

Health Care Values

What makes health care a good (or bad) investment?

Photo: Clever Cupcakes. Source: Wikimedia Commons

Lots of people are looking at health care stocks. Since the end of 2015, their performance has been fairly modest, rising by less than 6%, while the rest of the market has returned almost 18%. Health care is among the cheaper sectors, with a forward P/E ratio of only 16.4x, vs the market’s 18.4x. Only telecom, which has falling revenues, is cheaper. So they are intriguing to value investors.

But what makes a healthcare company profitable? Any profitable company is going to invite competition. In order to sustain its profits, a company has to have some kind of structural advantage. This advantage can come from several factors.

The most significant, in healthcare stocks, are intangible assets, particularly patents. Patents typically last 20 years; it takes 8 years to develop a drug – although that time is shrinking. Branding is also powerful. Brands convey a certain quality assurance process, which is especially important in the developing world.

A cost advantage is also a strong driver of returns important. Cost advantages can come from several sources: the location, the company’s supply-chain management, or economies of scale. A related factor is also efficient scale. A company might be profitable treating a certain rare disease, and its competitors know that if they enter that market all the profits would disappear. So they hold off – at least for a little while.

Network effects and switching costs are the final economic moats that contribute to health care company profitability. A network effect creates a situation where the more consumers that use a service, the more valuable that service becomes. This especially applies to health insurers. The more people that enter their systems, the better pricing they are able to obtain. And switching costs are the inverse: when it’s difficult to replace a product or service, people keep using it even if a better product becomes available.

Health Care Payment Network. Source: CFA Institute

Innovation in these areas is by far the most important factor to consider. Since patents provide the widest economic moat, everyone wants to develop a new, patented, blockbuster drug. According to Morningstar, the hottest area of new drug development is in immuno-oncology: drugs that help our bodies find a cancerous growth and destroy it. They help our own immune systems to fight off cancer. The market for these drugs is potentially huge. But once a drug is patented, the clock begins ticking. Profits will plunge once the patent expires and generic competitors enter a market. The big pharma companies truly need to innovate or die.

Finally, we have to consider politics. Healthcare is an intensely political area: through its various programs, the government is the largest purchaser of health care products and services. And people see their co-payments go up and they get upset. It’s easy for politicians to promise to bring drug prices down. Of course, they rarely spell out how they will do this. Nevertheless, health care pricing is a political hot potato: no one wants to touch it, and they toss it away at the first opportunity.

By focusing on innovation and looking for firms with a sustainable advantage, investors can find a lot of valuable companies that appear fairly priced. Health care is a key are of the economy. It belongs in any diversified portfolio.

Douglas R. Tengdin, CFA

Fishing for Value

Finding valuable investments is a lot like finding a good place to fish.

Photo: Volker Lekes. Source: Pixabay

In both cases, you need to keep working at it. On its face, fishing is pretty simple: cast your lure out where the fish are biting and reel them in. In the same way, value investing is simple as well: find companies selling at a discount to their intrinsic value and buy them. A company selling below its intrinsic value offers investors a margin of safety.

But finding them is never so simple. With fishing, you have to consider the time of day, the wind, whether it has rained recently, and what kind of season it’s been this year—hot and stormy, or cool and placid. All of these affect where the fish like to hang out, and what lure they might be attracted to.

Value investing gets complicated, too. Intrinsic value is just the present value of all the money a company will deliver in the future. The concept seems pretty basic; the practice is a lot more subtle. Is the cash flow stable or volatile? Stable cash flow is worth more. How much debt does the company have on its balance sheet? Debt increases risk. How fast—and for how long–can they grow earnings? And how much experience does this management team have in producing a steady, growing earnings stream?

Source: Charles Brandes, Brandes on Value

Both fishing and investing require great patience: casting your lure out over and over again; examining company after company, year after year. But both offer great rewards, not just in what they produce, but in the process itself. You learn new things all the time!

In the 17th century Izaak Walton wrote that fishing is so pleasant that it is a reward to itself. It brings a “calmness of spirit”. Finding investment value is similar. Just get there before other anglers—and other investors—scare away all the fish!

Douglas R. Tengdin, CFA

Chief Investment Officer

The Two (Investment) Cultures

Can’t we all just get along?

Teamsters wildcat strike, Minneapolis, 1934. Source: Wikipedia

Fifty-five years ago scientist and novelist C.P. Snow gave a lecture on “The Two Cultures,” bemoaning the gap of understanding between literary intellectuals and scientists—between the humanities and science. At the time, policy-makers worried that many scientists had never read Dickens, and that the Atomic Age would establish a technocratic tyranny, a “Brave New World.” To these people Snow asked, “Can you describe the Second Law of Thermodynamics? Or what is meant by mass and acceleration?” In other words, do you understand basic physics?

Continue reading The Two (Investment) Cultures

The Consolation of Markets

Where do we find financial value?

Global Market Update - Fortune Wheel
Lady Fortune with the Wheel of Fortune.
Source: Wikipedia

In sixth century Rome, the philosopher Boethius was awaiting trial—and eventual execution—on a trumped up charge of conspiracy. While in prison, he wrote The Consolation of Philosophy, an immensely influential work that outlines how to be content in a world beset by treachery and evil. The key, he explains, is to look beyond our outward circumstances to the “one true good” we find within. Current conditions are always in flux—moving up and down on a “Wheel of Fortune.” The only thing we can control is our own virtue. True happiness comes from inside.

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The Competitive Edge (Part 2)

How do you pick winning stocks?

That’s the question that many ask. Security selection is a key way to add value to a portfolio, one of the three approaches mentioned yesterday. Critical to finding winning securities is having a way to identify them.

One common approach is the value method. This looks at a company’s financial statements and compares them with its market value. If the company is cheap enough, it’s a buy. An example is the A&P chain store. After going public in 1929, it declined during the depression to a value below its working capital. Canny investors bought it and saw the price triple in a year.

Value investors tend to look at a company’s balance sheet to find opportunities. By contrast, growth investors look how a company is run—whether it is positioned to capitalize on demographic trends or new technology to expand into the future. Global growth investing involves understanding how countries develop, and to capitalize on these changes.

A growth investor might have seen database design as a critical future industry in 1990, and have invested in several competing database startups—Sybase, Progress, and Oracle. Over the next 20 years, these three firms returned an average of 15% per year, while the broad market advanced at half that rate. But it was a bumpy road!

Growth and value investing are different ways to deliver the same result: superior returns. Both require insight, intelligence, and patience. The key is knowing how an approach can fit into your style.

Douglas R. Tengdin, CFA

Chief Investment Officer