Top Research and Ideas You May Have Missed

Is Quant Value Giving Intrinsic Value Investors a Bad Name? Surely, you don’t believe Warren Buffett’s “style” is out of favor?

By Brian Nelson, CFA

I need to make sure that you’re aware of something very important. The media and perhaps many investment professionals define the concept of “value” as companies with low price-to-book (P/B) ratios, and the concept of “growth” as companies with high price-to-book ratios. This definition of “value” and “growth” and their corresponding returns have been magnified in writings throughout the media and across quantitative research, even in prestigious journals. Warren Buffett has been rallying against most quantitative applications and how “growth” and “value” are defined in popular media and quantitative research for decades.

Here’s one of the Oracle’s most famous quotes.

But how, you will ask, does one decide what [stocks are] “attractive”? Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth,”…We view that as fuzzy thinking…Growth is always a component of value [and] the very term “value investing” is redundant. — Warren Buffett, Berkshire Hathaway annual report, 1992

The traditional quantitative “value” factor has been underperforming for the past 15 years or so, and factor distribution tables from J.P. Morgan (here) and Credit Suisse (here) only highlight the value factor’s prolonged weakness. Why is this important? Well, many investors may believe that true intrinsic value investors are also underperforming and in a more dire sense that value investing is dead. I cannot stress enough the vast differences between the concept of enterprise valuation, as in arriving at a fair value estimate, and the traditional definitions of “value” that are based on price-observed metrics such as the P/B ratio. It is simply the difference between night and day.

So what am I trying to say? For one, intrinsic value investing is not dead (in some ways, it is doing really well), and its popularity may be suffering from an association with the traditional quantitative value factor, which has been doing very poorly in live, walk-forward studies. These studies are all over the media, too. Where I believe that continuous arbitrage of price-to-fair value opportunities will lead investors to long-term success as in intrinsic value analysis (and what we do at Valuentum), I do not believe that the traditional value factor, which has underperformed more in its live, walk-forward testing than its near-100 year backtest, will lead to success.

Intrinsic value estimation involves building an entire discounted cash-flow modeling framework on the basis of firm-specific fundamentals, while the traditional quant factor looks at a company’s price-observed P/B ratio, which in a large sense may represent an impractical and ambiguous measure of value. Your knowing this could mean the difference between investing in true intrinsic value processes, as in enterprise valuation, and investing in potential spurious correlations of value, as in many or some quantitative applications, in my view. To be successful, the investor must first understand the true definition of intrinsic value, something that drives multiples, not something that is derived by multiples.

Please read more about this in my new book, Value Trap: Theory of Universal Valuation — and please don’t forget to leave a review of the text on Amazon here. We’re making some great progress on the first part of the 40/40 goal, and I only have you to thank for this. Thank you! I always want to keep how we use our methodology in front of you, too, so there is a great read on it here. The write-up helps explain why we remove companies like CVS (CVS), General Electric (GE), and Kinder Morgan (KMI) before their share-price collapses, but perhaps hold on to Facebook (FB) and (AAPL) during tough times. Business-model evaluation, balance-sheet assessment (net cash), and future expected free cash flows are prime determinants in this respect. I need you to become an expert on all three, and I think my book is a great start on that!

Valuentum’s schedule to meet you is filling up fast. So far this year, we’re going to be in Chicago, Silicon Valley, St. Louis, the Twin Cities, and Los Angeles (all confirmed). We’ll be in Phoenix later in 2020, and we hope to meet our good friends in Cleveland and Milwaukee/Madison again soon. Chicago is coming up fast. We’ll be at DePaul University on Saturday, April 13, to visit the American Association of Individual Investors (AAII) chapter and talk about the key takeaways of Value Trap: Theory of Universal Valuation! Don’t miss it. I have included our schedule later in this note. Please catch up on top research you may have missed below, too.

Top Research You May Have Missed

Risks Remain Prevalent For Mortgage REITs, April 3

The mortgage REIT space remains inherently risky as it is sensitive to difficult to predict mortgage markets, and many in the group employ significant leverage to augment net interest margins. We prefer more diversified plays on income, and while we dig deep into mREITs in this piece, we think caution is still very much in order.

Facebook’s Huge New Opportunity in Instagram Checkout, Reiterating Fair Value Estimate ~$230, April 3

We continue to like Facebook, and we’re huge fans of Instagram Checkout. Many may not know it yet, but Instagram Checkout may mark the beginning of retailers’ websites becoming obsolete. The sell-off last summer in Facebook was a big gift for those that stuck with our thesis.

