Notes on September 1994 Tweedy Browne Semi-Annual Report (Classic Guru Shareholder Letters Review)
Here is the the investment manager's report from the first semi-annual report of the Tweedy Browne American Value and Tweedy Browne Global Value Fund in September 1994.
(1) "we have most of our money invested in stocks that are cheap compared to book value or earnings, or both. It would be nice, and enormously protable, to be able to know which stocks were going to rise on any particular day, or on which days the market indices would rise or fall. Then all an investor would have to do is own those stocks on those days, or go long or short the indices, depending upon their predicted daily direction. Unfortunately, at least for us, we believe this is an impossible task. What we think we do know is that, on average, a portfolio with certain fundamental financial characteristics generally will produce satisfactory, if not superior, returns. It is a bit like planting seeds: sometimes they take longer to germinate due to a patch of bad weather; but, given good seeds and proper soil, we will eventually have a harvest..."
(2) "...However, in the most recent year, earnings declined substantially to 223 lira per share, not a particularly unusual event given its business and economic conditions in general. However, this temporary decline in earnings produces a rather high current price/earnings ratio of 32.6x. This results in an overall average higher P/E ratio for our Fund. Although there is no guarantee that earnings will recover to the level attained in 1992, 1,610 lira per share, the price/earnings ratio for our investment in Cementerie di Sardegna would be 2.8x if earnings do recover to that level..."
(3) "...we do find many bargains among smaller cap companies. Some academic studies have shown a small cap effect in improving investment returns. Small companies sometimes find it easier to grow than large companies, and the number of potential corporate acquirors is probably greater for small companies than large companies..."
(1) Low P/E and Low P/B have been the metrics of choice for Tweedy Browne. As usual, value investors acknowledge that their core competencies are not in market timing.
(2) Peter Lynch has also warned about buying low-P/E cyclical stocks which are at the peak of their earnings.
Investors need to be cautious in judging stocks solely on a P/E basis.
(3) Two things are at play here for small cap stocks. First, a simple illustration of the base effect is that it is easier to double $1 to $2, compared with doubling $1 million to $2 million. It is easier to grow revenue and earnings from a smaller base. Second, buyouts by management, private equity firms, or corporates have been a common exit for value investors with smaller companies more likely to be acquired than bigger companies.
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