two-day plunges

After "Liberation Day" (April 2), in which President Donald Trump unveiled tariff rates far higher than virtually all investors suspected, the S&P 500 (SNPINDEX: ^GSPC) experienced a whopping 10.5% plunge.

That's the fourth-worst two-day plunge in the past 75 years. Not only that, the April downdraft came after the market had already been on a downward trajectory since mid-February.

The good news for investors? History suggests that this is likely a great time for long-term-oriented investors to buy.

According to Stansberry Research, the April 3-4 tumble is the fourth-worst two-day stretch in the market since 1950. Looking at the other top 10 two-day plunges, all occurred at the outset of genuine crises -- the 1987 "Black Monday" plunge, the Great Financial Crisis of 2008, and the outbreak of COVID-19 in 2020:

As you can see, following these two-day plunges, stocks exhibited mixed performance one, three, and even six months later, with positive average returns but also with a very wide skew. In fact, even after the two-day plunge that ended on Oct. 7, 2008, the market was 17.2% lower six months later.

However, when one looks out a year beyond these 10 other instances, the average return is a whopping 27.2%, with every single instance in the green and the biggest one-year recovery at 59.2%. Look two years out, and the average return is 40.4%, with gains as high as 69.5%.

Warren Buffett is famous for the quip, "Be fearful when others are greedy and be greedy when others are fearful." Certainly, if the history of nauseating two-day drops is any guide, Buffett has historically been right on all counts.

But it's not just Buffett who has long touted the virtues of buying when others are selling and selling when everyone wants to buy. Buffett peer and Oaktree Capital founder Howard Marks, also a storied value investor, summed up the case nicely in his recent investment memo titled Nobody Knows (Yet Again).

In that memo, Marks notes how Oaktree went ahead and bought into both the 2008 financial crisis and the COVID-19 crisis, despite being highly uncertain about the future, unsure whether there would be further downside, and having no idea how or when the crises would end. All he knew was that financial assets were now heavily discounted.

The reason Marks takes a price-and-valuation-based approach and not one based on trying to game out future events is that:

We can't confidently predict the end of the world; we'd have no idea what to do if we knew the world would end; the things we'd do to gird for the end of the world would be disastrous if it didn't end; and most of the time the world doesn't end.

Buffett and Marks are, of course, not the first to espouse contrarian investing. After all, the phrase "Buy when there is blood in the streets" is attributed to 18th-century British nobleman Baron Rothschild, who coined the term after he bought into the panic following the Battle of Waterloo, which ultimately yielded him a fortune.

But there's also a case against buying today

Certainly, a lot of history suggests that buying into this market, while perhaps risky in the near term, is nearly certain to pay off in the long term. However, there are a couple of counter-narratives investors should be aware of that could make this time different.

First, the market is more expensive today than it was after those prior crashes. After the 1987 crash and the 2008 crash, the S&P 500 price-to-earnings (P/E) ratio was in the low- to mid-teens. In March 2020, the valuation was higher, in the low 20s. Today, the S&P 500 is around 26.9 times earnings.

While it's true that the average valuation of the market has been pushed up by the rise of the highly valued and heavily weighted "Magnificent Seven" stocks in recent years, the higher valuation on a historical basis means investors might not enjoy such historically robust post-drop returns from here.

Second, the implementation of tariffs, unlike these other instances, risks pushing up inflation, which may tie the hands of the Federal Reserve. Remember, the Fed responded to Black Monday, the 2008 Financial Crisis, and the COVID crisis by lowering interest rates. The Fed even went so far as to cut the Federal Funds rate to zero in 2008 and 2020 while also purchasing longer-term U.S. Treasuries, which kept rates low to stimulate the economy.

In recent days, various Fed officials have stated publicly that since tariff policies could drive up inflation, the Federal Reserve may be more limited in its ability to provide monetary stimulus this time. And whereas the Federal government in 2008 and 2020 was doing everything it could to help the situation, today the problem has actually been caused by the government, at least the Executive branch, which is still in the beginning of its four-year term.

But don't be paralyzed; stick with your plans

So, for all these reasons, it's quite possible that the market could experience further downside from here. On the other hand, the current administration also has more ability to rectify the situation than the administrations during those other market downturns, since it's also the entity that ignited this particular market crash in the first place.

All in all, if you do have investable dollars and engage in regular stock buys or 401(k) or IRA contributions, there's no reason not to invest today as long as it's within your financial plan and risk tolerance. As history has shown, times of great uncertainty are often the very best times to purchase stocks.

That said, the differences between the current crisis and 1987, 2008, and 2020 keep this investor somewhat cautious. Therefore, investors may want to think twice before committing heavily to stock-buying and/or using leverage to do so.

Charlie Munger

NEW YORK, Nov 28 (Reuters) - Charles Munger, who died on Tuesday, went from working for Warren Buffett's grandfather for 20 cents an hour during the Great Depression to spending more than four decades as Buffett's second-in-command and foil atop Berkshire Hathaway Inc.

Munger's family had advised that he died peacefully on Tuesday morning at a California hospital, said Berkshire.

The union of Munger with Buffett is among the most successful in the history of business; they transformed Omaha, Nebraska-based Berkshire into a multi-billion dollar conglomerate with dozens of business units.

Yet the partnership that formally began when they teamed up in 1975 at Berkshire, where Buffett was chairman and Munger became vice chairman in 1978, thrived despite pronounced differences in style, and even investing.

Known almost universally as Charlie, Munger displayed a blunter form of musings, often in laconic one-liners, on investing, the economy, and the foibles of human nature.

He likened bankers to uncontrollable "heroin addicts," called the virtual currency Bitcoin "rat poison," and told CNBC that "gold is a great thing to sew into your garments if you're a Jewish family in Vienna in 1939 but I think civilized people don't buy gold. They invest in productive businesses."

Munger was no less pithy in talking about Berkshire, which made both he and Buffett billionaires and many early shareholders rich as well.

"I think part of the popularity of Berkshire Hathaway is that we look like people who have found a trick," Munger said in 2010. "It's not brilliance. It's just avoiding stupidity."

