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Thomas Macpherson
Thomas Macpherson
Articles (192)  | Author's Website |

Are We Value Investors?

We were recently talking to a fellow investment manager and somewhere in the conversation - quite nonchalantly - they mentioned that we weren't really value investors. I laughed at the comment and asked why they thought that was the case. They stated (and I paraphrase here) that essentially we were growth-at-a-reasonable price investors because we didn't invest in true value companies. They went on to say our companies were too successful (measurement wise), had not suffered recent operational or strategic crises, and were too richly valued to be considered truly "value" stocks.

This gave me great pause as I truly respect and admire this individual's insights and investment prowess. Are we well and truly GARP investors? Has all that time spent reading the great investment gurus' writings and creating valuation models and tools been a waste of time? I have always believed much like Buffett that all investing is value investing. Anything else is speculation, and Im pretty sure we havent been speculating all these years.

In our definition, equity value investing is purchasing shares of a corporation in which the markets have created a significant variant between the price of the stock and the intrinsic value of the companys shares. Nowhere does that require investment in net-nets, cigar butts, or turnarounds. Nor does it mean a company must have a low PE ratio, low price to sales ratio, or other value measures (though they may include one, some, or all of these attributes). I happen to believe that strong fundamentals such as return on capital, rock solid balance sheets, and high profitability provide significant downside protection of our investments. For Nintai, the defining factor is the discount to intrinsic value. Without it, we simply will not invest. To me that puts our investment style in the value investor camp.

Edward Huang said that every single person has a different perspective when looking at the same thing. We couldn't agree more. At Nintai it is a frequent event to find significant disagreements about a possible investment opportunity. During this process we look to find an investment that meets Seth Klarman (Trades, Portfolio)s description of Buffett buying great companies at great prices. Our internal disagreements always center on the two descriptors: great companies and great prices.

At Nintai we have a relatively set criteria for defining a great company (see our article on our investment criteria here): high ROA, ROE, ROC, little/no debt, significant FCF, and a competitive advantage in the marketplace. The tricky part is defining a great price. We use a proprietary hybrid DCF method to get to a value per share, but generally defining what is a great price is relatively subjective. Our recent purchases (SWI, CBOE, CLCT, CPSI) we believe represent great companies at great prices. We expect to be owners of these businesses for the long term and are excited to see them grow for many years to come. We dont believe we paid excessively for growth but rather obtained an adequate margin of safety in each respective investment case.

Seeking Value Today

The reason we bring this up is two-fold. First, we sometimes find individuals and institutions can get too caught up in creating a definition for value investing. Attempting to set strict criteria can blind us to opportunities which - in the long term - might provide significant returns. In addition, it can block out means and methods that might provide us with valuable tools in our hunt for value.

Second, we are frequently asked about finding investment opportunities in todays market environment. With our recent purchases, we still remain at a roughly 20% cash position. As value investors, we simply cannot find that many opportunities in todays market. That said, we currently have two companies on our watch list that intrigue us and could be added to the portfolio if either their intrinsic value grew or their price per share dropped (or both would be best). Neither would be considered a Ben Graham value stock they are quite profitable, generate high returns, have no debt, and have a generous amount of cash on the balance sheet. Management are great allocators of capital. They clearly meet our criteria as great companies. Unfortunately they arent valued as great prices. If the gap between the value and price widened more we would certainly be investors.

Linear Technology (NASDAQ:LLTC)

The first stock is Linear Technology. Linear Technology designs and manufactures standard high-performance analog (HPA) integrated circuits for an immensely diverse customer base spanning industrial, automotive, communications, and high-end consumer electronics. Linear is a cash-generating machine. Lothar Maier, CEO, has kept a laser focus on sticking with products and clients who are willing to pay for quality. The company generated 38% ROE, 28% ROA, and 58% ROC. The company converts roughly 40% of revenue into free cash. It has no short or long-term debt and roughly $570M cash on the balance sheet. Its product, processes, and expertise provide the company with an extensive competitive moat. It currently yields 2.8%. Obviously a great company. The only problem is that our estimated fair value is $44/share or a 7% discount to intrinsic value not a great price. So we wait.

United-Guardian (NASDAQ:UG)

Our second company is United-Guardian. The company through its Guardian Laboratories Division manufactures and markets cosmetic ingredients, personal care products, pharmaceuticals, medical and health care products, and specialty industrial products. It also conducts research and development, primarily related to the development of new and unique cosmetic and personal care products. The company generated 28% ROE, 25% ROA, and 61% ROC. The company converts 32% of revenue into free cash. It has no short or long-term debt and roughly $6M cash on the balance sheet. It currently yields 4.2%. While down roughly 23% over the past year, the stock still only trades at a 7% discount to our estimated fair value.

Neither of these companies would be held up as the model value stock. With PEs of 20 and 22 respectively they certainly wouldn't be considered cheap by traditional value investors. By using multiple measurement tools it is likely several value investors would come to the same conclusion neither company provides a satisfactory investment opportunity. However, at Nintai we keep an eagle eye on two things the company financial criteria and its price to value ratio. We care little about PE or PEG ratios. While different than a more traditional value model we all get to the same finding neither provides an adequate margin of safety at this time.

