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20 May 2009
Vanishing value has the market rallied too far, too fast?
James Montier (44) 20 7762 5872 email@example.com
Perhaps I am odd, but I have come to the conclusion that I prefer falling markets to rising ones. Not for any sadistic or even masochistic reason, but rather I like finding stocks that I can buy. Unfortunately the swift rebound in the markets is leading to rapidly vanishing deep value opportunities. In early March 179 stocks passed my deep value screen, whereas today only 63 names appear. The good news is that I think one can still build a diversified high quality basket from the names on the list. Names like BP, Merck, Novartis still appear. However, if this erosion of value continues, I’ll soon be worrying about a value drought.
Two months feels like a lifetime in these markets. But I am astounded by the speed of the value bounce. In early March my deep value screens were showing an unusual degree both in length and depth. High quality names like Microsoft and Sony were appearing on my lists. However, deep value has enjoyed a remarkable couple of months. The list of stocks I put together is up 48% since early March (against a global market return of 33% - all measured in dollar terms). Whilst I should presumably be celebrating such a performance I am actually more concerned that the number of deep value stocks is disappearing at a rate of knots. In March, 179 stocks passed the Graham deep value screen. Today around 63 pass. In Japan, 57 stocks passed in March; today there are 11. In Asia, there were 67, but only 17 today. Similarly our net-net screen was throwing up nearly 600 stocks globally in early March the highest number of such stocks I have ever seen. Today I can find 369 (although 62% of those are Japanese small caps reaffirming my belief that this is amongst the cheapest asset classes in the world). Whilst not yet entirely absent, the erosion of value at such a swift pace alarms me a little. At this rate, Ben Grahams wise words When such [bargain] opportunities have virtually disappeared, past experience indicates that investors should have taken themselves out of the stock market and plunged up to their necks in US Treasury bills will become all too relevant in a short time. At this rate all we will have left is relative value. I dislike relative value as Ive never been comfortable simply buying a stock because it was cheap relative to another stock. As Seth Klarman notes Absolute-performance-oriented investors will buy only when investments meet absolute standards of value.
IMPORTANT: PLEASE READ DISCLOSURES AND DISCLAIMERS BEGINNING ON PAGE 6
Perhaps I am odd, but I prefer falling markets to rising ones. Not because I am a sadist, or for that matter a masochist, or even because I am bearish by nature rather because falling markets generally throw up far more opportunities for me to invest in. For instance, if you can cast your mind back two and a bit months (it seems like a lifetime in these markets) I put out a note (Mind Matters, 4 March 2009) which provided a list of deep value opportunities. These were stocks that passed four criteria (an earnings yield at least double the AAA bond yield, a dividend yield at least two-thirds the AAA bond yield, total debt less than two-thirds tangible book, and a Graham and Dodd PE of less than 16x). One of the features of that list was the unusually high quality of the names it generated. Stocks such as Microsoft, BP, Novartis and Sony all appeared. The other feature was the length of the list, with 179 names appearing. The selection has performed remarkably well. Since publication, the deep value stocks identified have risen some 48% in dollar terms (the MSCI All World has risen 32% over the same period).
Performance of the deep value baskets since 4/3/2009 (rounded, %) *
Deep value stocks MSCI index
UK Europe Asia Japan US Global
34 37 55 37 33 48
30 32 39 22 24 33
Source: SG Global Strategy * Please note that past performance is not necessarily any guide to future returns. Figures shown do not include any transaction or execution costs. Full details of the portfolio and its history are available upon request.
However, this leaves me in a quandary. The number of opportunities has shrunk rapidly in some places. For instance, in Japan only 11 stocks now pass our four criteria. This compares with 57 Japanese stocks that passed in March, and is lower than the 19 Japanese stocks that passed in July 2008! Similarly, in Asia only 17 stocks pass the screen compared with 67 in March. Worldwide, the number of deep value opportunities stands at a little over onethird of the number I found in March.
Number of stocks passing our deep value screen
Now US UK Europe Japan Asia Global
Source: SG Global Strategy
4 March 10 20 25 57 67 179
6 18 12 11 16 63
The good news is that, I think, one can still build a relatively high quality diversified portfolio from the 63 names that appear on our deep value screen. For instance, BP, Novartis, Merck and Cannon still appear (a full list can be found on page 5). However, I suspect that one will need to be careful if the deep value opportunities continue to disappear at this rate. The relative paucity of bottom-up opportunities can itself be a signal. As Ben Graham opined
20 May 2009
True bargain issues have repeatedly become scarce in bull markets
Perhaps one could even have determined whether the market level was getting too high or too low by counting the number of issues selling below working capital value. When such opportunities have virtually disappeared, past experience indicates that investors should have taken themselves out of the stock market and plunged up to their necks in US Treasury bills. Regular readers will know that I am also a fan of Grahams net-nets. Of course, in todays market place the vast majority of net-nets will tend to be small caps. In my note from 4 March I wrote Currently I am finding the highest number of net-nets I have ever come across. In fact, I found almost 600 net-nets in March. Thanks to a 50% gain in that basket, today I can find 369. Over 62% of these are Japanese, reaffirming my view that Japanese small caps remain among the cheapest assets in the world.