Lyft Takes a Fall, S-1 Reads Like Business School Homework, Apr 2

Reminiscences of the dot-com boom came back to the markets with the over-hyped initial public offering of Lyft, a stock that continues to get shellacked as its first days as a publicly-traded enterprise. Those that know Valuentum know that we wouldn’t touch such investments with a 10-foot pole. The company lost $43 per share in 2018.

Big Bank Roundup, Bank of America Catches Our Eye, Apr 1

In this article, let’s catch up with how far the big 6 banks in the US have come since the height of the financial crisis exactly a decade hence. We will highlight the improvements in the banking system, some of the key risks, and a few high level thoughts about the individual franchises leading the US banking system. We like Bank of America the most, and we include diversified banking exposure in the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio.

Tesla and GameStop Face Selling Pressure After Notable Disappointments, Apr 4

Tesla reported a significant shortfall in its first quarter 2019 deliveries amid global distribution growing pains, which called in to question its ability to deliver on its reiterated guidance for 2019. Meanwhile, video game retailer GameStop continues to face challenges presented by headwinds beyond its control and expects its revenue contraction to accelerate in fiscal 2019. We’re not interested in shares of either company.

Reports on Stocks in the Machinery & Tools Industry, Apr 4

Our reports on stocks in the Machinery & Tools industry can be found in this article. Reports include ATU, BGG, CFX, CR, DOV, FLS, GGG, IEX, IR, ITW, KMT, LECO, NDSN, PRLB, ROLL, SSD, SNA, SWK, TKR, TTC.

Reports on Stocks in the Energy Equipment & Services (Large) Industry, Apr 2

Our reports on stocks in the Energy Equipment & Services (Large) industry can be found in this article. Reports include BHGE, FTI, HAL, NBR, NOV, SLB, TS, WFT.

Reports on Stocks in the Management Services Industry, Apr 3

Our reports on stocks in the Management Services industry can be found in this article. Reports include BAH, CRAI, CXW, FCN, G, HURN, NCI, RECN.

Reports on Stocks in the Food Products (Small/Mid-Cap) Industry, Apr 1

Our reports on stocks in the Food Products (Small/Mid-Cap) industry can be found in this article. Reports include CALM, DF, FLO, FDP, HAIN, HRL, JJSF, LANC, MKC, SJM, THS, TSN.

Recent Editions of the Monthly Newsletters

The Newsletter Portfolios are Housed in These Monthly Publications

Dividend Growth Newsletter, April 2019 (pdf download), released Apr 1

Best Ideas Newsletter, March 2019 (pdf download), released Mar 15

The Exclusive Archives (password required)

The High Yield Dividend Newsletter archives are only available via email at this time.

Next Up: The quarterly Financial Advisor publications, including the DataScreener, are due to be released in April 15. The next edition of the Dividend Growth Newsletter and High Yield Dividend Newsletter will be released May 1.

In Case You Missed It

Financial Advisor Level Publications

In early January, we released our Financial Advisor Publications, including the DataScreener, via email to financial advisor level members. If you have not received them or would like to upgrade your membership to do so, please contact us at info@valuentum.com.

The next editions of the financial advisor publications will be released April 15. If you are a financial advisor level member and you haven’t yet taken advantage of our fully-populated valuation models, please send an email to info@valuentum.com including the tickers of those you’d like to view. We are available for any questions.

Brian Nelson In Chicago April 13!

We can’t believe we’re saying this, but the book tour for Value Trap starts in Chicago April 13th. Will you come visit us? Here is the tentative schedule for the remainder of 2019/2020. Can you believe it? We’d be super excited to meet you if you’re in town. We’ll have more details about upcoming events as the year progresses. If you have any other suggested venues/cities, please just let me know! Let’s make it happen. Here’s what I have penciled in at the moment.

April 13: Chicago (DePaul University, see image that follows)
May 11: Silicon Valley
August 3: Twin Cities (Jax Cafe in Minneapolis)
September 17: St. Louis
November 16: Los Angeles (Skirball, Magnin Auditorium)
October, 2020: Phoenix

Contact Kevin Truitt at kevin.truitt@att.net or Kolita Keys at keys.lits@gmail.com for more information about Chicago!

Praise for Value Trap: Theory of Universal Valuation

Value Trap: Theory of Universal Valuation is Valuentum’s first book on finance. If you haven’t read it yet, please pick up a copy right now! Order a paperback from Amazon here, or the pdf digital copy here.

“This book is a welcome, no-nonsense addition to the many straight-shooting financial guides on the market.”