Sunday 24 January 2016

Repeat or not?

reflection concerning repeating or not

I have desperately been searching my own blog for an article or comment that I wrote concerning that I have started to be more and more unhappy with the low P/E and P/B strategy since I find that it does not live up to what it promises. I did unfortunately not manage to find it and for this reason I now write this reflection concerning the matter. So if you remember what I then wrote then please excuse an old man for ranting on and on about same things.

The reason why I, at least in my mind if not in text, claimed that I was unhappy was because the strategy by David Dreman included not only that low P/E and P/B companies would over time outperform the others BUT ALSO that when the market drops and when there are bad news then the low P/E and low P/B companies will not fall as much as the market because they ARE already so low.

This is now the second or third correction that I see where this is simply not the case. It is not the case at all. My crappy low P/E, P/B companies are doing even worse than everyone else and they keep coming with bad news that keep making their share price drop into the basement. If the price is above zero then there is always potential for further share price decreases and a 50% drop can always become a new 50% drop no matter what your entry point in that company is.

Now I am starting to be really fed up with this strategy. Really fed up.

For my coming investment in February in my mind I am standing at a T-cross in the road because I do not have enough money to invest to accomplish BOTH to increase my holding in the crappy, poor performing companies that keep dropping like stones AND increase my holdings in solid performing companies that are now very fairly traded because the market is not happy with their growth and outlook.

To give more direct company names into the decision. Then on one side we have: DB, Coba, RWE and E.On and on the other side we have: BASF, Intel and IBM.

The first side have only given me grief and the other side have kept paying me nice dividends and have continued to run their business with yes, flat earnings, but with we talk about earnings and not losses as the others have kept given me year after year.

In the best of worlds I should have had 10k € in cash so that I could have bought 2k € BASF, 2k € Intel, 2k € IBM, 2k € DB and 2k € Coba but alas I cannot. Oh, and I would also have liked to push 1k into Tessenderlo since I will soon get diluted AND I get Picanol at a 40% discount as it now is.

Should one then start to think about which company will remain pushed down for the longest so that there will be other chances to step into it at these levels?

If so, then my guess and I admit it to be based on absolutely nothing, would be that DB, Coba, BASF and Intel will increase faster than the others which then once again brings me back to 50% considering to invest in the crappy, poor performing companies.

One day we will all die. Until my day comes do I really want to increase my grief by owning companies that keep disappointing me? Why not make life happier and easier buy owning companies that does not build up my grief? And I am not talking about share price here. I talk about companies having a solid business making a solid profit versus companies that are forced to take losses no matter if that is based on a bad year or them being forced to write down "assets" that they have claimed to have. This does not influence the cash flow but it shows the change of the business alternatively that incompetent, often previous, managers that have been writing up the assets higher than what they were worth. No matter which both are equally bad for me today as a shareholder.

The thing is that I know I can handle the grief, which I also know that many cannot, but does that mean that I should?


Hmmm said...

Good to see you coming to your senses although at 3 years it did take a while !!

As I have written to you before - PEs differ by industry and hopefully the performance shows why cyclical and lower quality business have a terminally lower multiple than non cyclical or quality business - there is a tonne of other parts that crest a multiple but too numerous for a blurb-

I reiterate you have been doing part one of value investing which is to find cheap companies - the problem is they are all cheap for a reason , simple analysis akin to what you post simply isn't good enough to determine if the issue is temporary or not .

Most of your portfolio consists of structurally challenged companies with seemingly permanent issues which have caused you permanent loss of capital.

Always happy to help because now you have realised the current method is incorrect it is never too late to take what you have learned and start doing proper analysis understanding how fixable your portfolio companies are and only investing in those where you can identify the problem and a workable solution .

Look forward to continuing the dialogue

Fredrik von Oberhausen said...

Hi Hmmm!

Yes, you have told me that before and obviously I am very slow in changing. I cannot say that I have 100% changed yet but companies such as Eniro, Fugro, Gerry Weber and Asian Bamboo will hopefully NOT enter my portfolio again. Not only because of my current thoughts but also because of the checklist that I made and that I will try to follow before I make a new investment.

But... for instance that DB is trading at a P/B of 0.2 makes no sense to me. Should the assets of DB be valued 7.5x less than Handelsbanken (p/b of 1.5)? I simply cannot comprehend such things.

I will keep trying to improve and we shall see what comes out in the end.