Japanese small cap price to book ratio
2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09
Source: SG Global Strategy
While they have not yet vanished entirely, deep value opportunities are certainly thinner on the ground. It may appear tempting to pursue an alternative approach by either easing the parameters or even looking for relative value in order to increase the size of the potential universe. I can understand why one might be tempted to remove the dividend constraint in the current market environment. As an experiment I ran the screen without the dividend constraint, but it only added 20 names to the list. I always shy away from relative valuation. I have never been comfortable with the idea of buying a stock simply because it was cheap relative to another stock. As is often the case, Seth Klarman puts it best, arguing that focusing upon relative valuation is largely caused by relative benchmarking as it is in essence a way of reducing your tracking error. Money managers motivated to outperform an index or a peer group may lose sight of whether their investments are attractive or even sensible in an absolute sense... Absolute-performance-oriented investors, by contrast, will buy only when investments meet absolute standards of value. They will choose to be fully invested only when available opportunities are both sufficient in number and compelling in attractiveness, preferring to remain less than fully invested when both conditions are not met.
20 May 2009
Stocks passing the deep value screen (rounded)
Company EY DY MKt cap ($) G&D PE Country
OMV AG Kesko Oyj Rautaruukki Oyj Total S.A. Vallourec S.A. Deutsche Lufthansa AG MAN AG Cosco Pacific Ltd. HongKong Electric Holdings Ltd. Kingboard Chemical Holdings Ltd. Orient Overseas (International) Ltd. Television Broadcasts Ltd. Wharf (Holdings) Ltd. Yue Yuen Industrial (Holdings) Ltd. Ambuja Cements Ltd. Aneka Tambang ENI S.p.A. Koninklijke Boskalis Westminster Royal Dutch Shell Class A StatoilHydro ASA SembCorp Industries Ltd. Singapore Airlines Ltd. Singapore Press Holdings Ltd. Skanska AB Novartis AG ASUSTeK Computer Inc. Compal Electronics Inc. Inventec Corp. U-Ming Marine Transport Corp. AGA Rangemaster Group PLC Anglo Pacific Group PLC Bloomsbury Publishing PLC BP PLC Braemar Shipping Services PLC Castings PLC Charter International PLC Computacenter PLC Diploma PLC Greggs PLC Headlam Group PLC Hornby PLC Kier Group PLC Millennium & Copthorne Hotels PLC Renishaw PLC Royal Dutch Shell PLC (CL B) T. Clarke PLC Ted Baker PLC Carnival Corp. Chevron Corp. Genuine Parts Co. Marathon Oil Corp. Merck & Co. Inc.
18 9 20 12 21 14 18 12 9 11 14 8 9 14 12 9 14 16 16 10 10 15 9 9 9 8 11 11 19 16 22 9 12 19 20 16 14 9 9 13 16 12 9 12 15 19 8 12 18 9 17 14
4 5 9 6 7 8 4 5 5 4 4 6 3 6 3 13 8 7 6 3 4 9 9 6 5 5 8 7 13 5 6 4 7 8 7 4 5 6 4 8 9 4 3 6 6 11 5 6 4 5 3 6
10,280 2,630 2,813 122,649 6,227 5,746 9,237 2,317 11,661 2,108 1,970 1,656 9,398 3,340 2,343 1,550 92,897 2,117 150,053 64,619 3,475 9,399 3,164 4,356 90,279 5,933 3,403 1,532 1,681 94 205 136 143,304 97 94 1,427 426 223 610 329 57 597 1,037 463 149,541 71 227 20,982 132,068 5,113 20,264 53,708
10 14 9 11 12 11 13 10 14 9 6 15 12 11 16 15 9 14 8 13 16 11 12 12 14 10 11 12 14
Austria Finland Finland France France Germany Germany Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong India Indonesia Italy Netherlands Netherlands Norway Singapore Singapore Singapore Sweden Switzerland Taiwan Taiwan Taiwan Taiwan
5 United Kingdom 12 United Kingdom 11 United Kingdom 13 United Kingdom 13 United Kingdom 8 United Kingdom 15 United Kingdom 8 United Kingdom 14 United Kingdom 16 United Kingdom 14 United Kingdom 10 United Kingdom 12 United Kingdom 10 United Kingdom 13 United Kingdom 10 United Kingdom 7 United Kingdom 15 United Kingdom 12 13 14 10 10 United States United States United States United States United States
20 May 2009
Stocks passing the deep value screen (rounded) (cont’d)
Company EY DY MKt cap ($) G&D PE Country
Nucor Corp. Canon Inc. Daiichi Sankyo Co. Ltd. Fuji Media Holdings Inc. Ito En Ltd. Itochu Techno-Solutions Corp. Konami Corp. Mitsubishi Rayon Co. Ltd. NHK Spring Co. Ltd. Nok Corp. Ono Pharmaceutical Co. Ltd. Otsuka Corp.
Source: SG Global Strategy
15 7 8 6 7 9 8 10 18 15 7 11
3 3 5 3 3 3 3 2 2 2 4 3
12,225 46,308 12,227 2,840 1,179 1,713 2,461 1,592 1,231 1,869 5,324 1,352
15 15 16 14 13 14 15 14 16 12 16 16
United States Japan Japan Japan Japan Japan Japan Japan Japan Japan Japan Japan
20 May 2009
Deutsche Lufthansa ENI MAN AG MAN AG OMV OMV StatoilHydro Vallourec
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20 May 2009