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Jae Jun
Jae Jun
Articles (186)  | Author's Website |

What Has Worked in Investing?

There are about 40 strategies for selecting stocks in the Tweedy Browne handbook. Here's my take

As the market continues to climb, it is easy to look for new ways to invest and potentially get off course.

Despite how well you are doing, there is always the temptation to look at what others are doing and kick yourself for the ones you have missed.

I mean, check out what Amazon.com Inc. (AMZN) and Microsoft Inc. (MSFT) have done.

Amazon is up 47% year to date and CEO Jeff Bezos is the richest man in the world again.

Microsoft is up 44% this year.

Wow.

Essentially, anyone who bought FANG (Facebook (FB), Amazon, Netflix (NFLX), Alphabet's Google (GOOG)) stocks are making a killing this year.

But is that skill or luck? Or am I being a sore loser? 

Well that is one way of going about it.

The other way is to ignore what people are doing, turn off the market news and read Tweedy Browne’s method of what has worked in investing.

The point of Tweedy Browne (Trades, Portfolio)’s handbook is to share the strategies and guidelines used at the firm to select stocks.

There are about 40 strategies in the handbook with a short description along with historical results.

To make it easier to understand, the strategies are broadly assigned to five categories:

  1. Low Price in Relation to Asset Value (low price-book ratio).
  2. Low Price in Relation to Earnings (low price-earnings ratio).
  3. A Significant Pattern of Purchases by One or More Insiders (officers and directors). Large share repurchases can be a component of this.
  4. Significant Decline in a Stock’s Price.
  5. Small Market Capitalization.

These are simple, tried and true categories, many of which are shared in the handbook.

Here is one I like:

Buying stocks with a low P/B ratio as well as stocks below 66% of net current asset value (NCAV) make for good investments (if you can find them).

To emulate a quick and broad search off of the five categories, here is a quick screen I whipped up in Old School Value:


My filters are set to look for:

  • P/B stocks between 0 and 4.
  • P/E ratio between 0 and 15.
  • Diluted shares outstanding showing a negative compound annual growth rate over a three-year period to indicate a sign of repurchases.
  • Stocks in the bottom 10% of the pile close to their year-low price.

If I wanted to broaden the universe a bit more, I could expand the last criteria from the bottom 10% to the bottom 20%.

Sticking with the bottom 10% filter, I get the following results:

  1. GameStop (NYSE:GME)
  2. Juniper Networks (NYSE:JNPR)
  3. Big Five (NASDAQ:BGFV)
  4. Macy’s (NYSE:M)
  5. Foot Locker (NYSE:FL)
  6.  Alaska Air (NYSE:ALK)
  7. Bed Bath & Beyond (NASDAQ:BBBY)
  8. Express Scripts (NASDAQ:ESRX)
  9. Celestica (NYSE:CLS)
  10. Discovery Communications (NASDAQ:DISCA)

Of the 10, five are in retail and two are in communications.

With the way the market has been, you get an idea of which sectors and industries are out of favor right now.

I would not blindly buy any of these companies.

Frankly, many scare me.

Take a look at GameStop.

Right off the bat, it does not pass my sniff test.

  • Increase in debt.
  • Decline in revenue.
  • Business model that once made it profitable is being attacked.
  • Multiples constantly in decline.

This is a company that has turned it around, but the numbers do not lie.

Certain numbers scream value, like a price to free cash flow ratio of 3.5 and a low P/B, but unless you are buying a big basket and spreading your bets, taking a large position in GameStop makes me uneasy.

If you do a quick and dirty discount cash flow to get an idea of what the numbers say, GameStop is a very undervalued stock.

But how will the business and narrative play out?

Look at the numbers in the image below and the comments.

If I see a big disconnect like this between fair value and the stock price, obviously something is not right.

Either:

  1. I am wrong.
  2. The market is wrong.
  3. The market and I are both wrong.

I like to look at the DuPont analysis to check whether the return on equity (ROE) is valid.

In GameStop’s case, there is a warning sign.

Do you see it?

There are actually two warning signs.

Asset turnover has been dropping while leverage has increased.

No two ROE are identical. By breaking it down like this, you can see that a supposedly consistent ROE looks very different.

GameStop is an easy pass for me.

The stocks I have found are definitely out of favor, but at least they are a different look to what is being displayed on finance sites where they only talk about stocks at their 52-week highs.

What has worked in investing?

Despite what the market is doing, I highly recommend Tweedy Browne’s handbook as long-term results do not lie on what has worked in investing.

Disclosure: No position.

About the author:

Jae Jun
Old School Value is a stock grader, value screener and valuation tool for busy value investors.

Visit Jae Jun's Website


Rating: 4.8/5 (4 votes)

Voters:

Comments

cyoung1989
Cyoung1989 premium member - 3 months ago

Thanks for the good read! I enjoyed the article and agree on GameStop directionally. I understand this is a screen. No screen is perfect and the sniff test makes sense, but I'm curious to know whether you have a means of screening for businesses going through a business model transition.

My curiosity comes mainly from following GameStop over the past couple of years. They've been plowing cash into Tech Brands (which is basically a bunch of AT&T stores). In either case, it seems to me like GameStop is moving from a once great (now dysfunctional) business model to a so-so model. Physical retail to physical retail. So the prospects for GameStop seem mediocre still, but what if the transition actually went to a more interesting model?

I wrote about Daihatsu Diesel (TSE: 6023) not long ago showing a business transition. The company originally manufactured combustion engines for ships. Since 10 years ago, they've slowly, but surely built a high margin service parts & maintenance business, which seems to have gone unnoticed with the turmoil in the shipping industry. If GameStop was jumping from its used game model to something with sticky revenues, higher margins, and sufficient scale, the increased level of debt would probably be good news.

Anyway, if you have any ideas on how to screen for businesses going through a transition, I'm all ears!

Cheers,

Clay

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