In the poker movie Rounders, the main character Mike McDermott (played by Matt Damon) says the following: “Listen, here's the thing. If you can't spot the sucker in the first half hour at the table, then you are the sucker.” The same can be said about investing; as I’ve wrote in the past, you MUST have an advantage over the competition if you plan to beat the averages – and if you can’t identify what that is, there’s a good chance you are soon to be fleeced.
This advantage can come in multiple forms: a common one is an informational advantage, which can sometimes be found among small cap stocks that aren’t covered by the analyst community. However, this is increasingly difficult: In an era where key information is instantly attainable, the unfound is often being discovered by curious investors like those on GuruFocus.
While I still think that an informational advantage can be attained (particularly among the hated and misunderstood), the real winners come from a combination of multiple advantages – particularly, among those names that look like short-term losers. If there is one thing mutual fund and hedge fund managers hate, it’s volatility (obviously they’re more concerned with downside volatility than upside volatility); my personal opinion is that this is largely their own demise – if you look to bring in as much money as possible, regardless of client understanding of the firm’s strategy, you are setting yourself up for trouble. While managers understand this, there is one glaring conflict of interest – their paycheck is often dependent on AUM.
Career risk has led to an obsession with short term results; as a result, the holding period on most major exchanges is less than a year - in this world, the market is your master, not your servant. Not having clients to keep happy is a blessing; for the individual investor, this is a competitive advantage – assuming that you capitalize upon the opportunity.
An example of this is currently being played out with J.C. Penney’s (JCP); here is what I said in the conclusion of a recent value contest submission for the company:
The problem for the time being is that JCP is in limbo: the promotions and coupons aren’t there to attract the old customer base, but there are still few signs of any real change to the average consumer. I think there are clear catalysts on the horizon, particularly as shops enter the store starting in August and the media and Wall Street once again set their sights on Johnson & Co. Some people will feel the need to wait for assurance of success; I believe that the intelligent investor can look at the current variables (management’s track record, key shareholder’s track record, plausibility of the business strategy, difficulty to replicate, etc) and see that the current valuation is a steep discount to J.C. Penney’s intrinsic value.
As of the today, that contest submission has received roughly 1,200 views, with the consensus from the comment section being that the real estate value and the announced cost cuts collectively make it worth more than the current market cap (correct me if I misunderstood anybody’s comments), essentially making JCP the equivalent of a free call option dependent upon the successful implementation of a clear and compelling strategy, backed by one of the most successful investors of the past 15 years.
The question then is clear: Why does the stock continue to suffer? My opinion is that the short term issues are keeping many institutional investors away; J.C. Penney’s will have to report another set of quarterly earnings before the vocalized strategy has been implemented, and I wouldn’t be surprised if they look pretty rough. Of course, why should this matter? It is three months of results that will become part of the history of what JCP used to be; for people who call themselves value investors (and presumably believe that intrinsic value is equal to the discounted value of a company’s future cash flows), this quarter is essentially noise – and why the market may act like 90 days of financials determine a company’s intrinsic value, the reality is that it's essentially meaningless.
As usual, Warren Buffett (BRK.B) said it best, way back in August of 1979: “You pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.” While uncertainty is still a factor with Penney’s, the odds appear to be out of balance – particularly when one considers the track record of the key players in the game.
More than uncertainty, I think this is a simple case of the potential for near-term pain (3% days in both directions have been the norm) scaring away investors who can see the rationale for long-term gain; combine this with the barrage of macroeconomic noise, and many people have simply frozen up – and as usual, will wait for higher stock prices (and lower forward rates of return) to spark their interest in equities.
For value investors, this is an opportunity to capitalize on the herd’s fear of short-term volatility; the sucker’s at the table – and the time left to recognize it is drawing to a close.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.