Wherever large enclaves of European immigrants settled in America, it would not take long for a handful of breweries to open for business in the local community. These breweries distributed their fermented concoctions to the local taverns and clubs within close proximity to where the beer was produced. Unlike the Internet companies of today, brewing beer for most of the 19th century was not a scalable business model. Unpasteurized beer with active yeast has to be consumed within a short period of time after the fermentation process is completed. Otherwise, these liquid bread products become moldy and give off a rank odor. Nobody likes to drink stinky beer pumped out of vintage kegs that have been stored for who knows how long.
One tea leaf indicator that is used to get a sense of the future direction of the overall stock market is the number of stocks moving down in price. More stocks are now trading below their 200-day moving average than above it. Some investors might view this negatively, but an increasing number of stocks falling in price is a telling sign that brighter days lie ahead for deep value investors. Falling stock prices are a necessary but insufficient condition for deep value stocks to bubble up to the surface. This may seem counterintuitive to investors who desire an ever-rising stock market, but for value investors, the opportunity to find true bargains increases following a significant market decline.
While sitting next to the chief executive officer (CEO) of Blackrock on a panel at the recent Delivering Alpha Conference, billionaire Carl Icahn commented on the risk associated with investing in a high-yield bond exchange traded fund (ETF). Making a negative comment on a financial product when its CEO is sitting right next to you might make some people feel a little uncomfortable, but billionaires are not average people. Icahn’s concern was regarding the lack of liquidity in high-yield bonds. If redemptions cannot be met in an ETF that holds junk bonds, investors could be forced into taking severe losses. However, blaming an institution for losing money in an oversized ETF product that holds a large number of junk bonds is sort of like blaming Dr. Joseph-Ignace Guillotin for a capital punishment contraption bearing his name. Guillotin was neither the inventor of the decapitation device nor a fan of the death penalty. The French physician only recommended its use as a more humane way to deliver a death penalty sentence. Likewise, Blackrock did not invent the high-yield bond ETF and offers a number of other investment products that vary in terms of risk level. If you do not like junk bonds, you might consider investing in a more conservative financial product, which would result in a shaving cut rather than a beheading if illiquid junk bonds were to head south.
Benjamin Graham’s Defensive versus Enterprising Investor Performance over the Dismal Decade of 2000–2009
In a previous blog (see Benjamin Graham’s Value Investing versus the Robo-advisor), I illustrated included a chart outlining the performance of the United States stock market over the course of every decade covering during the past 100 years. Stock performance over the past decade (2000–2009) was not only a net loser, including the paltry dividend income received, but it even underperformed the 1930s depression era. If the typical investor had known this information at the start of the year 2000, I’m confident he or she would have remained on the sidelines in cash.
Stanford University Professor Deborah Gordon spends her days analyzing the behavior of harvester ants that populate the dry desert of Arizona. She’s observed how an ant colony manages its water consumption in search of seeds, the ants’ primary food source. Water is in limited supply for a desert ant, so it’s important they balance their conflicting goals of foraging for seeds and consuming water in the process. Looking for seeds and conserving water is accomplished by having only a limited number of partially blind ants patrolling above the surface in search of food at any one time. If one of the patrol ants stumbles upon some seeds, it heads back to the nest and tells all of its friends. By touching the antennae of other ants huddling near the surface of the underground nest, the patrol ant gives the signal for others to join in the collective effort to search for seeds. This efficient food-gathering process results in far less water consumption for the ant colony as a whole. Instead of a large number of ants randomly moving about the surface, wasting precious water resources under the hot desert sun, they become active only when a high probability of gathering a large number of seeds exists.
Jared Diamond in his book Guns, Germs, and Steel: The Fates of Human Societies provided compelling evidence on why certain groups of people manage to gain the upper hand over the indigenous people they have conquered. One of the reasons certain societies gain a competitive advantage over others comes from the environments to which they were exposed over generations. A classic example of this is European dominance over the various indigenous groups they encountered in Africa and in the Americas. Europeans had the lead in comparison with other social groups in both forging weapons into steel and enjoying immunity from certain diseases because of their close proximity to the livestock they raised. The environmental factors to which they were exposed over generations played a key role in providing them with competitive advantages, enabling them to establish colonies in the New World as opposed to being subjugated.
What percentage of students in a typical high school would be classified as part of the in-crowd? I’m confident that people’s responses to that question are dependent on where they felt they were ranked in the popularity caste system back in their school days. Former students on the outer ring of popularity (including financial advisors such as myself who advocate a value investing philosophy) probably estimate a smaller popularity percentage in comparison with the former captain of the football team or his cheerleader girlfriend. Let’s classify the cool kids in a typical brick-and-mortar high school as representing twenty-five percent of the entire student body. Many students aren’t part of the in-crowd but are eager to gain their peers’ acceptance, hoping to move up on the popularity totem pole. However, unlike high school, popularity is something to be avoided, not sought-after, when it comes to selecting stocks for a portfolio.
A Performance Summary of Previous Studies Analyzing Benjamin Graham’s Net Current Asset Value Stock Selection Criterion
The table below is a summary of various studies that analyzed the performance of Benjamin Graham’s stock filtering criterion of purchasing stocks trading below net current asset value (NCAV). The calculation involves subtracting all liabilities, including preferred stock, from only the current assets on a company’s balance sheet. The calculation is then converted to a per share figure by dividing this approximate measure of a company’s liquidation value by the total number of common shares outstanding. The table below picked through each study and pieced together a sampling of the performance data using the net current asset value criterion.
I always enjoyed magic tricks as a child, so when the movie The Prestige was released in 2006, I was eager to see it. Early on in the film, a narrator describes the three parts of every magic trick. These parts are as follows:
1) The Pledge – The magician shows you an ordinary object—say a deck of cards or a rabbit.
2) The Turn – The magician takes the ordinary item and makes it disappear.
3) The Prestige – Making something disappear isn’t enough. In the third act, the object is brought back from out of nowhere to the sounds of applause from an audience eager to be duped.
We live in a time period where the “winner-takes-all” outcome is no longer restricted to a handful of industries. Actors and professional athletes are two classic examples of this “all-or-nothing” phenomenon, where a few elites make all of the money and the rest are waiting tables. Unfortunately, through no fault of anyone in particular, this brutal business model has now moved into a number of other industries, thanks to disruptive technology. Someone who is a competent Certified Public Accountant (CPA) in a small town preparing tax returns for various small businesses has now been displaced by an online accounting package that knows all of the tax-avoidance angles and provides tax preparation for little to nothing.