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We’ve added 3 New Speakers to the 10th Annual New York Value Investing Congress!

  • Guy Spier manages the Aquamarine Fund  in Zurich and made headlines by bidding $650,100 with Mohnish Pabrai for a charity lunch with Warren Buffett. He recently authored  the critically acclaimed The Education of a Value Investor.
  • Andrew Left is Executive Editor of Citron Research. He has the longest published and most highly predictive track record of any market commentator or columnist on the specific topic of fraudulent and over-hyped stocks.
  • Adam Crocker is co-manager of Metropolitan Capital Advisors with CNBC’s Karen Finerman. Metropolitan is a  value-oriented hedge fund founded in 1992.

We are now offering  a special discount – over 50% off! — on registrations for the NY Congress taking place September 8 & 9, 2014.  This year, seating will be strictly limited to 275, so we would encourage Greenbackd readers to register now, before we sell out.

Regular Price: $5,995 Special Offer – Over 50% off untill offer expires: 7/15/14

Discount Code: GREENBACKD

URL:  http://www.valueinvestingcongress.com/congress/register-now-partners/

Below please find information about the event:

10th Annual New York Value Investing Congress

  • Date:  September 8 – 9, 2014

Confirmed speakers include:

  • Leon Cooperman, Omega Advisors
  • Alexander Roepers, Atlantic Investment Management
  • Carson Block, Muddy Waters Research
  • Whitney Tilson, Kase Capital
  • Sahm Adrangi, Kerrisdale Capital Management
  • David Hurwitz, SC Fundamental
  • Jeffrey Smith, Starboard Value
  • Michael Kao, Akanthos Capital Management
  • Guy Gottfried, Rational Investment Group
  • John Lewis, Osmium Partners
  • Tim Eriksen, Eriksen Capital Management
  • Cliff Remily, Northwest Priority Capital
  • With many more to come!
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Greenbackd and Eyquem Investment Management are proud supporters of the Capitalize for Kids Investors Conference.

Capitalize for Kids brings the investment community together at an annual event centered around great investment ideas and in doing so, provides support for the Hospital for Sick Children. Sophisticated investors will converge to meet, share ideas, and learn from some of the world’s most successful money managers, many of whom rarely share their ideas publicly.

This year’s speakers include Larry Robbins, founder of Glenview Capital Management; Jamie Dinan, founder and CEO of York Capital Management; Jacob Doft, Jeffrey Smith CEO and CIO at Starboard Value; Sahm Adrangi Managing Partner, Kerrisdale Capital Management; Steven Shapiro, founding partner of GoldenTree; and more than a dozen other world class institutional investors ready to share actionable ideas with attendees and detail their approach to analyzing potential investments.

Where:

Arcadian Court
401 Bay Street, Simpson Tower, 8th Floor
Toronto, ON M5H 2Y4

When:

October 23 – 24th, 2014

Fees:

Single Seat: $2,500
Table of 10 Seats: $25,000

Contact Information:

Register Today for Capitalize for Kids Investors Conference

Our Speakers 

  • Lee Ainslie III of Maverick Capital
  • Steve Shapiro of GoldenTree Asset Management
  • Marc Lasry of Avenue Capital
  • Larry Robbins of Glenview Capital Management
  • Jody LaNasa of Serengeti Asset Management
  • Jamie Dinan of York Capital
  • Jacob Doft of Highline Capital Management
  • Michael Thompson of BHR Capital
  • Brian Zied of Charter Bridge Capital
  • Jeffrey Smith of Starboard Value
  • Evan Vanderveer of Vanshap Capital
  • Frank Brosens of Taconic Capital
  • Jeff Hales of Alignvest Capital
  • Scott Ferguson of Sachem Head Capital Management
  • Chuck Akre of Akre Capital
  • Guy Gottfried of Rational Capital
  • Sahm Adrangi of Kerrisdale Capital
  • John Thiessen of Vertex One

What Are We Supporting?

We are committed to raising funds in support of the highest priority needs of the Centre for Brain and Mental Health. An investment in one of the key funding priorities listed below will help ensure that SickKids remains at the forefront of brain health research, learning, and care for the benefit of children everywhere:

  • Seed Funding Grant Competition
  • Integrative Fellowships
  • Knowledge Translation Program
  • Neonatal Intensive Care Unit (NICU) MRI Scanner
  • Epilepsy Classroom

Register for Capitalize for Kids Investors Conference

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MoI Cover

John Mihaljevic’s The Manual of Ideas: The Proven Framework For Finding The Best Value Investments builds on his and his brother Oliver’s wonderful work with the Manual of Ideas newsletter.

The book is a  comprehensive assay of value investment theories, accompanying methods for identifying undervalued stocks, and practical considerations in the application of each strategy. John covers the following value investment methods:

  • Benjamin Graham’s “cigar butt” rule;
  • the sum-of-the-parts analysis;
  • Joel Greenblatt’s “Magic Formula”;
  • small cap stocks;
  • special situations;
  • equity stubs; and
  • international stocks.

John also suggests following great managers, and using the portfolios of “superinvestors” as a source of ideas.

The book is set out in logical, easy-to-follow format, and it is a worthwhile addition to any value investor’s library. It will be most useful to intermediate-level value investors who have developed an appreciation for the art, but not yet settled on a style. For my part, I am an advocate for “deep value,” which John limits to Grahamite net nets and subliquidation stocks, but which I define more broadly. (My definition covers most of the methods John highlights excluding Greenblatt’s “Magic Formula” for the reasons I have discussed in several posts including How to beat The Little Book That Beats The Market: An analysis of the Magic Formula and How to beat The Little Book That Beats The Market: Redux.) I highly recommend it.

Buy John Mihaljevic’s The Manual of Ideas: The Proven Framework For Finding The Best Value Investments.

Disclosure: I was provided with a free copy of the book for review, and I am quoted in it. I receive a small commission for books purchased on Amazon through this site.

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The Hong Kong University of Science and Technology Value Partners Center for Investing has examined the performance of value stocks in the Japanese stock market over the period January 1975 to December 2011. They have also broken out the performance of value stocks during Japan’s long-term bear market over the 1990 to 2011 period, when the stock market dropped 62.21 percent.

The white paper Performance of Value Investing Strategies in Japan’s Stock Market examines the performance of equal-weight and market capitalization weighted quintile portfolios of five price ratios–price-to-book value, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-priceexcluding the smallest 33 percent of stocks by market capitalization.

The portfolios were rebalanced monthly over the full 37 years.

The authors find the value quintile of equal-weighted portfolios book-to-market, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-price generated monthly returns of 1.48 percent (19.3 percent per year), 1.34 percent (17.3 percent per year), 1.78 percent (23.6 percent per year), 1.66 percent (21.8 percent per year) and 0.78 (9.8 percent per year) percent in the 1975–2011 period.

The returns diminished over the 1990 to 2011 period. The value quintile of equal-weighted portfolios book-to-market, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-price generated monthly returns of  0.84 percent (10.6 percent per year), 0.78 percent (9.8 percent per year), 1.31 percent (16.9 percent per year), 1.13 percent (14.4 percent per year) and 0.0 percent (0.0 percent per year) in the 1990–2011 period, respectively. In contrast, the Japanese stock market lost 62.21 percent.

They find similar results for market capitalization-weighted portfolios sorted by these measures, as well as for three-, six-, nine-, and twelve-month holding periods (excluding the leverage-to-price ratio).