EXPANDING BUFFETT'S HORIZONS

Munger and Buffett did differ politically, with Munger being a Republican and Buffett a Democrat.

They also differed in personal interests.

For example Munger had a passion for architecture, designing buildings such as a huge proposed residence for the University of California, Santa Barbara known as "Dormzilla," while Buffett claimed not to know the color of his bedroom wallpaper.

Yet at Berkshire, the men became inseparable, finishing each other's ideas and according to Buffett never having an argument.

Indeed, when Munger and Buffett would field shareholder questions for five hours at Berkshire's annual meetings, Munger routinely deadpanned after Buffett finished an answer: "I have nothing to add."

More often, he did, prompting applause, laughter or both.

"I'm slightly less optimistic than Warren is," Munger said at the 2023 annual meeting, prompting laughter after Buffett expressed his familiar optimism for America's future. "I think the best road ahead to human happiness is to expect less."

Like Buffett, Munger was a fan of the famed economist Benjamin Graham.

Yet Buffett has credited Munger with pushing him to focus at Berkshire on buying wonderful companies at fair prices, rather than fair companies at wonderful prices.

"Charlie shoved me in the direction of not just buying bargains, as Ben Graham had taught me," Buffett has said. "It was the power of Charlie's mind. He expanded my horizons."

ORACLE OF PASADENA

Fans dubbed Buffett the "Oracle of Omaha," but Munger was held in equal esteem by his own followers, who branded him the "Oracle of Pasadena" after his adopted hometown in California.

Munger reserved many of his public comments for annual meetings of Berkshire; his investment vehicle Wesco Financial Corp, which Berkshire bought out in 2011; and Daily Journal Corp, a publishing company he chaired for 45 years.

To fans, Munger was as much the world-weary psychiatrist as a famed investor. Many of his observations were collected in a book, "Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger," with a foreword by Buffett.

"I was raised by people who thought it was a moral duty to be as rational as you could possibly make yourself," Munger told Daily Journal shareholders in 2020.

"That notion," he added, "has served me enormously well."

In 2009, during the worst U.S. recession since the Great Depression, he tried to put his followers at ease.

"If you wait until the economy is working properly to buy stocks, it's almost certainly too late," he said at Wesco's annual meeting.

After that gathering, Los Angeles Times columnist and Wesco investor Kathy Kristof wrote about Munger: "He gives us hope."

TETE-A-TETE

Born on Jan. 1, 1924, Munger as a boy once worked part-time at the Omaha grocery run by Buffett's grandfather Ernest.

Buffett also worked there though he and Munger, who was 6-1/2 years older, did not work together.

Munger later enrolled at the University of Michigan, but dropped out to work as a meteorologist in the U.S. Army Air Corps during World War II.

Despite never getting an undergraduate degree, Munger graduated from Harvard Law School in 1948.

He then practiced law in Los Angeles, co-founding the law firm now known as Munger, Tolles & Olson, before turning in the mid-1960s to managing investments in stocks and real estate.

Munger was a success, easily outperforming the broader market between 1962 and 1975 at his investment partnership Wheeler, Munger & Co.

According to Buffett biographer Alice Schroeder, Munger met Buffett in Omaha in 1959, where at a private room at the Omaha Club they "fell into a tete-a-tete" after being introduced.

More conversations followed, and they were soon talking by phone for hours on end.

"Why are you paying so much attention to him?" Munger's second wife Nancy reportedly asked her husband.

"You don't understand," Munger replied. "That is no ordinary human being."

KNOWING HIS MILIEU

The two shared the "value investing" philosophy espoused by Graham, looking for well-run companies with undervalued share prices.

Sometimes Munger and Buffett deemed those companies "cigar butts," meaning they were out of favor but had a few "puffs" of life left, but they often proved worth holding onto for decades.

Both generally shunned technology companies and other businesses they claimed not to understand, and they avoided getting burned after the late 1990s dot-com bubble went bust.

Instead, they oversaw purchases such as the BNSF railroad in 2010, and ketchup maker H.J. Heinz Co, which Berkshire and private equity firm 3G Capital bought in 2013. Berkshire and 3G later merged Heinz with Kraft Foods.

It was Munger who suggested that Buffett make one of Berkshire's few non-U.S. investments, in Chinese automobile and battery company BYD Co.

Munger was also responsible for introducing Buffett to Todd Combs, who along with Ted Weschler run parts of Berkshire's investment portfolio.

Unlike Buffett, who opened a Twitter account - seldom used - Munger resisted heading into social media.

"That's not my milieu. I don't like too many things going on at once," he once told Reuters.

But in many other ways, he was much like his business partner, especially in not chasing the latest trends.

"I am personally skeptical of some of the hype that has gone into artificial intelligence," Munger said at the 2023 annual meeting. "I think old-fashioned intelligence works pretty well."

Munger lived modestly and drove his own car, though he used a wheelchair in his final years.

He was also a generous philanthropist, pledging more than $100 million in 2013 to build housing at the University of Michigan.

Nancy Munger died in 2010. Charlie Munger had six children and two stepchildren from his marriages.

***

Yahoo Finance

Becky Quick looks back

Final CNBC interview

CNBC looking back

Whitney Tilson

5 Investing Basics from Ben Graham

The Intelligent Investor is considered to be the best book on value investing every written. The Fourth Edition, which contains Jason Zweig’s additional, more modern, commentary, is about 600 pages long.

It works best when investors dig into just a single chapter.

In the first chapter, Graham and Zweig both lay out 5 investing basics.

1.       A stock is not just a ticker. You actually own a business with underlying value.

2.       The stock market swings between bulls and bears. Have a plan.

3.       The future value of every investment is a function of its present price.

4.       You will be wrong. Have a “margin of safety.”

5.       Develop discipline and courage.

The fifth investing basic sounds so simple. Yet “discipline and courage” is the most difficult part about long-term investing.

-- Tracey Ryniec

add low, trim high

With regard to rebalancing, it’s one of the most beneficial disciplines in that it forces us to do what we know we’re supposed to do — add low, trim high. Notice I adjusted that from the classic “buy low, sell high” adage; which can infer an all-or-nothing strategy. Frankly, investors should never think of investing as either “get in” or “get out.” That is gambling on moments in time; while investing should always be a disciplined process over time.

- Liz Ann Sonders

Charlie Tian looks at Cathie Wood's fund

Starting this week, I will be writing a weekly column on the market. Over the years, I have put most of my effort into the technology side of GuruFocus, though I still wrote my book, "Invest Like a Guru." I have spent more time observing the market lately. I hope that by sharing my observations of the market, it will help our GuruFocus community. Please do follow me here on GuruFocus.com.

I cannot start this column by overlooking that the once red-hot ARK Innovation ETF (ARKK, Financial) dipped below $100 for the first time since last November. ARKK is now more than one-third below its peak of $156 a little over three months ago, back when its star manager, Cathie Wood, was everywhere on financial media and attracted a large group of followers into her funds. She was hailed by some as the new Warren Buffett (Trades, Portfolio).

If we look at ARKK's performance numbers today, it is still one of the best, if not the best, among all ETFs, mutual funds and hedge funds over the past 12-month, three-year and five-year periods. The chart below compares the performances of ARKK versus Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) over the past 12 months. ARKK still outperformed by more than 10%.

Unfortunately, the majority of the investors that own ARKK today are losing money because more than half of its assets flew into the fund over the past six months. In contrast, almost every one of the investors who bought Berkshire Hathaway over the past 12 months has made money.

That is the price you pay if you chase hot funds. Sometimes it is painful for the fund managers, too. They may have good track records, but they lost more money than they made.

This reminds me of Bruce Berkowitz (Trades, Portfolio), the manager of the Fairholme Fund (Trades, Portfolio). After his tremendous track record during the first decade of this century, he was named Morningstar Fund Manager of the Decade, was considered the new Buffett and had a large following on GuruFocus as well. Money poured into his fund. At the end of the first quarter of 2011, Fairholme Fund (Trades, Portfolio) had more than $20 billion under management. But with a few missteps with his stock picks and the headwind with value investing, most of those chasing the fund withdrew as they could not endure the loss. By 2018, Fairholme Fund (Trades, Portfolio)'s assets were less than $1 billion. Around 95% of the money was either lost or withdrawn. This is the history of the asset value in the Fairholme Fund (Trades, Portfolio).

The Cathie Wood phenomena is a lot more like the Janus Fund during the dotcom era of the 1990s. Heavily invested in technology stocks, Janus routinely led the list of the best mutual funds. Money poured in at the rate of $1 billion a day. Back then, $1 billion was a lot more money than it is today. Then the dotcom bubble burst, Janus Fund lost money in three consecutive years from 2000 to 2002 and ranked at the bottom of mutual funds. The investors who once were rushing into the funds were streaming out, and most of them lost money. The fund never bounced back.

Chasing hot funds never works. Sure, skill is needed in stock picking. That is why we have Warren Buffett (Trades, Portfolio). But most of the star managers became stars not because they are better at stock picking, but because they are the most aggressive person in their style of investing while that style has the wind at its back. But every once in a while, the direction of the wind changes. With the Covid-19 pandemic, technology stocks, especially those with hyper growth prospects, gained momentum and many saw their price multiplied in a matter of months. Cathie Wood owns a lot of them. About half of the stocks she owns are those of earningless hyper growth companies. She became the hero, but then the direction of the wind turned.

That was what happened to Janus Fund. This is what is happening to Cathie Wood, too.

I personally know a lot of people who bought ARKK. I surveyed them yesterday and every one of them lost money and about half of them sold at a loss. I wonder whether the size of ARKK will repeat that of Fairholme Fund (Trades, Portfolio) a decade ago.

But maybe it is time for Berkowitz's value approach to shine again. After more than a decade of underperformance and reaching the bottom at the second half of 2020, value stocks are coming back. It has outperformed since then, as shown in the chart below, which illustrate the difference in rolling five-year annualized return between Russell 1000 Value and Growth.

The pattern of the stock market from 2010 to 2020 looks a lot like what happened from 1990 to 2000. We know what happened to the Janus Fund. We have yet to see what will happen to Cathie Wood.

History does rhyme.

5 pieces of financial advice from Warren Buffett

“I will tell you how to become rich. Be fearful when others are greedy. Be greedy when others are fearful.” Most people chase what’s hot. As euphoria builds money pours in. Until it collapses. Buffett does exactly the opposite. He buys when most people are selling. And waits when most are buying. Incredibly difficult to do. And incredibly rewarding.

“Price is what you pay. Value is what you get. I like buying quality merchandise when it’s marked down.” Most people chase price. The higher the price the more money flows in. Until the value can’t sustain the price. Buffett chases value. Looks for investments priced under their worth. Then buys and waits for others to discover their value.

“I don’t look to jump over seven foot bars. I look for one foot bars I can step over.” Most people try to hit home-runs. They speculate on the next big hit. And keep striking out. Buffett instead invests to build wealth steadily. Rare home-runs. Lots of singles that win games.

“Successful investing takes time, discipline and patience.” Most people want to get rich quick. So they continually take long bets that frequently blow up. Buffett takes a long term view. He’s happy to build wealth over a lifetime rather than a year or decade.

“What we learn from history is that most people don’t learn from history.” Most people whether euphoric or depressed refuse to learn from those who were successful. And they pay the price. Buffett always learned from others. And reaped the rewards.

-- Doug Armey via Quora

Mohnish Pabrai

[12/14/20] Being an investor is a continual learning process. The only way one can keep up with the investment environment is to change with the times, learn about different subjects and adapt to the changing environment.

There are many examples of successful investors who've needed to make these changes to stay relevant. One is Mohnish Pabrai (Trades, Portfolio). In a recent speech to the UCLA Student Investment Fund on Nov. 5, Pabrai explained how his investment strategy has adapted over the past few years.

A changing style

Pabrai started off as a deep value investor. When he started his hedge fund around 20 years ago, he focused on finding deeply discounted securities, buying them at a fraction of their net worth and then holding the stocks until the discount between intrinsic value and the market price had narrowed. As the value investor explained in his recent speech:

"I was always looking -- for the last 20 years -- for discounted pies. I didn't really care whether the pie grew or not. My take was that if I bought a business for 40 cents or 50 cents on the dollar, and I've always implicitly assumed that market efficiency would kick in in two or three years. So if I'm correct that a business is worth a dollar and I'm buying it for 50 cents, and I sell it for 90 cents and that convergence takes place in two or three years, it's a very nice rate of return in the 20s."

This "very nice" rate of return, he explained, removed the need to find high-quality compounder style businesses.

However, as he went on to explain, there were two problems with this approach: the fact that "you've got to keep finding the next one and the next one" and "taxes."

A much better approach, he observed, would be to find high-quality businesses and sit on them for decades. But this was not the way "Mohnish is wired," the value investor explained to his audience.

"He is unable to pay up for great businesses," Pabrai added. Other investors are more willing to pay up, but "I know Mohnish and Mohnish is just not wired that way."

This is a remarkable statement because it shows the need to understand our own qualities as investors. Lots of different investment strategies achieve positive results, but there's no point in following a process if you're not comfortable with it. This realization won't occur overnight. It requires emotional intelligence and experience to know what you are comfortable with, and more importantly, what you're not comfortable with.

Rather than pursuing an investment style he was not happy with, Pabrai took the best of both the quality and value methods and merged them into something he was happy with:

"So I am limited to a universe where a compounder is maybe not recognized, or it has hit a temporary hiccup or something where the valuation is really cheap, but there is a genuinely long runway for growth ahead. Instead of just getting off that train when it looks fully priced, which is what I did many times in the past, the idea is to stay on the train and only get off the train when it gets so egregious."

Pabrai explained that he had made this mistake several times in the past, which was part of the reason why his strategy changed. He had sold good companies too early and moved on to other businesses that have not been so successful. This was one of his main lessons of 2020, he told his audience. But with "20 to 35 years" of life left in him, he added, it was not too late to change course.

[12/10/14] Mohnish Pabrai’s long-only equity fund has returned a cumulative 517% net to investors vs. 43% for the S&P 500 Index since inception in 2000.  That’s outperformance of 474 percentage points or 1103 percent.

Pabrai is a classic value investor in the tradition of Warren Buffett, Charlie Munger, Seth Klarman and Joel Greenblat.

Like Buffett, Pabrai looks at a stock not as a piece of paper but as the ownership of a business.  He has no interest in a company that looks ten percent undervalued.  He is angling to make five times his money in a few years.  If he doesn’t think the opportunity is blindingly obvious, he passes.  This requires him to apply his X-Ray vision to the fundamentals, and weigh the downside risk (the margin of safety) vs. the upside potential (the moat) at a given price.  His mantra: Heads I win, tails I don’t lose much.

Next, Pabrai practices patience.  He takes Charlie Munger’s admonition to heart that money is made not in the buying or selling but in the waiting.  As far as I am aware, he has not made a single new investment in 2013.  He says that if he can find a couple of investment ideas a year, that’s plenty.  His current preference is to keep a cash store of between 10%-20%.  This seems like a tremendous drag for a fund posting numbers like his, but he is really biding his time for a distressed situation to come along when he can deploy this trove at the valuation he wants.  During the next crisis, when everyone is jamming the exits, he will go all in.

Once you start purchasing stocks, Pabrai says the next  step is to closely examine every trade that doesn’t work, and figure out what went wrong.  Let me pause right here, because this is key to his whole method.

There is nothing more tempting that to sweep mistakes under the rug.  Denial is one of our top defense mechanisms.  If you are lucky, these trades come to haunt your sleep like Marley’s ghost.  If you are unlucky, you repress them forever.

Due to his background in engineering, Pabrai does not gloss over mistakes.  Investing is a field where you can have a high error rate (buying something you shouldn’t have, selling something you shouldn’t have, not buying something you should have, not selling something you should have) and still be successful.  He takes as a given that mistakes are inevitable.  The point is to learn from them so they are not repeated.  A major portion of his annual meeting is devoted to publicly analyzing investments where he lost money for his partners.  Lately these errors are becoming harder to find, so he has been reduced to talking about investments that didn’t fare as well as expected.

[Looking at dataroma, Pabrai has 8 stocks in his portfolio with over 99% in 4 stocks: ZINC, BAC, C, PKX.  Hmm.  Maybe I should buy more C?]

[11/28/14] "Forbes: So summing up in terms of what do you think do you bring to value investing that others perhaps don’t, that give you a unique edge?

Pabrai: I think the biggest edge would be attitude. So you know, Charlie Munger likes to say that you don’t make money when you buy stocks. And you don’t make money when you sell stocks. You make money by waiting. And so the biggest, the single biggest advantage a value investor has is not IQ; it’s patience and waiting. Waiting for the right pitch and waiting for many years for the right pitch.

FROM: Forbes Transcript: Mohnish Pabrai (Trades, Portfolio) 04/12/2010

(successful) value investing

Value investing strategies can become unpopular during bull markets. Rising valuations and optimistic forecasts can cause some investors to switch to growth strategies that place less emphasis on buying stocks at low prices.

However, in my view, value investing is a logical long-term approach to use when allocating your capital. It can help you to avoid excessive risks and generate high returns through buying quality companies when they trade at low prices.

Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) chairman Warren Buffett (Trades, Portfolio)'s track record highlights the potential success of a value investing approach. His patient attitude and simple strategy could be key reasons for Berkshire's 20% compounded returns in the past 55 years.

Focusing on fundamentals

It is tempting to follow the lead of other investors in a bull market or in a bear market. For example, some investors may now find themselves becoming more optimistic about the prospects for stock prices after the market's 50% gain since March. Likewise, investors may become pessimistic about the S&P 500's prospects during a bear market because stock prices have experienced a decline.

However, avoiding bullish and bearish sentiment could be crucial for anyone seeking to become a successful value investor. Ignoring your emotions makes it easier to judge investment opportunities based on facts and figures, rather than the prevailing mood among your peers. This could improve the efficiency of your capital allocation and allow you to take a contrarian view when it is advantageous.

Buffett has sought to maintain an even temperament throughout his career. As he once said, "The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd."

Using a patient approach

Rising stock prices over recent months may mean there are fewer companies trading at a discount to their intrinsic values. It is tempting to buy stocks that are overvalued in this situation, rather than holding cash due to low interest rates. However, using a patient approach that waits for more attractive risk/reward opportunities to appear could be more effective.

In my opinion, the ability to turn down unattractive investment opportunities could be an important trait of successful value investors. A selective approach may mean that you sometimes miss out on stocks that go on to generate high returns. However, it will also help you to avoid unnecessary risks that may be present in the current bull market.

As Buffett once said, "The stock market is a no-called-strike game. You don't have to swing at everything - you can wait for your pitch."

Adopting a simple strategy

Value investing is a simple means of allocating capital. At its core, it is a long-term strategy that focuses on buying quality businesses when they trade at prices below their intrinsic values. They are then held until there are more attractive places that offer superior risk/reward opportunities available elsewhere.

Therefore, successful value investors do not need to use complicated formulas or complex methodologies when managing their portfolios. Complexity may be far less important than consistency and self-discipline when using the market's cycles to your advantage.

Despite being one of the wealthiest investors of all time, Buffett's approach to managing Berkshire's capital has always been very simple. As he once said, "You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ."

-- Robert Stephens, CFA

Nifty Fifty deja vu?

If you look deeper under the hood of the stock market, you’ll see that there is a significant dichotomy between bytes stocks and atoms stocks. The atoms are losing to the bytes, badly. If you compare performance of the S&P 500 (SPY) traditional market-capitalization index – the one you see in the news – to its less-known cousin, the S&P 500 equal-weighted (RSP), you’ll see a significant disparity in performance.

In the market cap-weighted version, the top five stocks (all five are members of FANGAM gang – Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT)) now represent 21% of the capitalization of the index (the last time this happened was 1999) and thus account for 21% of the returns. In RSP these stocks have a weight of 1% (they’re just 5 out of 500 stocks).

Just as any propaganda needs a certain germ of truth to grow from, so do bubbles. The FANGAM are incredible companies (germ of truth), and they function better in the virus-infested world (another germ of truth). But at the core, their existence is grounded in the world that is built of atoms, not bytes.

The Nifty Fifty stocks come to mind here. Those were the fifty stocks – the who’s who of the 1960s –that made America great (then): Coca Cola (NYSE:KO), Disney (NYSE:DIS), IBM (NYSE:IBM), Philip Morris (NYSE:PM), McDonald's (MCD), Procter & Gamble (PG) … the list goes on. Though today we look at some of them as has-beens, in the ’60s and ’70s the world was their oyster. Coke and McDonald's were spring chickens then, spreading the American health values of diabetes and cholesterol (okay, maybe I’m being too hard on them) across this awesome planet.

Although it was hard to imagine in the ’70s that any of these companies would not shine forever, they are a useful reminder that even great companies get disrupted. Avon (AVP), Kodak (KODK), Polaroid, GE (GE), Xerox (XRX) –all were Nifty Fifties, and all either went bankrupt or are heading towards irrelevancy.

In the 1960s and early 1970s these stocks were one-rule stock – and the rule was, buy! They were bought, and bought, and bought. They were great companies and paying attention to how much you paid for them was irrelevant.

Until.

If you bought and held Coke or McDonald's in 1972 (or any other Nifty Fifty stock), then you experienced a painful decade of no returns; in fact, at times you were down 50% or more. Coca Cola was as great a company in 1974 as it was in 1972, but the stock was down 50% from its high. Okay, Coca Cola was trading at 47 times earnings in 1972. But even a company like Procter & Gamble that was trading at “only” 32 times earnings in 1972 was down almost 50% in 1974 from its 1972 high. It took until the early 80s – a decade – until investors who bought Nifty Fifties at the top broke even – and this applies to almost all of them.

Another issue: If you held many Nifty Fifties for 20 years, from 1972 to 1992, they would have delivered a decent (10%-plus) return. This sounds great in theory; however, most people would have run out of patience after a decade of no or negative returns and thus not have been around for the fruits of the ’80s decade. In other words, shareholders who bought the stocks in 1970 were not the ones who benefitted from the returns in the late ’80s.

Today the Nifty FANGAM has turned into one-rule stocks – buy! (irrespective of price). If you did not own them over the last decade, your portfolio had an enormous headwind against it.

But what the Nifty Fifties showed us is that company greatness and past growth are not enough. Starting valuation – what you actually pay for the business –matters. The great companies will still be great when their stocks are down a bunch and they have a decade of no returns. Dividends aside, stock returns in the long run are not just driven by earnings growth but by what the price-to-earnings does as well. If price-to-earnings is high, it’s mean reverts – declines – chipping away at the return you receive from earnings growth.

Ben Graham

[1/22/20] The Benjamin Graham breakthrough

[7/8/15] 15 Thoughts from Grandmaster Ben Graham

[8/17/06] Foolish Book Review: The Intelligent Investor

[8/11/06] Ben Graham's equation<!- via Rick Daley value_investment_thoughts-->

[11/12/05] brknews passes along this article by Sanjay Bakshi who writes about Graham's rule of minimum valuation.

[11/9/05] Shai has generously passed me more items on Ben Graham from his blog.

[11/7/05] Graham's simple rules

[10/18/05] Two lessons from Benjamin Graham

[8/6/05] Ben Graham is still pointing the way

[8/6/05] A test of Graham's stock selection criteria

[8/5/05] Graham's Net Current Asset Value Strategy (dryice's follow up)

[8/4/05] High Performance Graham Stocks (a Ben Graham screen)

[8/3/05] Graham favored two methods: buying stocks that were selling substantially below the value of their assets, and selecting companies that boasted consistent earnings and solid financial foundations.

5 signs you're a value investor

1.  You are obsessed with Warren Buffett

Do you watch every interview on CNBC that Buffett does?