PoomK said...

Banks usually have a rather lousy business model.

First, they lend money and get interests in returns. So Banks' "earnings" are based on projection of complicated model, leaving all unknown as credit risks. Simply put, they lend money and EXPECTS that their customers will pay back. This expectation is sometimes too positive. If a failure happens, such as defaults or hair-cuts, then banks' bottom line will be hit hard. Very hard.

Second, banks borrow other people money, so that they can generate more returns. This is called a leverage, which is kind of a double-edged sword. Because when the business is doing well, banks can expand their investment faster than using only their money. But on the other hand, if there's a mistake, and they will a tremendous loss. The effects will be disastrous.

In the case of DB, it has a leverage ratio of 25. That's probably one the the highest in the world. So this IS a big risk.

Third, banks grow fast when their leverage expands. But at an already high leverage, investors will raise questions if their bank could grow much further. This effects on lower market expectations, such as on lower P/E ratio, as well as other indices. DB could be such kind of mature banks.

To summarize, banks are high risk, high (expected) returns kinds of stocks. Even after years of good businesses, banks can instantly bankrupt at any moment.

Now on the portfolio in general, I've been reading you blog from time to time, as you may have noticed. I think the investment based on valuation indices such as P/E, P/B, D/E, etc. alone is dangerous. Because obviously you want to look beyond the numbers to see what's really going on inside the companies. Not just by comparing simple indices. This is the job of accountants, not investors.

In the case of RWE and E.On, the stocks might seem cheap at the time, but if you had looked at their businesses, their nuclear power plants were being forced closed by the German government. That means a big part of their income is going to be decreased. And they might have to be forced to write off values of unused power plants. There might have had problems with social unions, and so on.

However, I was quite surprise to see you bought the parent company of Primark. This was a totally opposite investment style as you usually did; more Lynch than Graham. I personally think a mixture between both is profitable in long term, at least it did well for myself in the past years. Simply put: it is best if you find a cheap company (as in Graham's cigar butt), but has a solid business with growth potential (Lynch's shopping strategy). I know it's hard to find such kind of stocks, but you will find one once in a while. Don't miss that chance.

Best wishes

Hmmmm said...

PB should never be used to value a bank - Tangible book can be but TB implies you make your own valuation of the entire asset base - if DB has written down assets and HB hasn't , they will make the same earnings but have markedly different PB.

Technology has pretty much made PB redundant - was good in the 30s but no more .

Try and spend more time in your analysis - a new company should at least have a couple of pages dedicated to pulling apart each business.

I am buyside which means I don't write rambling imitation notes but I do have 50-60 page slide decks per idea and even then investing is difficult .

A good approach to value investing now would be Uniqlo and Fast \Retailing - it ain't cheap and it has issues ?terrible lfl in main country Japan' but on a mid term view, if it can continue its successful international expansion it can possibly double sales and double EBIT which means 4x Today EPS - now you need to better understand why Japan LFL has turned negative , does it impact the rest of the business etc etc

As a suggestion you should start modelling your ideas and generating your own multiples

Fredrik von Oberhausen said...


Interesting though is that Handelsbanken, that I brought up as a representation of a good bank, has a leverage of 23 today. The American banks have been pushed down to around 10 which I must admit sounds more healthy.

I must admit that I have not thought about banks going instant bankrupt. I mean, what you say is of course correct but, they have so many ways of fooling around with their balance sheets like slippery eels that it will be tough to have them go bankrupt. Especially any bank that have classical banking as backbone with well... more tangible assets behind the credits given. Pure investments banks is a different story and I would more pick them out for more likely to go bankrupt.

If I have understood things correctly then 2008/2009 was the worst banking crisis since the 1930 depression. If a bank survives that then how scared should one be as an investor regarding instant bankruptcy? The biggest fear I feel as an investor in banks is dilution via the issuing of new shares to survive (=not go bankrupt). With the high leverage they do not need to bring in many billions to have their books very quickly look good again.
Still... with too many derivative any bank can implode on itself. I have no fear regarding my banks Coba and DB but I also realise that I must stop to push more money into them because it starts to be too much.

