The Long and Short of It: Key Takeaways from the Value Investing Congress 2014

David Barr and Felix Narhi had the opportunity to attend the recent Value Investing Congress meeting in New York. CNBC has dubbed the event “The Super Bowl of Value Investors”, albeit we believe most value investors would agree that our true Super Bowl takes place each May in Omaha.

One of the great things we enjoy about investing is the fact that knowledge tends to be cumulative over time – it helps to be in a constant “learning machine” mode. If you stop learning in this world, the world rushes right by you. We are constantly seeking ways to improve our process over time which includes absorbing lessons and ideas from successful investors.

Here are the three themes that struck us the most, with our further thoughts on these topics highlighted in italics below.

1. General Market Conditions: Equities are “the best house in the financial asset neighbourhood”.

We thought Omega Advisor’s Leon Cooperman best summed up the general market conditions today.

• He believes that US equities are trading within a zone of fair value, but stocks still represent “the best house in the financial asset neighbourhood”.
• He believes that, other than structured credit, US fixed income was poised to deliver negative returns.
• He was positive on European and Japanese stocks due to general undervaluation and because where their respective markets are within the business cycle.

After an extended bull run, many investors are wondering if the US markets are close to an intermediate peak.  Of course, there is no way of knowing, but Cooperman pointed to research that showed markets peak about two years following an initial rate hike on average.

We are long-term oriented and concentrated investors. Over shorter periods, it is hard to avoid the gravitational pull of general market conditions. Yet, there will always be stocks and industries that are out-of-favour, temporarily depressed or otherwise overlooked regardless of market conditions which will fuel the best future returns.

Following the US stock market peak in 2000, there were plenty of traditional companies that performed well despite the overall decline of the stock market – it was the wildly overvalued tech-related names that drove general market levels down. Here’s an example which is also an odd coincidence: The “Great Tech Bubble” ended on March 10, 2000. On that day, the NASDAQ hit its all-time high of 5,132 (vs. August 2014 close ~4580). That same day, Berkshire Hathaway (BRK) shares traded at $40,800, their lowest price since mid-1997 (vs. August 2014 close ~$205,880). Excluding dividends, the NASDAQ index is still below its all-time 2000 highs while BRK has increased more than five-fold over the same period. Our takeaway? Sensitivity to valuation, careful stock selection and patience make a big difference over the long haul.

We believe investors that are overly focused on the macro picture and overall market conditions will miss all sorts of opportunities that will always be available at the micro level, regardless of market conditions. True, there are more compelling ideas available when the overall markets are depressed, but we believe there will be many well-known companies that investors will look back on a few years from now and have wished they had bought today.

2. Go Short: “12 Reasons Not To Short”, But Here Are Three Short Ideas Anyway

There were three presenters from the short side – Carson Block of Muddy Waters, Andrew Left of Citron Research, and Whitney Tilson of Kase Capital. Their ideas were 500.com (WBAI), Zillow.com (Z), and Exact Sciences (EXAS), respectively.

Short selling has been exceptionally difficult and largely a return sapping endeavour since the current bull market began in 2009.  Indeed, Tilson’s presentation was entitled “12 Reasons Not to Short”. His conclusion: shorting is a really tough thing to do, so avoid it. Yet, he was clearly unable to resist his own advice because his new “idea” was another short!

The best investors are, above all else, business-like in their investing approach. The more business-like an investor is, the less he will likely be sidetracked by guesses, bets or speculations on the short-term direction of individual securities, which, ultimately, is what shorting is all about. In addition, when shorting, your upside is capped and your downside is unlimited[1] – precisely the opposite of long positions. Importantly, stock markets generally head up over time as business value is built up. Virtually all of the large personal fortunes in the world have been made on the long side. As such, we believe maintaining a long bias and business-like approach is the most constructive path to wealth creation over the long haul.

At Pender we are predominantly long investors. But when it comes to constructing a portfolio we think there are times when limited shorting does make sense in order to potentially enhance returns and reduce volatility. There are three main ways we would do this.

• As an alternative to holding cash, maintaining a short book enables the investor to stay more fully invested most of the time while preserving the option of being able to act when the markets swoon from time to time.
• Shorting can also be a sound strategy when one is pursuing a merger-arbitrage strategy, a strategy where the stocks of two merging companies are simultaneously bought and sold to create a “riskless” profit. This is a strategy Buffett used in his early partnership days that helped him earn positive returns even in years when the general market posted meaningful declines.
• Finally, shorting can help to reduce portfolio volatility which might be beneficial to those investors who find it difficult to stomach the manic-depressive emotional cycles of the stock market.

3. Go Global: Deep Value Available in Some Foreign Markets

Overall, the presenters at the conference were finding more undervalued ideas in markets outside the U.S. markets. The Korean stock market (KOSPI) was identified as particularly cheap.

We found many of the global ideas presented at the conference compelling on the surface, like a granite maker in India (Aro Granite), a global retailer based in France (Rallye), and a construction company based in Korea (SamHo Development). We think going on a global hunt for value is a perfectly sound strategy. However, we also feel it is very important to stay within one’s circle of competence.

Historically it’s been a challenge to invest in foreign markets due to the a greater possibility of making mistakes and impairing capital where we didn’t understand aspects of local accounting standards, business culture and other important business drivers. Moreover, we believe there continue to be plenty of opportunities within the North American markets, including through a growing number of companies with meaningful and expanding global operations.

However, with increasing globalisation and standardisation of accounting methods and more, we see a number of global opportunities outside of North America that fit into our expanding circle of competence. In the quest to compound your capital over time, expect Pender to “go global” in the hunt for value.

David Barr and Felix Narhi, September 17, 2014

[1] Caveat: Technically, this is accurate if no other action is taken after the initial short position. However, in practice upside of more than 100% is possible if a stock goes down because additional shares can be shorted, without the need to add more capital, thereby compounding returns if the stock continues to decline. Also, infinite losses can be prevented by placing stop losses.

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