Do you read every one of Berkshire’s shareholder letters, attend the annual meetings because you’re a shareholder, or quote Buffett on social media?

An obsession with Mr. Buffett is one big sign that you’re probably a value investor yourself.

2.  You love stocks trading at 52-week lows

Benjamin Graham, the father of value investing, has told investors to look for stocks trading on new 52-week lows.

If you enjoy looking at those stocks because you’re thinking you’re getting a bargain, you could be a value investor.

3.  You buy and hold your stocks

Buffett has owned some of his stocks for decades. Have you? If so, you may also be a value investor.

4.  You love “boring” companies

Buffett has gotten rich owning some of the more “boring” types of companies including industrials, railroads, energy and, famously, insurance.

5.  You never buy companies with negative earnings

If you don’t understand what all the fuss is about with Uber or Lyft, both of which don’t have positive earnings, you may be a value investor.

Seth Klarman on buying

[4/26/17] Position sizing is another important part of portfolio management. Different stocks can command different percentages of your investment portfolio, depending on conviction. Klarman believes one of the best strategies to build a position, as well as an understanding of the business you are investing in, is to build a new position gradually:

“The single most crucial factor in trading is developing the appropriate reaction to price fluctuations…One half of trading involves learning how to buy. In my view, investors should usually refrain from purchasing a 'full position' (the maximum dollar commitment they intend to make) in a given security all at once…Buying a partial position leaves reserves that permit investors to 'average down,' lowering their average cost per share, if prices decline…If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices. If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place.”

[12/13/17 - waiting for the bottom?]

“While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed...the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.”

[12/3/18] Seth Klarman's 3 Pillars of Investing

[8/19/19] “In a market downturn, momentum investors cannot find momentum, growth investors worry about a slowdown, and technical analysts don't like their charts. But the value investing discipline tells you exactly what to analyze, price versus value, and then what to do, buy at a considerable discount and sell near full value.

And, because you cannot tell what the market is going to do, a value investment discipline is important because it is the only approach that produces consistently good investment results over a complete market cycle.”

The Buffett Yardstick

Warren Buffett of Berkshire Hathaway (BRK) says it’s “probably the best single measure of where valuations stand at any given moment.”

The “Buffett Yardstick,” as longtime money manager Jesse Felder of the Felder Report calls it, plots the total value of the stock market against the overall size of the economy. What makes it so valuable, he says, is that it’s good at telling investors what to expect from equities going forward.

So what’s it telling them now?

Felder put the “Yardstick” (inverted) up against forward 10-year returns in the stock market in the chart below to create what he describes as the best representation of one of his favorite Buffett quotes: “The price you pay determines your rate of return.”

According to this measure, Felder says investors are paying such a high price for stocks that they are likely to receive basically nothing in return in the coming decade, and that includes dividends.

“At the same time that potential returns look so poor, the potential for risk may be greater than it has been in generations,” he wrote, pointing out that investors have been piling on margin debt lately to increase their exposure to an overheated market.

Howard Marks - books summary

“I didn’t set out to write a manual for investing. Rather, this book is a statement of my investment philosophy. I consider it my creed, and in the course of my investing career it has served like a religion.”

Howard Marks (Trades, Portfolio) wrote those words in the introduction to his 2013 book, “The Most  Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor.” It is based on his occasional memos to clients at the Trust Company of the West and then at Oaktree Capital, the company he cofounded in 1995.

The title originated with a client meeting in which Marks explained the most important thing about investment success, only to find himself trotting out a series of most important things—18 of them in total.

Chapter 1 - Second-level thinking
Chapter 2 - Market efficiency
Chapter 3 - The concepts of value
Chapter 4 - Price and Value
Chapter 5 - Understanding risk
Chapter 6 - Recognizing of risk
Chapter 7 - Controlling risk
Chapter 8 - Cycles present opportunities
Chapter 9 - Following the pendulum
Chapter 10 - Bad decisions
Chapter 11 - Catching falling knives
Chapter 12 - Looking for bargains
Chapter 13 - Patient opportunism
Chapter 14 - The hazard of forecasting
Chapter 15 - The Cycle
Chapter 16 - Luck and value investing
Chapter 17 - making money and/or avoiding losses
Chapter 18 - investing pitfalls
Chapter 19 - Second level thinking
Chapter 20 - what returns are reasonable?

Martin Whitman

So many wonderful retrospectives were written about Marty Whitman during his lifetime that another seems superfluous—yet we just can’t help ourselves.

Whitman, the founder of Third Avenue Management, died last week at the age of 93. To financial journalists, he was a generous source and teacher about value investing, especially deep value, the kind that really meant investigating a company. He often picked up the phone to share an idea in his gravelly New York voice, or to critique a story. In fact, he loved teaching: He instructed students at Yale School of Management for decades and endowed the Whitman School of Management at Syracuse University.

For investors in his funds, he produced great returns for years and wrote pungent shareholder letters that rivals studied closely. (One from 2013 called the work of that year’s Nobel Prize winner Eugene Fama “utter nonsense” and “unscholarly.”)

Whitman focused on distressed debt years before it became popular. He believed in the primacy of the balance sheet versus the income statement, and read debenture documents as though they were comic books. He believed that companies were wealth-creating machines, partly through what he called “resource conversion,” including mergers and acquisitions and spinoffs. And he rarely sold his stocks. “The idea of selling was absolute anathema to him,” says Amit Wadhwaney, co-founder of Moerus Capital and a protégé.

All of this contributed to him beating the stock market by a wide margin over at least 20 years. He was “like a kid in a candy store when markets were imploding, says Curtis Jensen, a portfolio manager at Robotti & Co. and another protégé. “He was jogging into the trading room hourly to buy stocks that were getting marked down during the Long-Term Capital Management and Russian ruble crisis.”

Before he became a money manager, Whitman was an investment banker who did a hostile takeover of Equity Strategies, a closed-end fund. This became the foundation for Third Avenue Management, which opened its doors in 1986. Once Whitman bought the bankrupt bonds of Anglo Energy, he needled his lawyer, Tony Petrello, to join the new company, asking him, “Do you want to be a principal or an advisor?” Petrello eventually became CEO of Nabors Industries, one of the biggest drilling companies. Whitman served on the Nabors board until 2011.

“Better than most,” says Jensen, “he emphasized that only three to four variables counted in what would drive an investment: The rest is just noise.”

Whitman stepped back from his firm in 2012. Third Avenue has stumbled in recent years, ironically after a downturn in distressed debt sank its Third Avenue Focused Credit fund. Value investing has also struggled since the financial crisis. Assets fell. In a 2015 interview with Barron’s, Whitman said, “I don’t know if you could even call us a success after the 2008 redemptions. We never really came back. It’s been tough.”

Born and raised in the Bronx, Whitman favored sweatshirts and khakis for the office, and forthright, sometimes salty language. Once, chatting with Barron’s about a famous bankruptcy investor, he said, “The bankruptcy fraternity here is very small. [This person] goes out to dinner with them and schmoozes them. In this country, you litigate by day and fornicate by night. He’s very good at fornicating by night. I go home to my wife and children.”

Throughout his 70s, Whitman walked across Central Park daily to the office and back. He had a habit of running across intersections if the traffic light was about to change. In mid-conversation, he might break into a dead run to catch a train. In his later years, he sometimes announced to people, “Let’s make money the old-fashioned way.”

Now, investors must figure out how to do by themselves.

stock market ignorance

Friday's column advocated self-awareness. The stock market's movements seem to be meaningful, but their signals are spurious. Therefore, investment wisdom consists of learning to avoid the temptation to trade. The investor who acknowledges his ignorance is better off than the investor who does not.

A reader, Marvin Menzin, noticed. "Your advice implies that investors should buy and blithely hold. It ignores the possibility they might want to reduce your exposure because of excess stock-market valuations. I think it would be an excellent column if you were to address when investors should rebalance to lower-risk portfolios, especially when it's a retirement account and taxes are not germane. Investors are told to stay the course. The Titanic stayed the course!"

Well, Mr. Menzin, this is that column. Although I must confess, the "when" is exceedingly rare.  Since World War II, I can think of only one clear and obvious occasion when U.S. stock investors should have reduced their exposure.

To start: A portfolio's stock position should indeed be traded regularly, through mechanical rebalancing. If stocks perform well, such that a portfolio that was initially 60% stock/40% bonds becomes 70/30, then it's logical to return to the original allocation. After all, nothing changed from the initial decision.

Rebalancing, however, is more easily said than done, because while maintaining a consistent asset allocation makes economic sense, it's not much fun to implement. Selling winners feels good if stocks then decline, but if they do not, the opportunity cost can sting. Worse yet is the opposite situation. Mr. T had one word to describe how people feel after they buy equities when the headlines are urging otherwise, only to see stocks fall further. Pain indeed.

Thus, rebalancing is best done automatically: Establish a trading rule; follow its instructions devoutly; and suffer no regret if the transaction turns out badly. After all, the decision was the model's, not yours.

Unfortunately, I do not see how mechanical processes can guide investment strategies that are based on stock-market valuations. Those who have tried--most famously by using the Shiller CAPE P/E Ratio, which examines stocks' cyclically adjusted price/earnings ratios--have failed. Such measures work well in hindsight, but they have not been useful predictors. Their explanatory power has been academic rather than actual.

Historical Assessments

For 20 years following the conclusion of World War II, there was no judgment to be applied. Remaining in equities was the correct decision.

Then came 15 terrible years, through the mid-1980s, when the stocks were devastated by inflation. For that stretch, investors would indeed have done well to avoid equities. However, making that choice involved understanding the economy, not judging the level of equity valuations. It wasn't that stock prices were particularly steep. It was instead that inflation spiked far higher than it had been, and also far higher than it would become.

Since the early 1980s, stocks have crashed three times.

Two of those occasions, I believe, were almost impossible to anticipate. Black Monday in 1987 came out of nowhere; even in hindsight, it is difficult to understand why. The 2008 financial crisis, on the other hand, happened for well-documented reasons. But once again, the determinants were economic. Across the globe, banks collapsed and housing markets sunk. No stock-market indicator could have anticipated that.

The one occasion in which judgment served was during the "New Era," when technology stocks posted valuations that still exceed all subsequent levels. Sentiment was equally overheated. That truly was a time to slash one's stock-market exposure. Even then, though, the timing needed to be right. Those who sold equities in 1996 fared worse than those who stayed the course and held through the worst of the downturn.

In short, Friday's column overstated its case. Sometimes stocks do cost too much. But recognizing when that situation arises, and profiting from the knowledge, is a severe task.

-- John Rekenthaler

the value of a stock idea

The value of a stock idea can come from a combination of four sources:

1. How much money you put in the idea.
2. How cheap the stock is.
3. How fast the stock is compounding its value.
4. How long you own the stock.

The ideal stock would be a business quickly compounding its intrinsic value per share, which you are able to buy at a deep discount to intrinsic value, which you feel confident allocating a big chunk of your portfolio to and which you are going to hold for a very long time.

Take Buffett’s investment in Coca-Cola for example. This was considered a big bet by Berkshire. By my calculations, however (admittedly, very approximate based on the data I have), Buffett allocated perhaps just under 20% of his entire stock portfolio to Coca-Cola at the time he built the position. Despite putting just 20% of his portfolio into the stock in the late 1980s, however, Berkshire ended up not only with a position that today is worth about 13 times what he originally bought – the one position alone is also worth several times what Berkshire’s entire portfolio was when he made the Coke investment.

How did he do that?

Let’s look at the four ways to get the most out of a stock idea:

1. You can put a lot into the stock (Buffett put 20% of his portfolio into Coke).
2. You can hold the stock a long time (Buffett has now owned Coke for just under 30 years).
3. The stock can compound is intrinsic value at a high annual rate (Coca-Cola compounded EPS at about 11% a year for the first 25 years Buffett owned the stock).
4. You can buy the stock when it is cheap (the P/E on Coke went from 15 when Buffett bought it to 30 recently).