Conclusions

We dont think having strict quality criteria makes Nintai any less of a value shop than low turnover or PEG requirements. Our main focus from the beginning of investigating a potential investment until its sale is the disparity between value and price. There are many roads to the Forum but all take you to Rome. We think there are as many methods to value investing as there are roads leading from the Italian countryside to center city. We avidly read about other value investors methodology because we know we can always learn more about what makes a successful value investor. In the end, thats what makes this such an interesting career. We wouldn't want it any other way.

As always, we look forward to your thoughts and comments.

About the author:

Thomas Macpherson
Thomas Macpherson is Managing Director and Chief Investment Officer at Nintai Investments LLC. He is also Chairman of the Board at the Hayashi Foundation, a Japanese-based charity serving special needs children and service pets. The views expressed in his articles are his own and not necessarily those of the firm. He is the author of “Seeking Wisdom: Thoughts on Value Investing.”

Visit Thomas Macpherson's Website


Rating: 5.0/5 (8 votes)

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Comments

jtdaniel
Jtdaniel premium member - 5 years ago

Hi Tom,

I really enjoyed your article. I have come to believe that mixing GARP and pure value stocks can really enhance portfolio return. Hence my recent purchases in Nestle (GARP) and Loews (below book value). Given Nestle's strong franchise value, I see it as no more risky than Loews over an extended holding period. Perhaps the best thing about GARP stocks like Neste, Wal-Mart or Abbott Labs is that the investor should have no fear of averaging down. Most of my profits over the last 30 years have come from averaging down into legacy holdings. Best, dj.

batbeer2
Batbeer2 premium member - 5 years ago

Thanks for an article worth reading.

You say:

>> In our definition, equity value investing is purchasing shares of a corporation in which the markets have created a significant variant between the price of the stock and the intrinsic value of the companys shares.

There are many schisms of the church of value investing but it is indeed a matter of definition. Perhaps "true value investing" as referred to by your interlocutor could be defined as the activity of buying a dollar worth of assets for 50 cents.

It appears few people on the interweb realize that there are important differences between the former and latter definition.

More than 95% of the ideas presented on this site or on a place like VIC, not to mention SA are about companies trading at a percieved discount of 15% to 30%. Assuming the analyses are correct, those would be 70ct dollars; not 50ct dollars.

While some wil (rightly) claim they are willing to pay a bit more for quality, I believe at least some of it is explained by the fact that few are willing to go the extra mile to find that 50% margin of safety; thinking 25% should be enough and hoping the market will soon realize the error of its ways.

Ever hopeful I continue to hunt for quality stocks at a 50% discount. In eight years I have found three. The bad news is that the first two times, I didn't recognise the quality. I'll let you know when I find another one.

@ jtdaniel

Loews is IMHO a very good idea now. After you back out CNA and the excess cash at the holding level you get a pile of beaten down assets for free. Seacor was brought to my atention this week and is worth a look. In part they operate in the same space. I just found out the CEO of Seacor is on the board of DO.

jtdaniel
Jtdaniel premium member - 5 years ago

Hi Batbeer,

Not to worry, there is always another bear market. I haven't seen any 50 cent dollars in the quality stocks I track since 2009. Perhaps BP in 2010 would qualify, but that name did not interest me. Berkshire was a good value in 2011, but certainly not a 50 cent dollar. Maybe there have been such opportunities in small bio techs or net nets, but I would have never noticed. Best, dj

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

DJ: thanks for your comment. We think high quality companies at a reasonable discount to fair value will generate adequate returns over the long run. You selections look like great companies to us. Bat: your comment highlights the differences. We rarely find a great company at a 50% discount to our intrinsic value and find that 25% meets our needs. Thanks again to both of you for your comments. Best. - Tom

Adib Motiwala
Adib Motiwala - 5 years ago    Report SPAM

Disney is up what 250% + dividends in 5 years? Was that not 50% off in hindsight. Remember, not everything looks statistically cheap on a trailing basis for an investor to realize its a bargain. Yes, the multiple has expanded greatly with improved profits. But clearly it was depressed.

Such investing is nuanced and takes experience.

This is a good article and worth thinking about. Bucketing value investing , GARP or growth based on multiples or kinds of companies.

Being open minded and constantly looking and improving and doing self analysis to see one can develop is a must.

thanks for sharing your thoughts and all the folks who commented

Thomas Macpherson
Thomas Macpherson premium member - 5 years ago

Thanks Adib for your comment. Glad you enjoyed the article. As usual, there is more wisdom in the comments section than the original text! Best - Tom

AlbertaSunwapta
AlbertaSunwapta - 5 years ago    Report SPAM

^^ I'd say that price vs. intrinsic value is the yardstick - not hindsight. Stocks already above long term based intrinsic value can and often do become multibaggers.

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