They also investigated the cumulative payoff in dollar terms of investing $1 in the portfolios having the highest values of our value measures with monthly portfolio rebalancing in the 1980–2011 period. Value investing strategies based on stock’s book-to-market, dividend yield, earning-to-price , cash flow-to-price , and leverage-to-price grew $1 into $115.98, $81.88, $433.86, $281.49, and $6.62 respectively, while the aggregate stock market turned $1 into a mere $2.76, in the 1980–2011 period. This implies that these value investing strategies rewarded investors 42.0, 29.6, 157, 102 and 2.40 times what the Japanese stock market did. The effective monthly compound returns of the various investing strategies are 1.25 percent, 1.16 percent, 1.60 percent, 1.48 percent and 0.49 percent, while the aggregate stock market only delivered 0.27 percent in this period.

Japan Value

Four out of five value investing strategies actually rewarded investors with positive returns in the bear market that spanned two decades from 1990 to 2011, turning $1 into $4.77, $4.25, $17.17, and $10.91, implying profits of 377 percent, 325 percent, 1617 percent, and 991 percent respectively, while the stock market plunged 62.21 percent after reaching its peak in January 1990. In addition, every one of these value investing strategies continued to generate positive returns between the pre-global financial crisis peak in 2007 and December 2011.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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In The Siren’s Song of the Unfinished Half-Cycle John Hussman has a great annotated chart comparing the ten-year returns estimated by the Shiller PE to the actual market returns that emerged over the following ten years from each estimate (from 1940 to present):

Hussman estimates the ten-year return using a simple formula:

Shorthand 10-year total return estimate = 1.06 * (15/ShillerPE)^(1/10) – 1 + dividend yield(decimal)

He justifies his inputs to the simple formula as follows:

Historically, nominal GDP growth, corporate revenues, and even cyclically-adjusted earnings (filtering out short-run variations in profit margins) have grown at about 6% annually over time. Excluding the bubble period since mid-1995, the average historical Shiller P/E has actually been less than 15. Therefore, it is simple to estimate the 10-year market return by combining three components: 6% growth in fundamentals, reversion in the Shiller P/E toward 15 over a 10-year period, and the current dividend yield. It’s not an ideal model of 10-year returns, but it’s as simple as one should get, and it still has a correlation of more than 80% with actual subsequent total returns for the S&P 500.

Here is Hussman’s application of the simple formula to several notable points on the chart and comparison to the subsequent returns:

For example, at the 1942 market low, the Shiller P/E was 7.5 and the dividend yield was 8.7%. The shorthand estimate of 10-year nominal returns works out to 1.06*(15/7.5)^(1/10)-1+.087 = 22% annually. In fact, the S&P 500 went on to achieve a total return over the following decade of about 23% annually.

Conversely, at the 1965 valuation peak that is typically used to mark the beginning of the 1965-1982 secular bear market, the Shiller P/E reached 24, with a dividend yield of 2.9%. The shorthand 10-year return estimate would be 1.06*(15/24)^(1/10)+.029 = 4%, which was followed by an actual 10-year total return on the S&P 500 of … 4%.

Let’s keep this up. At the 1982 secular bear low, the Shiller P/E was 6.5 and the dividend yield was 6.6%. The shorthand estimate of 10-year returns works out to 22%, which was followed by an actual 10-year total return on the S&P 500 of … 22%. Not every point works out so precisely, but hopefully the relationship between valuations and subsequent returns is clear.

Now take the 2000 secular bull market peak. The Shiller P/E reached a stunning 43, with a dividend yield of just 1.1%. The shorthand estimate of 10-year returns would have been -3% at the time, and anybody suggesting a negative return on stocks over the decade ahead would have been mercilessly ridiculed (ah, memories). But that’s exactly what investors experienced.

The problem today is that the recent half-cycle has taken valuations back to historically rich levels. Presently, the Shiller P/E is 22.7, with a dividend yield of 2.2%. Do the math. A plausible, and historically reliable estimate of 10-year nominal total returns here works out to only 1.06*(15/22.7)^(.10)-1+.022 = 3.9% annually, which is roughly the same estimate that we obtain from a much more robust set of fundamental measures and methods.