Regarding E.On and RWE... well... It is not easy for democratic countries with "functioning" legal systems to cease assets from companies. Sure the politicians can take their decision but then the legal body can often change that in favour of the companies. In Sweden one nuclear power plant was closed down due to a political decision. Who ended up walking away as the winner from that? The company did. They sold their nuclear plant at a very fair price to the Swedish government that could then shut it down at their will and they did. It also made Denmark happy since that power plant was very close to Copenhagen and they had for years feared a nuclear meltdown which is fully understandable.

I admit that the German government is doing it more clever by, in a sense, increasing the costs so much and by forcing the nuclear generated power plants to subsidise the green energy that the profits are practically gone... this should have made E.On. and RWE to close down their plants on their own, due to lacking profitability, but they still have not done that and I do not think that they will.

At some point I also started looking upon the big utility companies like the pharma companies. When they have nothing in the pipeline they go out and buy it and often the price is cheaper compared to own development. In the future I expect the utilities to go out and buy the wind power plants, to buy the solar panels plants etc at low prices due to the small companies going bankrupt... due to all the subsidies FROM the bigger companies these small ones survive.. still...

Yes, I today have three different strategies, at least that is what I try to have:
1. The low P/E, low P/B, acceptable ROE and acceptable to high dividend
2. Lynch (ABF, Fast Retailing, TJX)
3. Managers (Tessenderlo, Avtovaz)

But I need to bring in my checklist on all of it to make sure that I stop making foolish investments.

Fredrik von Oberhausen said...


I agree that looking at tangible book for banks would be more useful.

Well, technology has definitely open up more pure service companies where P/B indeed is useless but the kind of companies that for instance Graham liked to invest in still very often have a P/B that makes sense. This does however then also mean that if one is looking outside of Grahams' companies of interest then his valuations should also not be used. I agree also on this.

I am a strong believer in that too much information clogs ones judgement. In the past I would even have meant that the likelihood of getting married to the company increases the more one analyse the company. Today I know, at least for me, that no matter what I seem to get married to my companies that I buy so actually I might as well break them completely apart with more analysis but I will not do that for the overall analysis and only for any new companies that I will be stepping into. Also... I am an amateur investor that are trying to create my future pension fund and I do not have the means to make such intensive analysis that professionals are doing to convince investors to pay them fees.

Fast Retailing has some difficulties in Japan, in my opinion, due to two reasons: 1. The Japanese consumption has generally dropped and 2. They over expanded in their home market.

Regarding #1 they cannot do anything but #2 they have started to close down stores and, which I find interesting, they are franchising their stores to employees which liberates more cash for them to expand even quicker abroad.

The Japanese market will not grow much more then inflation in the future, with the Uniqlo brand, and they need to tighten their costs, to increase their earnings there, which they are also doing. By bringing the brands that they have bought in Europe and America back to Japan they have a possibility to grow more than inflation also in Japan but with Uniqlo it will be hard.

It seems as if you have looked at Fast Retailing yourself. So what are your opinions then regarding the Japanese market?

hmmmm said...

Actually, Fast is on my long list but haven't done too much work into it aside from realizing it is probably fully penetrating the home market of Japan.

I am drawn to an international opportunity here because they have proven the model on smaller scale in most of the other developed counntries and their appalling margin probably hides some low hanging fruit.

If/when I get to it, I'll give you my full view.

As an amateur investors, best thing is to focus on 2 and 3.... make a spreadsheet of all your liked quality companies and the price at which you would own (could be 20%/50% lower whatever) then sit back and wait. When one of that quality list hits your target, investiage the problem that ahs brought it to where you are, if it's fixable then buy, if not, leave it.

By using PE's you are implictly accepting that the sell side are the smartest guys and have no alterior motives besides a good investment. Because of this, consensus PE is more or less meainingless... I would much rather by a quality company at 15x than a shlt one at 10x

Fredrik von Oberhausen said...


I look forward to your full view on Fast Retailing one day in the future! Hopefully I will still own them when you arrive with your report because I expect it to be good. Well... at least people in Europe keep going to the stores and they walk out with a bag so I am pretty sure they will keep growing here... I am probably one of the few that walks in and out without buying something which is not based on that I do not like what they sell I simply go there to take a look at how many customers they have.

You say that 2 and 3 are the best ones for amateurs. Yeah that could be correct. For pure tax reasons the best for us small guys is to buy and never to sell and to collect dividends in the meantime... after all... in the end I will need those yearly dividends to support my life when I retire since I will get nothing else.

I will not change my investment approach completely and I will definitely not start to sell what I have but I will try to go more and more for healthy companies.