Coke is pretty close to a perfect example of some value coming from all four possible sources of getting the most out of an idea.

Whitney Tilson shutting down hedge fund

(Reuters) - Whitney Tilson is closing his hedge fund Kase Capital, and will return capital to investors, he said in a letter to clients.

Tilson cited “high prices and complacency that currently prevail in the market” as main reasons for shutting down his fund.

“Historically, I have invested in high-quality, safe stocks at good prices as well as lower-quality ones at distressed prices,” Tilson wrote to clients on Sunday.

“... However, my favorite safe stocks (like Berkshire Hathaway and Mondelez) don’t feel cheap, and my favorite cheap stocks (like Hertz and Spirit Airlines) don’t feel safe. Hence, my decision to shut down.”

Kase Capital follows a spate of other notable funds that have gone out of business this year, including Eric Mindich's Eton Park Capital Management, and John Burbank's Passport Capital, which recently announced plans to shut its long-short equity fund. reut.rs/2fuEDoI

get rich slowly?

“The people who have gotten rich quickly are also the ones who got poor quickly.” - John Templeton

A July 1974 Forbes article profiled Sir John Templeton and highlighted some of the wisdom he implemented in his investment process. The article touched on his discipline of consistently praying to God “for wisdom and clear thinking” at the start of each directors' meeting for the Templeton Growth Fund. Templeton noted that even with prayer they still “make hundreds of mistakes, but we don’t seem to make as many as others.”

In the article, Templeton also advised that “ninety-nine percent of investors shouldn’t try to get rich too quickly; it’s too risky.” He advised, “Try to get rich slowly.” Templeton is on nearly every short list showcasing the most successful investors of all time, and certainly held in high esteem among value and contrarian managers like us.

... With that as a given, we want to remind investors of our role in all of this: we are long-duration investors. Contrarian investors make money when they buy into temporary misery and sell into excitement or mania. The great financier and investor Bernard Baruch would have illustrated good investing as “buy[ing] straw hats in the winter.” We would add by saying that once purchased, investors should simply do their best to get out of the way and allow the fundamentals of those businesses to drive the results. In Berkshire Hathaway’s (NYSE:BRK.A) (NYSE:BRK.B) 1996 letter to shareholders, Warren Buffett (Trades, Portfolio) advised:

“If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value."

At Smead Capital Management, we like to say that we are arbitrageurs of time. When the idea of having to wait becomes distasteful in the psyche of investors, they will greatly discount extraordinary – but perhaps mundane – businesses. We like to use those opportunities to acquire shares.

As contrarians who implement these tenets of investing, we own, in our view, a portfolio full of great businesses that lack current investor excitement. We operate on long-term ideas such as household formation, banking needs and the kind of sustained economic growth that paves the way for business and consumer spending to grow over time. We find attractive value in our banks, home-builders, media companies, health care and select retailers. We believe the economic needs our companies address will persist over time, and we want to be in front of the profitability and cash flow that can be gained in the process.

***

I wonder how good these Smead guys are?

I see they have a fund called Smead Value Fund.  Looking at the latest (2Q 2017) shareholder letter, SMVLX (the investor class shares) has returned 18.72%, 15.51%, 7.91% for 1 year, 5 years, inception (1/2/08).  The S&P 500 has returned 17.90%, 14.63%, 7.73%.  A very slight outperformance.  Which is actually good, because most funds underperform.

Looking at the website, their top ten holdings are AMGN, NVR, BRK.B, JPM, AXP, BAC, EBAY, PYPL, AFL, LEN.

I guess they're OK, but they're not really knocking it out of the park.

the only game in town?

The easiest way to understand why you don’t want to make money from the late stages of an expensive/futuristic stock boom is to look at what were considered the lowest-risk ways to play the 1990s boom. Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Cisco (NASDAQ:CSCO) were considered “pickaxe” companies to that boom because they were not dotcom flashes in the pan and were drafting on all the activity requiring their software, chips and routers created by the “internet revolution.”

Microsoft’s high stock price in 2000 was $58.38. It bottomed at $17.10 in early 2009. Today, Microsoft is projected to earn $3.02 in 2017 (Value Line). This means the stock sold in 2000 at 19 times 2017 earnings per share. Is it any wonder that investors have only seen 20% appreciation from the height of the Tech Bubble?

Intel and Cisco are even worse. Intel peaked at $66.75 in 2000, and it is projected to earn $2.80 in 2017 (Value Line), which means it traded at 23.8 times 2017 earnings back then. Cisco traded at $77.31 per share at its 2000 peak and bottomed two years later at $10.49. It was projected to earn $2.40 per share (Value Line). It traded for 32 times what it would earn 17 years later. This only happens when you are “the only game in town!”

Are we doing something very similar today? Here are the P/E ratios of the FANG stocks, Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOGL), based on Value Line estimates:

• Facebook – $4.75 in 2017, P/E ratio 32.
• Amazon – $7.95 in 2017, P/E ratio 125.
• Netflix – $1.10 in 2017, P/E ratio 148.
• Alphabet – $35.00 in 2017, P/E ratio 29.

A quick glance at these numbers shows that Amazon and Netflix are certainly as expensive as Cisco and other glamour large cap stocks were in 1999. Facebook and Alphabet are less expensive – or like what Microsoft, IBM and Hewlett Packard were in 1999. Therefore, as we consider how this might play out, we will ask how the FANG stocks became “the only game in town.” FANG dominance is best represented by their gains since the beginning of 2015 as compared to the gains in the remaining stocks in the Standard & Poor's 500 Index. The chart below shows that the FANG stocks gained 48.92% while the remaining stocks gained 4.96% on an equally weighted basis (1):

...

We have no idea when this euphoria episode will end. However, we believe we know what to do with it. When a group of stocks gets mega-popular, we must avoid the area the same way we would avoid Palm Beach during a Miami hurricane alert. This is especially true when it is “the only game in town.”

-- Smead Capital Management

***

[P.S. I personally own every stock mentioned above -- in varying degrees, with no immediate plans to sell.]