Deep Value Letter - Banner Ad / Email Capture

Friday, September 14, 2012

Pigs and Dividends

I made a remark the other day on twitter that has drawn a few comments from friends and associates during our never ending discussion of all things market and baseball. I said that the amount of intellect and energy spent on guessing the short term fluctuations in the value of corporation was staggering. Given that many, if not most, of those trying to game the underlying corporate value on a daily basis fail to beat the market itself it would seem to me that much of it is wasted. Some of my more active friends took umbrage to my remarks and insisted that my approach is not practical or realistic. Waiting for the markets to fall before becoming an aggressive buyer is foolish they scolded me and causes one to miss the big moves.

Clearly I disagree. Since I first read the story of Mr. Womack the pig farmer as a new broker back in the 1980s buying big down moves in the market just makes sense to me.  For those of you not familiar with my pig farmer friend he was introduced by John Train in an article in 1978. Mr. Womack would come into town when the markets were in a free fall and buy several profitable dividend paying companies that had fallen below $10 a share. He would hold them for a few years and when the news was all sunshine and candy he would sell his stocks for very large gains. He treated stocks like pigs and bought them when the market was weak and sold them during BBQ season. As a bonus Mr. Womack was quick to point out that pigs don’t pay dividends.

History is on my side of the argument as well. At least once a year we get a stock market decline of between 10 and 15% from the highs. Every couple of year we get one between 15 and 20% and around every three years or so we get one of those gut ripping bear markets that drag prices down more than 20% peak to valley. If you wait for prices to drop to the 10% level to really ramp up your buying activity and scale in as the market continues to fall you will be able to buy stocks far cheaper than the buy everyday crowd. If you plan to own them for a period of years, as I do, paying a lower price as a result of a market decline almost has to lead to higher returns.

I do not want to make this sound too easy. Look at the period from April to June of this year. The market fell roughly 10%, a regular occurrence if you are a student of market history. Yet if you were listening to the financial press or reading the papers it seemed that the world was going to end. In 2011 we saw a steeper selloff from August into October of roughly 19% and the doom and gloom was so thick you could cut it with a knife. Even if you started buying with the market down 10% and scaled in you have done much better than the market since that time. If you just added at every 5% additional decline you would have been in the market at a cost of 1160 on the S$P 500 and sitting on an 18% gain as of today. That’s better than almost all mutual funds over the past year and even bests the average hedge fund by a wide margin. That is accomplished by just buying the market itself without applying any valuation principles.

The real hard part comes from the simple fact that you will never catch the dead bottom of a market. If you do it was a fortunate accident. Consider the meltdown of 2008 to 2009. The ultimate drawdown was greater than 50%.  If you focus on safe and cheap stocks and believe that the world is not going to end the additional adverse excursion is just a chance to scale into sound investments at better prices.

An enormous amount of activity goes into try to trade and time the market on a daily basis. If you look at the overall returns of the hedge funds and mutual funds that engage in such activity most of them are not outperforming the buy despair and sell optimism distressed and value types like  Wilbur Ross and Howard Marks.  In my experience there are very few great traders and not many that good ones. The good ones all have extraordinary math skills and huge computing power that most of us cannot match. I cannot go head to head with James Simons and his specially cooled computer room. I can buy stocks with solid balance sheets below the realizable asset value when everyone is panicking and sell when Mr. Market cheers up.  History tells me that will fare better than most of the frenetic trading I see every day. 

No comments: