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What Type of Value Investors Are You?

10qk

gurufocus

362 followers
Today the hottest market news is the IPO of Zynga (ZNGA). It has nothing to do with most of the value investors. Naturally value investors pay little attention to IPOs; they may have missed some of the best investment opportunities such as Google (GOOG), or even MasterCard (MA) and Visa (V). But they sure did avoid a lot more casualties. In his recent interview with Charlie Rose, investing legend Seth Klarman said Warren Buffett went through three stages of value investing:

1. Buying cigar butts at good prices

2. Buying great companies at great prices

3. Buying great companies at so-so prices.

Mr. Klarman said he is still in the first stage, buying cigar butts at good prices. This is clearly the case from his recent purchase of Targacept (TRGT) after the stock price dropped 60% in one day.

An interesting question here is: What kind of value investors are you? Would you rather buy cigar butts at good prices, or buy great companies at great or so-so prices?

As long-term followers of Warren Buffett, we know that he was cigar butt investor when he was young and was not limited by the size of the capital he had. As Berkshire Hathaway (BRK.A)(BRK.B) grew bigger, he could only buy large chunks in large companies to “move a needle” in his portfolio. Most of us apparently do not have this problem (we wish we did). Even Seth Klarman, with more than $30 billion under management, can buy cigar butts. All of us can invest in cigar butts if we choose to. Do you choose to do it?

A company becomes a cigar butt for a reason, and usually for good reason. In the case of Targacept, it failed in a key drug trial that was expected to be successful. The market cap dropped 60% to $250 million, while the company has net cash of $210 million.

Investing in cigar butts can be hugely profitable, as Ben Graham proved in his long-term investment in net-net situations. (Check out the current list of net-nets in our Net-Net screener and the monthly Net-Net Newsletter.) Seth Klarman also proved that with his great long term track record. By the way, Seth Klarman is on the way to become the Investment Guru of Year 2011, according to the poll on GuruFocus homepage.

If it is that good, why don’t all value investors just invest in cigar butt situations and make huge profits out of them?

Just if it is that simple…

Most of the cigar butts situations are distressed. The companies are going through bad times, and the news about them is rarely good. As shareholders, this distressed situation with the company can make you distressed, too. You will have to go through a lot of frustrations. You may lose patience, lose confidence in the company, and even worry about its survival and become afraid of losing your investment completely. These investment may turn out to be hugely profitable, but the process might hurt. If you never experienced that, just ask Bruce Berkowitz how he feels about Bank of America (BAC).

Or you may just want to buy good companies at reasonable prices such as the companies in our Buffett-Munger screener. As Warren Buffett said, “I would rather buy good companies at fair prices than fair companies at good prices.” That should be much less stressful. You will certainly miss some 5-baggers in the short run, but it may well be as rewarding in the long run. The process is much easier and you can have much better night’s sleep.

Which way do you choose? What kind of value investors are you?

About the author:

gurufocus
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.3/5 (20 votes)

Comments

superguru
Superguru - 2 years ago
For me it is - "buy great companies at great or so-so prices"

I am not knowledgeable enough to buy cigar butts. My cigar butt record has been two failures and two successes. Overall I lost some money on cigar butts.

Liarspoker
Liarspoker - 2 years ago


I have a core portfolio of great companies bought at both great and so-so prices. These pay me a dividend which I reinvest into the same type of companies or cigar butts ( which also pay a dividend ).

In my mind I picture it like a musical band - the big guys are the rhythm section whilst the cigar butts can soar if they get it right like the soloist. The rhythm section is most important though.
tkervin
Tkervin - 2 years ago
I normally position much like Liarspoker. I have followed Klarman and others on more than one profitable puff in addition to owning a stable of solid Blue Chips.

Unusually for me I am 85% cash. If Europe plays out as I think it might.......great bargains are going to be available. Perhaps as good as 2008.

At sixty, this could possibly be one of my last, best, buy when "Blood is in the Street" moments.

If Europe is successful in a combination of kicking the can down the road, government restructuring and European financial integration, I still believe that a solid "Great Company" portfolio can be constructed at reasonable valuations.

At the risk of sounding like a broken record..........I am still waiting for that very "Fat Pitch"!
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Well, I have a number of cigar butts that started out as great companies in my mind. I do have one cigar butt that I intentionally bought. A micro-cap construction materials company in the final stages of winding down its business, plant sold, real estate sold, inventory sold, remaining staff on short term contract... cash is double market cap and possibly some unrealized value in a patent. What could go wrong!...probably had its cash at MF Global.
DocMoney
DocMoney - 2 years ago
For me, great companies at great prices, which, of course, happens during bearish sentiment. Right now, plenty of great European companies at excellent prices.

I am just not good enough to do cigar butts.

And I am working on getting better at doing nothing when no deals are available...
rgarga
Rgarga - 2 years ago
I just dont understand how you all can be so patient when i think i see fat pitches with 20% written all over them ... How do you know 30% pitch will come? I obviously am over excited about the situations around us. Buffett is too i think... But you all's patience is simply admirable. I have no cash left. Will get some more in january so will keep adding. Tough year so far.

Another thing is that i cant estimate when market will figure out that cigar butt and its real value. And more years that go by if that company is not really growing the lower the return. More speculation than one admits to there.
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
That cigar butt I picked up (see above) was CVE:WCT Wood Composite Technologies.

If you look at it note that it traded below 3 cents and sometimes around 2 cents for a year after selling most of its assets including real estate.

Post distribution, as far as I can tell it will still own it's original patents for composite deck extrusion and these should have some residual value.

The thing is, the population of investors, particularly these days, increasingly seem to follow only the largest companies. EMH increasingly applies to those companies, leaving little potential advantage beyond time horizon / arbitrage opportunities and simple misunderstanding of the very nature of these businesses. (i.e. Buffett's IBM purchase). However, some of the simplest investment gains available to smaller investors seems to be among the outcast and ignored companies.

By the way, WCT is a company located in Leduc, Alberta, only 10 minutes from my city but I'd never heard of it, never visited it, nor ever talked with anyone at the firm or anyone who knew anything about the firm, so it could have anywhere in North America. Stumbling on it while looking for deckboards for the cottage, i noted on its website that it had an investors link. Noting in its releases that it was closing up shop, all I did was follow its news and check out its filings on Sedar. The real deal I missed was failing to buy out its composite decking inventory when it liquidated it last year.

Oh, also insiders were buying so that should have been a signal to the market to at least check into this one. I also mentioned it to a number of friends and former co-workers. Not one as far as I know bothered to look into it. Who says markets are efficient!


Overall, I invest in great companies, plus broad based ETFs, plus a few value and dividend and int'l mutual funds. That is the great proportion of what I've invested in. I do try to chase a few high growth opportunities (patents, etc for moats, rapidly rising sales but not at break even but hopefully near profitability). I've had 15-20 such lottery tickets at a time. Small amounts of money in them. Eg My investment in WCT above was well under .01% but it was fun.
batbeer2
Batbeer2 premium member - 2 years ago
Type 2

That way, it is easier to consistently think and behave like an owner which IMHO is the core competence you need in value investing.

Were I to own a business outright, I would want that business to be profitable for at least my lifetime. I would also make sure it was run by managers I admire. Alas, as a minority shareholder, I have very little influence on the business or its management so I select stocks with those things in place.

And yes, with low turnover you only need one stock a year to keep your portfolio reasonably diversified. When you're looking to buy just one stock, it is easier to wait for the fat pitch. You find ten great companies or so and maybe one of them is cheap. One thing I like about it is that you can simply file away the nine expensive ones.... they may become cheap at some point.

Just random thoughts.

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