It’s interesting to me how many investors seem to be frustrated by the current market levels. Almost every value investor I respect, from Buffett to Einhorn, have expressed concerns with the fed’s policy and how high the stock market is in the face of on going economic weakness, the fiscal cliff, and the European crisis. Some of them have explicitly expressed their concerns, while other have implicitly expressed their concerns by raising large levels of cash. Personally, I’m a bit cautious on the market, as it’s getting harder and harder to find interesting net-nets or situations that I consider really undervalued. However, I don’t think the market is tremendously overvalued by any stech of the imagination- the ratio I consider most relevant for overall stock market valuation, market cap to GDP, points to a modestly overvalued stock market, and given how low interest rates are, how easy monetary policy is, and how strong most corporate balance sheets seem to be, I think that’s a pretty fair level.
But my thoughts on the markets aren’t what I want to discuss in this post. As I’ve said many times, I’m by no means a macro-investor, and I don’t think my thoughts on macro are either interesting or of value to my readers.
Instead, I want to talk about what I think investors who are having trouble finding drastically undervalued stocks should be doing. And the answer is not going massively into cash.
Instead, I think investors who are having trouble finding their “normal” undervalued stocks need to start looking for special situations, merger arb, etc. In other words, look for non-market corralated opportunities to park your cash while you wait for markets to pull back or to discover more interesting opportunities.
I’m obviously not the first person to think of this. And it is true these situations are both hard to find and require a bit of digging. But I think the efforts worth it, and I think it’s a hunt that’s necessary for small investors looking to outperform today’s markets.
I’ve felt this way for a while, but what inspired me to write this post is this (excellent) review of Buffett’s shareholder letters over at valueprax. When he was running money for his limited fund, he would lighten up on “generally” undervalued situations when he felt the market was high and he couldn’t find the normal undervalued stocks he was looking for. And would he just sit on all that cash? No, he put that cash into workouts and arbitrage situations.
Now, many will point out that Buffett returned all of his outside money in the late 60s/early 70s when he couldn’t find any undervalued stocks. And they’ll also point out that Buffett is holding tons of cash now, not investing in merger arbitrage and workout situations.
But I think there’s a pretty simple reason for that: both at the end of his fund and today, Buffett simply employs too much capital to invest in most workouts and arbitrage.
In other words, this is an advantage that we as small time investors have over Buffett and the big guys- we can invest in almost literally any stock / bond, and thus every workout situation is available to us.
So where would I recommend looking?
I’m personally looking at bankrupt equities, though I don’t have any good ones I’m currently in. I think turn around plays like Gramercy (GKK, Financial) and Premier Exhibits (PRXI, Financial) make for excellent investments which iwll ultimately have little correlation to the market. Things with fixed, hard catalysts like GYRO offer interesting plays with no correlation to the market. And of course, merger arb remains an interesting place, though I (again) don’t have any current opps there.
As I’ve said many times, I think that an interesting place to invest if you’re just looking to park a bit of cash and get some alpha to the markets is closed end funds trading at a discount that are likely to liquidate (per Special Opportunities Funds strategy). While I wouldn’t want to put all of my cash in those strategies, it’s a nice place to reduce some of your cash balance if you’re truly devoid of ideas.
Another fun idea is investing in pink sheet / over the counter stocks that are about to uplist to an exchange. While I wouldn’t want that to be the only part of an investment thesis in a stock, an uplisting can often serve as a catalyst to drive an undervalued over the counter stock closer to fair value, and it presents a nice firm timeline.
And, of course, there are still plenty of net nets / deep value stocks out there if you look hard enough!
Obviously, there are other places to look. And if you can’t find anything that falls in your personal circle that you feel comfy investing in with a nice margin of safety, than it’s way better to just sit in cash and speculate.
But I’m writing this article to say this: don’t get discouraged. You may have noticed that I took a pretty long dry spell the past two months in terms of writing articles. It’s because I was discouraged- it seemed every stock I looked at had enjoyed a 50% run before I got to it, and I was having trouble finding anything new and fun to talk about.
