Tag: Stocks

Drowning in Data

If you agree with the proposition that more information leads to more efficiency in pricing in the markets, that should probably lead to the conclusion that markets have never been as efficient. We’ve simply never had this much data and data has never been as accessible as it is now.

Gone are the days when Warren Buffett could comb through Moody’s manuals to find net-nets. Now, data-rich stock screeners are readily available to anyone. On top of that, there are armies of hedge funds other quantitative investment shops out there, crunching data and trying to advantage of any arbitrage opportunity they can find.

A Valuable Lesson of VAR

Had you argued this to me about a year ago, I would have wholeheartedly agreed. Today I’m not so sure. And here’s the reason why.

You see, I’m a football fan (soccer) and recently they have implemented something called VAR into the game. VAR stands for Video Assistant Referee. It basically means that during a game there is now an additional assistant referee who reviews decisions made by the head referee with the use of video footage and analytical technology in real-time. He is then able to communicate with the head referee during the game.

The objective of the VAR implementation is to minimize human errors causing substantial influence on match results. Previously, the referee had to make split second decisions on incidents. Now he or she can utilize VAR, which means better data. The VAR can analyse incidents by replaying it from different vantage points and use graphics to determine rulings such as offside. Sounds great, doesn’t it.

The Interpretation of Data

The really interesting thing about VAR, is that after its implementation there is still a fair amount of dispute regarding key referee decisions. Even with the additional data provided by VAR, pundits are still arguing whether decisions on offsides, penalties and such where correct or not.

It seems that more accurate data by itself doesn’t necessary lead to better decision making. The data still needs to be interpreted. In that sense, it’s not just a question of decision being subject to human error or not. Sometimes, different people will perceive the same data differently. It is in some way a matter of opinion.

Financial Data and Insights

If we apply this to the investing world, it is safe to say the following:

If you would show two analysts the same financial and operational data two competing companies, it is entirely plausible that the conclusions that those two analysts might draw from the data would be diametrically opposed.

The interpretation of the data will be subject to frameworks the analysts used to draw insights out of the data. Insight, per definition, is the power or act of seeing into a situation. But insight, is in the analyst, not insight the data.

What’s obvious is obviously priced in…

The title of this post is a quote from a famous bond investor Jeffrey Gundlach. Gundlach is the manager of DoubleLine Capital, a huge bond fund, which has earned him the nickname the Bond King. 

It is clear to me that information that is obvious, should be priced into the market price of a public asset. This is logical. But if you abide by this logic, you should also agree with the statement that everything that is not obvious, is not priced in. 

By this logic, you would also have to assume that, unless every possible event is inherently obvious to market participants, the price of a public security is inevitably always wrong, since it does not account for the obvious. 

In the same vein, being a contrarian is a valuable stance, but only if there is an non-obvious truth that the market isn’t accounting for. Successful contrarians, try to approach the world from a different perspective. But they only act on it when they feel they have discovered an under appreciated possibility. 

The key is that thinking contrarian is a process, being contrarian is an action. You don’t always think contrarian, but only sometimes be contrarian.

The Efficient Market Paradox

Two economists are walking down a street, discussing the Efficient Market Hypothesis, when one of them suddenly stops in his tracks. He points to the street and says “look, there’s a $10 bill!”

The other economist looks at him with a mixture of amazement and disgust as he replies in a reprimanding tone: “Obviously, if there was a $10 bill there, someone would have already picked it up.”

What this joke illustrates is the inherent paradox of the Efficient Market Hypothesis. For markets to be efficient, they are active participants. For participants to be active in a market, there needs to be an arbitrage. In a perfectly efficient market, the arbitrage is competent away by the activity of the participants. 

The Markets are Mostly Efficient

No market is perfectly efficient. New information is constantly entering the collective perception of the market. Once information becomes obvious, it will obviously be priced in, when markets are efficient. 

WIth the internet and other technological advancement in data gathering, analytics and distribution, markets have undoubtedly become more efficient. In the early value investing days of Warren Buffett, he would read through Standard and Poor’s manuals, making mental calculations of stock’s intrinsic valuation. Nowadays, this information is readily available and calculated, practically in real time. 

In a podcast interview on the Invest with the Best Podcast, Michael Mauboussin, presented a fascinating statistic:  

“I think that one of my other favorite statistics in the paper is that in 1976, there were less than 1 CFA charter holder, for every public company in the United States, and today there are 27 CFA charter holders for every public company in the United States. So a lot more eyeballs on the companies that are out there. And maybe there is clearly more dispersion in smaller midcap companies. But look, the world is just a super dynamic place. You see these value changes are quite dramatic. You think about 2020 and hardly anybody had any idea what was going to go on. It was really hard.”

