2018 seems to be ending on the wrong note in the markets. December is setting the wrong kind of records, and Q4 has been a bumpy one in general. This is what happens in the stock market sometimes, but it's been easy to forget over the decade-long bull market.
We're using the end of the year as a chance to lift our heads, survey the market, and see what might be coming ahead. To do so, we're inviting our Marketplace authors to do a series of roundtables. 2018 was another steady growth year for the platform, and we have a lot of great voices on the Marketplace, so we wanted to share their perspective with you.
Our Year-End Marketplace Roundtable series will run through the first full market week in January. We'll feature ten different roundtable discussions, with expert panels chiming in on Tech, Energy, Dividends, Other Income strategies, Gold, Value Investing, Small-Caps, Alternative investing strategies, Biotech, and the Macro outlook.
This roundtable looks at value investing. Does the market volatility mean value is coming back into fashion? Has value investing changed? We asked our panel to sort through the investing approach and how it fits today's market. We have 18 panelists, which is too much to read in one sitting, so we are breaking this into two groups of nine, to publish today and tomorrow. Here's today's nine authors:
- Ranjit Thomas, CFA, author of Stock Scanner
- Robert Honeywill, author of Analysts' Corner
- General Expert, author of Core Value Portfolio
- Value Digger, author of Value Investor's Stock Club
- Paulo Santos, author of Idea Generator
- Chris Lau, author of DIY Value Investing
- J Mintzmyer, author of Value Investor's Edge
- David Trainer, author of Value Investing 2.0
- Grant Gigliotti, author of Good [email protected] Prices
Seeking Alpha: The second half of the year appeared to be renewed vindication for value investing in part, as high-fliers like the FAANG stocks pulled back. How do you view the current climate for value investing?
Ranjit Thomas: The climate continues to be difficult. To be a successful value investor, you need to buy a company's stock at a reasonable valuation, but then the company needs to be managed well, with the executives making the right decisions. Typically, one has no control over this.
Robert Honeywill: Determining value is a pre-requisite to finding value. Using a DCF calculation to arrive at a present intrinsic value share price is a wrong-headed approach. It has no relevance if the discount rate and other assumptions are not disclosed. Also, a calculated share price different to the current share price is not actionable. Having expressed my views on that, there are always instances of mismatches arising between share price and share value. With a return of volatility, the opportunity for value investing might even improve.
General Expert: I believe that high-flyers don't impact value investing at all since they were never in the investable universe to begin with (although specifically Facebook (NASDAQ:FB)/Google (NASDAQ:GOOG) (NASDAQ:GOOGL)/Apple (NASDAQ:AAPL) have become disconnected from Amazon (NASDAQ:AMZN)/Netflix (NASDAQ:NFLX) in my opinion). I believe that overall market valuation remains high, thus it is still very difficult to pick out value stocks in bulk.
Value Digger: Actually, it's not only the FAANG stocks that have pulled back over the last months. Many technology stocks, home builders, Chinese, bitcoin and marijuana stocks have also pulled back over the last months. Hopefully, investors will learn the lesson and will return to value investing in 2019.
Paulo Santos: I think the current climate presents the largest number of deep value opportunities in the last half decade or so. These opportunities, though, tend to be based outside of the U.S. (though often with U.S. quotations).
Chris Lau: Nearly all sectors are falling along with the market, with FAANG leading the tech sector sharply lower. Tech investors need to decide if the 3x or 5x P/E in stocks like Micron (NASDAQ:MU) sufficiently discount the chip cycle downturn. Investors must weight that against many big firms forecast a 2H 2019 recovery.
J Mintzmyer: Not sure I agree with that summary as pretty much the entire market has collapsed and cheap stuff ("value") has only continued to get cheaper. Top performing stocks have continued to outshine many of the industrials, energy firms, MLPs, shipping stocks, etc. The current climate for value investing has been pretty terrible in terms of stock price returns, but I'm optimistic on forward potential. The more the market shakes out, the better the opportunities can get as long as we avoid fundamentally flawed firms and/or bad management.
