Value – The New Alternative by Charles Brandes (Notes from Thursday's 8th Value Investors' Conference in Omaha)
The conference is held at the new business school building of the University of Nebraska. The building was sponsored by one of Buffett’s earliest partners before he bought Berkshire. The total amount was $35.5 million.
Below is the transcript from the presentation and Q&A session with Charles Brandes:
As a firm, we are out of favor … Again: dogmatic, out of touch, and old fashioned. Some clients said that we are arrogant, because we believe too much in what we do, which is Graham Dodd value investing.
We are out of favor because we are too old fashioned. We only do equity, fixed income and cash. But there are many other alternative that we don’t do: ETF, commodities, swaps, managed futures, private equity, volatility arbitrage, hedge funds, put writings etc…
Since we are so out of favor, we pursue the new alternative, which is value investing.
The new Yale endowment model is an example of the alternative. But the institutional investors are not adding value. The study shows that institutional investors do not add value by doing too much.
The world has changed. Technology has changed our business, we have more digital touches than personal ones. The speed of information is greater, the magnitude of investor response has increased.
One thing we got caught in 2008 was the government interference. Some of the companies we own were affected.
Passive investment is attracting investment. Now only twice as much is managed by active management. Twenty years ago it was 20 times.
Opportunities for stock picking:
1. Fundamentals will prevail in the long term.
2. Price matters.
3. Wealth creation comes from business.
How about value traps?
Ben Graham: How can Valueline’s top-ranked performance be worse than the No. 3-4 ranked? Because they put momentum factors in the ranking to avoid value traps.
Q. What is your biggest investment mistake?
Not realizing that there are certain elements that were different this time in 2008-2009. Generally we don’t think it was different. There were a few things that were different. We did not anticipate a credit crunch of that degree. We weren’t careful enough to look at the companies that are leveraged. We were thinking it was a more normalized recession. We also bought the banks too early. We put our own stress test, but apparently they are not stressed enough.
I think we will have a normalized bank eventually.
Q: How difficult is it to find 50 cents on a dollar?
It is difficult now. But we are finding 70 cents on a dollar. The place we are finding a lot of value now is Japan. We are finding Japan is the cheapest we have ever seen. Some of the regional Japanese banks that have no bad loans at all, but they are trading at 60 cents on a dollar. All we need in Japan is a slight improvement, not a great improvement.
I am trying to avoid the questions not to benefit competitions.
Q: Can you discuss about your experience with Ben Graham about financial stocks? In his book he did not discuss a lot about financial stocks.
In 1930s Ben was wiped out. I think that affected Ben’s later investing in banks. He doesn’t invest much in financials and banks.
Q. Can you give comment on Buffett’s evolution from net-net to high quality companies?
I think if you are an investor, you really think about it. The rule of value and margin of safety do not go away. The factor for Buffett is the size of money. As an investor you do have to change. With $50 billion we have the same problem.
We are over-weighted in Japan, in Pharmaceutical.
Q. As an investor I can only focus on this many stocks. If the market gets too high, I have to look at more stocks. How do you manage this?
Fortunately we don’t have to deal with it, because many of our clients require we are 100% invested all the time. The easy Ben Graham said is in Chap. 4 of “The Intelligent Investor.” He said when the market is high, you can be in 25% in equities and 75% in bonds.
In Chap. 14, he said to buy growth at reasonable value. Similar to Charlie Munger’s moat discussions.
Q. How do you see the emerging market like China and India?
40% of the market cap in China is in 5 companies. The Chinese index is weighted in those. We are not finding any value in China. In India it is similar. 30% of the total market cap is in 5 companies, and they are highly priced.
We find a few smaller companies in China that are not that expensive.
We are looking at companies in China and India. We think that we will have opportunities in the future.
Q: One of the value investing principles is to concentrate, but you are diversified?
It is our rule not to put 5% in one stock, more than 20% in a sector. From an institutional investor point of view, we are relatively concentrated.
If you started your firm today, what would you do differently?
I think it would be a good time to start today. I don’t think I would do too differently. I would start with a few clients. Initially in 10 years I did not get a lot of money, I was not good at talking to people. But I got a good track record. Finally I got some marketing people. If I started today, I would hire marketing people earlier.
You own telephone companies from all over the world. It is the largest sector you have. Why is that?
Basically valuations. The industry is changing from wireline to wireless. The market is concerned about the wireline companies decline, but we found that they create a lot of cashflow. We think the market is way over reacted. I think TEF is traded at 4-5 earnings and yield 7%. Now it has 100% ownership in Brazil. You have those PE ratios, dividends, and you still have growth. That is why we own companies like that.
Did you add to value investing principle yourself after 35 years?
Ben Graham was one of the first in the investment world about behavior being a big aspect of it. But over 35 years there hasn’t big change. I am afraid that I cannot say I come up with a great theory.
What have you learned in the 40 years, the biggest lesson?
Never ever bring to me an airline stock, that I said before. But actually we did invest in AA, hurt badly, but then it came back, and we made money. So I did not really learn anything. (laughter)
How about pharmaceutical companies?
They have not generated any big blockbuster for the last few years. They have not recovered from the lows in 2009. I think they still have a long way to go. Our thesis is that the population is getting old. These companies are spending 17% of the profit for research. We think their research won’t be in vain. They are traded at 10-12 times earnings.