Degrees of Market Efficiency

It goes without saying that there are different degrees of efficiency. When you invest in big S&P 500 stocks such as Apple, Amazon or Netflix, you should be aware that there are hundreds of analysts that cover those stocks. You have to ask yourself what kind of an edge you have over those market participants. 

At the same time, there are plenty of markets and asset classes that are less efficient. There are many publicly traded stocks that don’t have a single analyst covering them. Outside of the stock markets there are all sorts of asset classes and markets where an individual can develop expertise and investment edge. Internet domains, for example, is an asset class that has a very vibrant secondary market and dedicated investors. 

There are plenty of $10 bills out there, waiting to be picked up.

The Implied Meaning of a Market Cap

“Apple is worth $2,000,000,000,000. That is a lot of money” said Anthony Pompliano on Twitter the other day. Dave Collum promptly corrected him: “priced at.” This is a very important and warranted distinction. We talk about the market capitalizations of companies all the time, but less often we think about what it actually implies. 

For Every Buyer there is a Seller

The current price of a publicly traded stock is the most recent point where the most willing seller and most eager buyer matched. So when Apple stocks ended a trading day at $498, the last buyer and seller that were matched were willing to do business for that price. For someone to buy, someone also has to sell. 

But the market price only gives us some information about the marginal sellers and buyers. One an average day, somewhere between 100 to 200 million shares of Apple stock will change hands. That’s a lot of shares. On particularly busy days, this will exceed 300 million. On a slow day, however, as little as 50 million shares will change hands. But Apple has 4.35 billion shares outstanding. So, even on the most hectic days, less than 7% of the outstanding shares will change hands.

The 7% figures is likely deceptive as high frequency trading and other forms of day trading and market making might overstate the fact that the majority of stockholders will not sell on a given day. 

Therefore, the market cap and stock price of a company will tell you where it is priced at by the market. it won’t tell you where the stock is valued at by the market.

This is the biggest mistake value investors make

Value Investing is seductively easy. Summarized into one sentence, Value Investing is the art of picking stocks that are undervalued, a.k.a. buying a dollar for 50 cents.

Tempting, right?

The big problem – paraphrasing what Johan Cruyff said about football – Value Investing is a simple concept, but it is extremely hard to invest with simplicity.

How Value Investors Buy Books

Consider the following analogy:

Put yourself in the shoes of a Value Investor in a book store. Having a natural inclination to buy stuff that is undervalued, you will automatically be drawn to the table with a big sign saying:

  • Books 50-80% OFF! 

…and therein lies the problem.

Buying a book is a bet with an asymmetric outcome. The downside is that you will buy a book and it might turn out to be a waste of your time, plus the $10 to $30 it cost to purchase it. The upside, however, is close to infinite. A good book can fundamentally alter your life.

Coffee consumption is another good example. If you could only drink one cup of coffee a day, you would probably not drink the first cup of joe available to you. You would be more selective. You might even be willing to pay more for the right one.

Mistakes of Omission

Most of the books on the discount table are crap. They are there for a reason.

The Value Investor, focused on the table of discounted books, might end up finding a book that is good enough to be worth the purchase.

At the same time, his attention is turned away from the books that can truly alter his life.

Do you disagree? Let us know in the comments below!

The Columbo Method of Equity Research

Remember detective Columbo? He was a phenomenal character played by Peter Falk in a 1970s TV series called…you guessed it…Columbo. Detective Columbo was a scruffy and simplistic character, dressed in his signature beige raincoat and crumpy white shirt with a loosely knotted tie.

Colombo is no normal detective series, though. As is you would expect, Columbo’s job is to solve murder mysteries. However, the episodes don’t play out with Columbo delving into each case and eventually discovering who is the murderer, in a sharp twist near the end. Columbo is a detective series without the mystery.

In the case of Columbo, each of the 69 episodes begins with the scene of the murder. So, as a viewer, you know from the beginning who the doer is. The rest of the episode is a mental wrestling match between the murderer and lieutenant Columbo.

The Colombo Technique of Investigation

In each Columbo case, the murder is committed by someone close to the victim. This allows Columbo to approach the suspect as a witness or someone who can help Colombo in piecing together the pieces of the puzzle.

To the assailant, Columbo seems totally incompetent. The scruffiness of his hair and clothing give the impression that he slept in his clothes. He constantly scratches his head and he asks the assailant for help. His questions are simplistic and make him look like he’s totally out of his dept.

But Columbo is playing a part. He’s playing dumb. The perpetrator grows confident and starts to get comfortable, even annoyed. The trap is set. In the final minutes of a Columbo episode, the perpetrator has made a mistake and Columbo wrestles him down for the tap-out.