But if you keep turning over rocks, you will find things to invest in, and you will find interesting work out opportunities. Keep at it, and you’ll be able to keep (relative) pace with the market while it’s rising, and you’ll have plenty of cash coming your way if and when the market ever falls.
Disclosure- long GKK, PRXI, SPE
But my thoughts on the markets aren’t what I want to discuss in this post. As I’ve said many times, I’m by no means a macro-investor, and I don’t think my thoughts on macro are either interesting or of value to my readers.
Instead, I want to talk about what I think investors who are having trouble finding drastically undervalued stocks should be doing. And the answer is not going massively into cash.
Instead, I think investors who are having trouble finding their “normal” undervalued stocks need to start looking for special situations, merger arb, etc. In other words, look for non-market corralated opportunities to park your cash while you wait for markets to pull back or to discover more interesting opportunities.
I’m obviously not the first person to think of this. And it is true these situations are both hard to find and require a bit of digging. But I think the efforts worth it, and I think it’s a hunt that’s necessary for small investors looking to outperform today’s markets.
I’ve felt this way for a while, but what inspired me to write this post is this (excellent) review of Buffett’s shareholder letters over at valueprax. When he was running money for his limited fund, he would lighten up on “generally” undervalued situations when he felt the market was high and he couldn’t find the normal undervalued stocks he was looking for. And would he just sit on all that cash? No, he put that cash into workouts and arbitrage situations.
Now, many will point out that Buffett returned all of his outside money in the late 60s/early 70s when he couldn’t find any undervalued stocks. And they’ll also point out that Buffett is holding tons of cash now, not investing in merger arbitrage and workout situations.
But I think there’s a pretty simple reason for that: both at the end of his fund and today, Buffett simply employs too much capital to invest in most workouts and arbitrage.
In other words, this is an advantage that we as small time investors have over Buffett and the big guys- we can invest in almost literally any stock / bond, and thus every workout situation is available to us.
So where would I recommend looking?
I’m personally looking at bankrupt equities, though I don’t have any good ones I’m currently in. I think turn around plays like Gramercy (GKK, Financial) and Premier Exhibits (PRXI, Financial) make for excellent investments which iwll ultimately have little correlation to the market. Things with fixed, hard catalysts like GYRO offer interesting plays with no correlation to the market. And of course, merger arb remains an interesting place, though I (again) don’t have any current opps there.
As I’ve said many times, I think that an interesting place to invest if you’re just looking to park a bit of cash and get some alpha to the markets is closed end funds trading at a discount that are likely to liquidate (per Special Opportunities Funds strategy). While I wouldn’t want to put all of my cash in those strategies, it’s a nice place to reduce some of your cash balance if you’re truly devoid of ideas.
Another fun idea is investing in pink sheet / over the counter stocks that are about to uplist to an exchange. While I wouldn’t want that to be the only part of an investment thesis in a stock, an uplisting can often serve as a catalyst to drive an undervalued over the counter stock closer to fair value, and it presents a nice firm timeline.
And, of course, there are still plenty of net nets / deep value stocks out there if you look hard enough!
Obviously, there are other places to look. And if you can’t find anything that falls in your personal circle that you feel comfy investing in with a nice margin of safety, than it’s way better to just sit in cash and speculate.
But I’m writing this article to say this: don’t get discouraged. You may have noticed that I took a pretty long dry spell the past two months in terms of writing articles. It’s because I was discouraged- it seemed every stock I looked at had enjoyed a 50% run before I got to it, and I was having trouble finding anything new and fun to talk about.
But if you keep turning over rocks, you will find things to invest in, and you will find interesting work out opportunities. Keep at it, and you’ll be able to keep (relative) pace with the market while it’s rising, and you’ll have plenty of cash coming your way if and when the market ever falls.
Disclosure- long GKK, PRXI, SPE