David Trainer: There have been and still are many stocks with valuations that that cannot be justified by their cash flows. We grouped many of these stocks into micro-bubbles and discussed them in "Bursting the Micro-Bubble" and "Bursting Another Tech Micro-Bubble". We think that at least part of the reason the valuations of these stocks get so disconnected from their cash flows is the lack of high fidelity research. With changes in accounting rules, the tax law distorting earnings, and the explosion in the length and complexity of corporate disclosures, investors need modern tools and technology to practice value investing with integrity. Only by performing real diligence (which requires reading the footnotes & MD&A of company filings) to determine the real cash flows of a business can one perform true "value investing." Value investing is by no means dead, there's just a whole lot more noise to cut through to find value.
Grant Gigliotti: The market is changing from a long bull market to a situation where stocks are declining to come closer to their real value. The US stock market is still significantly overpriced. The ratio of total market cap over GDP is currently around 130%, down from upwards of 150%, which supports that the market is adjusting. There is still room for the market and individual stocks to fall in price. As this happens and people start to panic and sell, it is the patient and confident value investor that will move in to buy up these good companies at bargain prices.
SA: One theme of the current market is that it's hard to find traditional value, so investors looking for that are forced into value traps. Do you buy this, and why or why not? If you do buy it, how are you adjusting?
Ranjit Thomas: Yes, many of the businesses trading at low valuations are in secular decline. I'm adjusting to it by making sure the company's earnings aren't declining however cheap the stock is.
Robert Honeywill: There exists a dichotomy between share price of a company and the value of a company's underlying business. This is best evidenced by Amazon, which has an amazing and steadily growing business, but which has huge up and down movements in share price, despite no identifiable change in the fundamentals of the underlying business. For a value investor, the way to avoid value traps is to make an intelligent assessment of what you might be able to sell the shares for in 1, 2, or more years, and any dividends you can reasonably count on receiving in the period you hold the shares.
General Expert: I believe that there is very little "pure" value left in the sense that there are no more companies with nothing wrong and are still trading at low multiples on an absolute basis. There are certainly lots of "relative" value left, but when you are debating whether to invest in a mature stock at 20x or another at 25x, I don't think that's true value investing. I am adjusting by looking at more growth-oriented stocks, although that is merely a byproduct of the process. If there is a stock trading at 5x earnings with no problems, I will jump on it.
Value Digger: We look for value plays with catalysts in order to avoid the value traps. Therefore, we don't look only for bullish ideas (undervalued stocks) with positive catalysts, but we also provide our subscribers with bearish ideas (overvalued stocks) with negative catalysts from a variety of sectors. For instance, we recently made a handful of bearish calls on grossly overvalued stocks with negative catalysts such as Quorum Health (NYSE:QHC), Capital Senior Living (NYSE:CSU), Michaels Companies (NASDAQ:MIK) and Genesis Healthcare (NYSE:GEN). We had 100% success, so our subscribers had the opportunity to make from 60% to 135% while holding these stocks just one or two months.
Paulo Santos: I believe that phrase applies well to many U.S. value stocks. However, it doesn't apply to deep value outside of the U.S., because there are high quality companies available at extreme discounts. The way we've adjusted, was in taking more ex-U.S. opportunities as of late.
Chris Lau: The risks of value trap are higher today than when the markets were rising. When the tide runs out, only the firms, characterised by manageable debt, and able to navigate through the slowdown, will survive. We must act more nimble and be more willing to close out a losing position before losses widen. Accept our mistake, move on from them, while continuing to hold the winners. Is the oil market a value trap? What about consumer discretionary or drug stocks? These are questions we keep asking Do-It-Yourself members.
J Mintzmyer: Until recently it was indeed difficult to find moderate and high-yield investments that weren't "traps." The recent pullback has brought otherwise solid firms into the value territory or the 'high-yield' zone for income investors. There are sort of two ways of looking at a 'value trap.' One is a bad trade that just keeps getting cheaper while people get angry with you. I can live with those. The worst part is when the company is really just junk and we made a bad call. I allow myself to look past the short-term pricing, but I try my best to avoid broken firms as those will simply never recover.
David Trainer: Absolutely agree! Value traps abound because traditional valuation metrics are flawed. In a recent series, we analyze the problems with P/E ratios, return on equity, debt-to-equity and price-to-book. Each of these ratios is based upon reported earnings, which fail to measure the true profitability of a firm. If your search for value begins with flawed metrics, your "value picks" will be equally as flawed. Instead, we focus on finding stocks that earn high returns on invested capital (ROIC) and are undervalued based on price-to-economic book value (PEBV), We know improving ROIC is correlated with increasing shareholder value, and we've invested many years and millions of $ in technology to get ROIC right.
Grant Gigliotti: I don't buy into the idea that it's hard to find traditional value, so investors are forced into value traps. If I do diligent quantitative analysis to find companies showing value, then I must also do qualitative analysis to figure out if it's really a good company to buy at this time. There are plenty of stocks out there that offer traditional value. You just need a good system of quickly narrowing down a large number of stocks with the fundamentals that you're interested in. Once you find this handful of stocks, then read the annual reports to find out if the company's business model will be successful in the future and if they maintain some type of competitive advantage. If you do proper quantitative and qualitative analysis, then you will find plenty of stocks currently offering real value.
SA: On the flipside, many value investors have given up on traditional value investing and tilted towards 'quality' or 'compounders.' Again, what do you think about this direction, and how have you adjusted, adopted, or avoided this?
Ranjit Thomas: I would say quality and compounding are a part of value investing. It's great if you can buy a business that is compounding earnings at a reasonable valuation. However, one needs to make sure you are looking at GAAP earnings, and not the pro-forma kind or worse something like EBITDA.
Robert Honeywill: I challenge anyone to tell me they know what their rate of return will be on an investment in shares based purely on review of qualitative factors. It is a sub-optimal approach. Analysts' Corner approach quantifies estimated rates of return based on the same underlying data used to develop qualitative factors and indices.
General Expert: I think "quality" companies and "compounders" are different, and the former is quite subjective. I think most people agree that both AMZN and McDonald's (MCD) are "quality" companies, but they are pretty much at opposite ends of the spectrum. As for "compounder," I think good investors have always tried to find compounders, metrics that measure "compounders" such as ROE and ROIC are not new. Perhaps traditional value investors are more willing to pay up for growth today, which echoes my belief that the definition "value" and "growth" is blurring, though that is more of a semantics issue.
Value Digger: We do tilt towards "compounders" when it comes to value investing. We focus on undervalued companies with positive catalysts and overvalued companies with negative catalysts from a variety of sectors.
Paulo Santos: In my view, quality is always necessary when pursuing a value strategy. It does one no good to buy something that looks cheap, only to see fundamentals deteriorate massively. "Compounders"/growth is a very desirable quality as well, though it often means the stock might be too expensive. Where possible, we also desire substantial growth, if available at reasonable valuations.
Chris Lau: Do not give up your style of investing and change to the trendy investing style of the day. Fads end. Value investing requires enduring pain and holding onto losses for a long time before the investment thesis plays out. Be honest and critical with your holdings: if it is not quality or dividends are not getting hiked, consider stocks that offer those characteristics.
J Mintzmyer: I believe quality is an essential part of value investing. If the quality isn't there then the discount better be somewhere between 'huge' and 'enormous' to compensate for the risk of picking a weaker company or a sub-par management team. Hearing the phrase "many value investors have given up..." is pretty terrifying. I certainly haven't. In the long-run, the market will once again be a weighing machine and will value companies on cash flows.
David Trainer: We would agree that there needs to be a re-thinking of value investing. Benjamin Graham and David Dodd's version of value investing does not work in today's markets. Back then, investors could trust reported earnings and balance sheets. Today, they cannot. With so much required to analyze 250+ page annual reports and do proper diligence on earnings, most investors gave up on value investing long ago. Moving forward, value investors need to leverage technology to analyze the voluminous corporate disclosures. That's exactly what we offer in Value Investing 2.0.
Grant Gigliotti: I try my best to view stocks in a balanced way. The company should provide good long-term fundamentals for 5-10 years, it should be selling at a bargain price, and it should be a quality business that I'm confident in holding for the long-term if need be. If a stock is selling at a great bargain, but it's a poor company, or I'm not confident in it, then I'm not touching it. For me, it needs to have that harmonious balance between fundamentals, value, and confidence.
SA: What do you enjoy about this approach to investing?
Ranjit Thomas: Once you make decisions, you soon find out whether you were right or wrong.
Robert Honeywill: What I enjoy is educating share investors the only way they can achieve a return on shares is through receipt of dividends and a gain on sales of the shares. The only way. The important things to assess in making a share investment are the likely dividend stream and the potential share price at exit. It is a purely forward-looking approach, influenced of course by past performance.
General Expert: I think when there is a high probability of positive developments in the future that is not being priced in today, then you feel vindicated if you are eventually right, or you make a quick buck if future developments become fairly priced today. Furthermore, if done correctly, you do have a margin of safety in that even if there are adverse developments, you are unlikely to totally lose your shirt in the long-term.
Value Digger: Everybody loves bargains, which is the case when you invest in undervalued stocks. We also love the triple-digit returns that we have been making from all our bearish calls on grossly overvalued stocks to-date.
Paulo Santos: This approach is arguably what investing is all about. Buying good businesses at prices such that, even if there was no market for the assets, over time they'd still provide a substantial return. Of course, the market recognizing the value and rewarding us earlier through price appreciation is always very desirable as well.
Chris Lau: Value investing is requires plenty of patience. I enjoy making few trades and waiting for the stock to get to a price I am willing to pay.
J Mintzmyer: There's occasionally a lot of short-term pain, for example the past 3 months have been the worst in my life after a stellar 2016 and 2017; however, if value investing is done correctly, the blow-ups will be very few.
David Trainer: The fun in Value Investing 2.0 is leveraging the latest in technology to scale expert analysis of corporate disclosures and make value investing with integrity possible for all investors. We believe all investors deserve access to the sophisticated fundamental research that Wall Street insiders use.
Grant Gigliotti: When I first got into stock investing, I thought it was just like gambling. Then after learning about the value investing strategies of Ben Graham and Warren Buffett, I realized that there was a real proven system to making gains based on facts and quality. Buffett said to buy a stock like you're buying the whole company, and this was when my eyes opened and my mind changed about stock investing. From that day onward, I enjoy buying a stock like I'm buying a living, breathing, and ever-changing business. Investing this way, makes me want to put my money in something that I believe in, and that makes value investing worthwhile.
SA: Why will you practice value investing in 2019, and how?
Ranjit Thomas: It's something that has worked for me and my investors over time. I will continue to buy and hold quality companies that are shareholder friendly and trading at reasonable valuations.
Robert Honeywill: Analysts' Corner has the processes and the tools to facilitate the assessment of potential dividends and share prices at various exit dates. An indicative rate of return is generated at the current share price, or a targeted share price at entry. Everyone's return expectations will not be the same, and the 1View∞Scenarios Modeling tool allows for this.
General Expert: Since I believe that all of the stocks in my portfolio are all meaningfully undervalued, I will continue to evaluate new developments in their industries. The process remains the same: have a high bar for investments and allocate capital to the best ideas.
Paulo Santos: The same as always, by looking for high quality businesses at substantially discounted valuations. In our approach, we sum this up as "cheap with same or better fundamentals down the road".
Chris Lau: Value investing is all that I know to practice. Things changed but things are the same: 2019 will start with better valuations. Keep going for stock picks that are under-valued and whose growth potential in the year is not priced in the stock.
J Mintzmyer: I invest to buy a percentage of a company as a part-owner. I focus on cash flows and try to achieve the best balance between accepted risk and potential reward. That's how I choose to allocate capital and I will continue to do so going forward.
David Trainer: As featured by Harvard Business School, our Robo-Analyst technology enables us to bring high-integrity value investing to our clients. We believe that as more investors have access to our unconflicted and comprehensive research, more investors are empowered to make more informed decisions. We use our tools and technology to produce all the reports for Value Investing 2.0, and we are proud to offer clients the tools they need to invest smarter and with better risk management. We will practice Value Investing 2.0 because we believe high-integrity fundamental research should be a part of every investment decision. We are not saying fundamentals should be 100% of investment decisions, but we believe they should not be 0%.