Stock Research and Colombo 

So, how does this relate to equity analysis? In stock research, there is no crime, there is no murderer. As an analyst, you have a stock and you build your opinion based on fundamental analysis.

But therein lies the caveat. You see, it is you who is the perpetrator because once you start your analysis, you start to for opinions. You will start subjecting your mind to all forms of mental biases. You become overly optimistic. You get anchored. You will start to look for confirmation in the data.

“But that’s me, I’m paranoic. Every time I see a dead body I think it’s murdered. Can’t imagine anyone murdering themselves.”  

– Lieutenant Columbo

As an analyst, you have to put on your mental raincoat and find your inner Columbo. You have to take a step back and start to ask yourself the simple question. The overly naive and borderline stupid questions. You have to confront yourself and find start to look for loopholes in your story.

Just One More Thing…

Lieutenant Columbo bombards his suspects with questions. He’s relentless. He keeps coming back with a question. He’s apologetic, he excuses himself. He just can’t help himself, he says. But he keeps coming back for “just one more thing.” 

Copying Top Investors and Their Portfolios

When it comes to investing, being a small fish in a big pond isn’t all that bad. Consider the following:

  • All institutional investors need to file a so-called Form 13F. They basically have to tell the Securities and Exchange Commission what they are investing in. Better yet, all this information is made public. 
  • What makes an institutional investor institutional, is that fact that they have clients. An institutional investor manages and invests money on behalf of their clients. And how do they get money from others to manage? Just like any other regular company…by selling. They literally tell how they invest and how they plan to invest. 
  • Some investors, like Carl Ichan, Bill Ackman and Dan Loeb are activist investors. How do they get active? By publishing to the public detailed reports on what they think the value is of the companies that they turn active on and how they think the company needs to do in order to achieve those valuations. 

All of this information is readily available for you as an investor. Big investors with small armies of stock researchers and equity analysts are publishing research in droves and filing disclosures on their positions every day. 

All of this information is available to you for free. 

How Scuttlebutt Investing Works

The Scuttlebutt method of investing is fathered by the legendary investor Phil Fisher. Fisher is likely most known for his bestselling book Common Stocks & Uncommon Profits.

Scuttlebutt investing, as the name indicates, begins with a story or some other anecdotal data point, that triggers interest. It might be a product you love, a competitor you hate because of her competence.

How to Practice the Scuttlebutt Method

This is just the starting point, though. You have a hunch. You might be on to something, but what’s the next step? Do you check the performance of the stock price, do you download the financial statements and start crunching numbers?

If you are a Scuttlebutt Investor, your research would be very hands-on. You might visit retail locations or even manufacturing facilities. You would get feedback from customers, resellers or even competitors. You would try to understand the competitive dynamics of the market, performing the Silver Bullet Test on the people you would talk to.

Following up with Fundamental Research 

The Scuttlebutt Method is great to validate investment ideas and building an intuitive understanding of the operational and brand-related qualities of a potential investment. Nonetheless, once you have strengthened your conviction about a certain stock, what you want to do is to cross-validate your finding with a fundamental analysis of the financial statements of the company.

This will give you a clearer picture of the business model and allows you to compare your scuttlebutt data points with the overall financial and valuation picture.

Discount to Net Asset Value | Protect Your Downside

One way to value a stock, especially those of companies that own various subsidiaries or a portfolio of assets, is by analysing the company’s discount (or surplus) to Net Asset Value.

Conglomerate Discount – The Case of Exor

We recently took a close look at Exor N.V., the holding company that controls such publicly traded companies as Fiat Chrysler Automobiles, Ferrari and CNH Industries. Conglomerates like Exor are interesting to analyse as they tend to trade a steep discount on the mark-to-market Net Asset Values (or market-adjusted book value).

In the case of Exor, the company trades at about a 30% discount on the market value of assets on the balance sheet. 

Point of Maximum Pessimism – The Case of Dundee Corporation

If you are a Contrarian Investor, you are trying to go where other investors feel extremely uncomfortable to be. You are trying to go where others are running to the exits, but at the same time, you don’t want to be too early. 

One of those situations is materializing at a Canadian Asset Management Company called Dundee Corporation. After a series of unfortunate events (and decisions), the market capitalization of Dundee is gone from about a billion dollars to about $74 million. 

The company trades at a steep discount to book value, but for good reason. The company has been haemorrhaging money as failed investments have sucked up cash and destroyed shareholders’ capital. 

But investors may have overreacted. Even though the company is taking drastic steps to turn the business around, Dundee’s stock is trading at about a 70% discount to book value. If the company manages to stop the bleeding, a significant re-rating might be in the cards.