Grant Gigliotti: Certainly. I will keep doing what I've been doing. When I go grocery shopping, I try to buy quality products when they're on sale. It's the same thing with stocks. This method doesn't get old. It's common sense and will always be profitable. I will continue to find good companies that I understand. Each business must be able to consistently grow over the long term. It must be able to keep the money it's made and make more money on the money that it invests. Value investing is my method for 2019 and it will continue to be my method onward.
SA: What was the big story or lesson learned for you in 2018?
Ranjit Thomas: A lot of stocks that look cheap (e.g. 10x EPS) can get a lot cheaper (e.g. 7x EPS) as worries about the economy grow. Money flow into or out of stocks have a big impact on valuations.
Robert Honeywill: I know and understand fundamentals. But, in a stock market where share prices fluctuate independently of the fundamentals, I acknowledge a role for technical analysis. I have developed a huge respect for Taylor Dart, who embraces both fundamental and technical analysis, and displays a wisdom beyond his years. His is a refreshing approach compared to the zealots arguing either fundamental or technical analysis is the only way.
General Expert: One of my core holdings plunged over 30% on earnings, and I think that is the biggest one-day downward movement that I've ever experienced on a core position. This is a good reminder why it's important to size your positions appropriately and leave enough capital to scoop up cheap(er) shares when it makes sense.
Value Digger: A series of unpredictable negative events can happen even if it's statistically almost impossible.
Paulo Santos: Cheap can always get cheaper. But we knew that already. What I always focus on is on whether fundamentals have taken a turn to the worse or not. If we bought cheap and business fundamentals held well, there isn't much to worry about if the stocks temporarily drop even more. After all, they could never get cheap if they couldn't get cheaper. The big story is thus mostly that in late 2018, the market sold off everything, cheap or expensive. As always, risk management was and is essential.
Chris Lau: When things head south, they sell-off more quickly than ever. Valuations don't justify a stock rebound alone. See Micron's 3x-5x P/E. The business cycle drives profit changes which in turn sets the stock's directional trend.
J Mintzmyer: Bottom line: cheap can always get cheaper. Not perhaps a new lesson for someone who deals with volatile sectors like shipping, but it's important to stress this especially to other investors who might not really be taking a company ownership perspective on things.
David Trainer: Fundamentals still matter. Comprehensive and unconflicted fundamental analysis need not be 100% of every investment decision, but it should not be 0%. Over the last 25 years, it has been difficult to execute a true value investing strategy simply because the market has, too often, not cared about fundamentals. Stocks traded with little relation to the actual performance of their businesses. This trend is ending before our eyes as high flyers, like Amazon, Netflix, Salesforce.com (NYSE:CRM), and Tesla (NASDAQ:TSLA) traded lower and lower. Despite recent positive reported results for these stocks, the market sends them lower as more and more investors have the tools to understand that true cash flows matter again.
Grant Gigliotti: While I do enjoy investing in large and consistent companies, I have learned that I need to be more selective about which companies I invest in. Money is not everything. Sometimes I find a great investment, but I struggle with investing in it because the company does something that is against my beliefs. At some point, we all have to decide between money and ethics. Some examples of moments that an investor may question themselves are the following:
- "Should I invest in Monsanto (NYSE:MON) if it has knowingly sold cancer-causing products?"
- "Should I invest in Equifax (NYSE:EFX) if I don't believe in its system of violating my personal privacy and its irresponsibility in protecting my personal information?"
- "Should I invest in Johnson and Johnson (NYSE:JNJ) if it knowingly hid information about its baby powder containing asbestos?"
SA: What is one of your best ideas for 2019, and what is the story?
Ranjit Thomas: I like a long position in LyondellBasell (NYSE:LYB). The company is well-run, pays a good dividend, buys back stock, and trades at 7x EPS. I see 40% upside in the stock if they can continue executing and generating the current level of operating earnings.
Robert Honeywill: General Electric (NYSE:GE) shares traded above $14 as recently as July. A turn around in Power could see a return to those levels, representing around 100% upside from current share price levels. I believe a large part of the problems, for both conventional and renewables power segments, stems from politicization of the war on CO2. This is a matter of continuing discussion in Analysts' Corner's think tank, "Saving General Electric". And yes, it is a play on "Saving Private Ryan", and it is a matter of great importance to the US and the rest of the world. A turnaround in Power is not assured, but it is worth keeping a close watching brief, given the potential upside.
General Expert: Last year I talked about Roku (NASDAQ:ROKU), and the stock has had an extremely volatile year. The story remains very much the same as before. Streaming is being rapidly adopted in the US and around the world. The latter half of 2018 saw increased competition from Amazon as the company aggressively marketed its Fire TV platform, which may have spooked investors. However, we also saw Facebook folding its OTT ad platform and Google Chromecast falling by the wayside. I believe that currently it's currently a two-way race between Roku and Amazon. As I've mentioned in my previous articles on Roku, the bull case for Roku does not depend on it totally taking over the US, much less the world. If Roku can just maintain its current market share of ~37% in ten years in the US alone, I believe that the stock should be worth well over $100 today.
Value Digger: One of my best value ideas for 2019 is OurPet's Company (OTCQX:OPCO). OPCO is overlooked due to its OTC listing, but it's a consistently profitable company from the pet industry with high insider ownership. The U.S. pet industry reached $86 billion in 2017 and continues to have a growth trajectory, according to a comprehensive new report by Packaged Facts titled U.S. Pet Market Outlook, 2018-2019. So far in 2018, pet companies have announced more than 30 mergers and acquisitions. The pet industry is a very dynamic segment of the retail sector, so we believe that amid vibrant M&A activity in the pet sector, OPCO could be the next takeover target.
Paulo Santos: There are so many. For instance, Gazprom (OTCPK:OGZPY) goes into 2019 extremely cheap, yet it will be concluding several large investment projects during 2019 which will provide added growth from 2020. RusHydro (OTCQX:RSHYY, HYDR.LSE) goes into 2019 extremely cheap, yet the current improvement could lead to a surprise increase in its dividend.
Chris Lau: Last year I picked Qualcomm (NASDAQ:QCOM), which did peak, only to give up much of its gains. In 2019, I will revisit boring 2018 picks that turned out well. Those include Walgreens (NASDAQ:WBA) and Dominion Energy (NYSE:D).
J Mintzmyer: I really like both of the Golar firms - Golar LNG (NASDAQ:GLNG) and Golar LNG Partners (NASDAQ:GMLP). The first one offers significant growth potential via the exposure to the surging global LNG markets, especially via floating LNG development projects and potential power import facilities. As I'm writing this, $GLNG is in the $23s, but I believe she is worth at least $35/sh. The LP was forced to cut their distribution, but still yields over 14% ($11.25) and has coverage. I expect that GMLP will trade closer to a 10% yield once market sanity returns ($15+).
As a 'bonus' for those who wish to speculate a bit more, I recently opened a position in Tellurian (NASDAQ:TELL) in the $6s. They are behind the Driftwood LNG export project, which tentatively could receive a FID in 1H-19. If it does, I believe the stock is worth about $20 by next summer and could trade as high as $60-$80 by the mid-2020s as the project comes online.
David Trainer: Cummins Inc. (NYSE:CMI). This company benefits from an unprecedented surge in freight demand, an economic story that has received relatively little attention due to the focus on the tax cuts, and tariffs headlines that dominated 2018. Understated reported earnings and a recent change to executive compensation plans also make this company a better value than most investors realize. CMI's accounting earnings don't reflect the improving economics of the business. Reported earnings per share are down 21% year over year for the trailing twelve-month (TTM) period. In contrast, after-tax operating profit (NOPAT), which removes accounting distortions, has grown 34% TTM. Best of all, the expectations baked into CMI's stock price remain overly pessimistic. At its current price, CMI has a PEBV of 0.9. This ratio means the market expects CMI's NOPAT to permanently decline by 10%. This expectation seems too low given that CMI has grown NOPAT by 8% compounded annually over the past decade and 10% compounded annually since 1998. Such pessimistic expectations create large upside potential. If CMI can grow NOPAT by just 5% compounded annually over the next decade, the stock is worth $186/share today - a 28% upside from the current price.