Simply put, secular bull markets begin at valuations that are associated with subsequent 10-year market returns near 20% annually. By contrast, secular bear markets begin at valuations like we observe at present. It may seem implausible that stocks could have gone this long with near-zero returns, and yet still be at valuations where other secular bear markets have started – but that is the unfortunate result of the extreme valuations that stocks achieved in 2000. It is lunacy to view those extreme valuations as some benchmark that should be recovered before investors need to worry.

The actual return deviates from the estimated return at several points, including the most recent ten-year period from 2002. Hussman comments:

Note that there are a few points where the estimate of prospective market returns would have differed from the actual market returns achieved by the S&P 500 over the following decade. These deviations happen to be very informative. When actual returns undershoot the estimate from a decade earlier, it is almost always because stocks have moved to significant undervaluation. When actual returns overshoot the estimate from a decade earlier, it is almost always because stocks have moved to significant overvaluation. Note the overshoot of actual market returns (versus expected) in the decade since 2002. The reason for this temporary overshoot is clear from the chart at the beginning of this weekly comment: the most recent 10-year period captures a trough-to-peak move: one full cycle plus an unfinished bull half-cycle.

While Hussman’s formula is exceedingly simple, with a correlation of more than 0.8 it’s also highly predictive. It’s currently estimating very attenuated returns, and investors should take note.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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Earlier this week I posted about the current controversy around the cyclically-adjusted earnings in the Shiller PE, most notably the contention that the real earnings used in the Shiller PE are lower than they would otherwise be because of two serious earnings recessions.

Another question about the Shiller PE is how accurate it has been historically as a forecasting tool. Asness has backtested the performance of the market from various Shiller PE starting points from 1926 to 2012, finding as follows:

Asness Shiller PEs

Asness observes:

Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker (best cases remain OK from any decile, so there is generally hope even if it should not triumph over experience!).

The Shiller PE at the time of Asness’s article was 22.2, and the current Shiller PE is 23.4. Both are squarely in the middle of the highlighted row:

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations. This could happen. For instance, it could happen if total real earnings growth surprises to the upside by a lot for a very long time. But unless you are comfortable with forecasting that, or some other giant positive surprise, we believe one should give credence to the lower forecasted average returns from history. While market timing might not be the answer, changing your plans — assuming a lower expected market return, perhaps saving more or spending less, or making changes in your portfolio structure — are all worth serious consideration. I think the Shiller P/E is quite meaningful for planning.

Asness examines several other interesting market-level valuation metrics, finding that they tend to support the implications of the currently elevated Shiller PE, noting:

Some outright hucksters still use the trick of comparing current P/E’s based on “forecast” “operating” earnings with historical average P/E’s based on total trailing earnings. In addition, some critics say you can’t compare today to the past because accounting standards have changed, and the long-term past contains things like World Wars and Depressions. While I don’t buy it, this argument applies equally to the one-year P/E which many are still somehow willing to use. Also it’s ironic that the chief argument of the critics, their big gun that I address exhaustively above [from the earlier post], is that the last 10 years are just too disastrous to be meaningful (recall they are actually mildly above average).

He concludes:

While it’s indeed important to remember that no valuation measure is near perfect (I stress that in my initial table), I do believe that the Shiller P/E is a reasonable method, an unbiased method (it’s been 15+ years since it was created so nobody cherry picked it to fit the current period), and a method that is decidedly not “broken” based on today’s inputs. It has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view the critics have not provided a good reason this time around — I think you are making a mistake.

The current Shiller PE of 23.4 implies a real return of less than 0.9 percent per year for the next decade, with a best-case scenario less than 8.3 percent annually, and a worst-case scenario of less than -4.4 percent annually.

Read An Old Friend: The Stock Market’s Shiller P/E (.pdf).

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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AQR’s Cliff Asness released in November last year a great piece called, “An Old Friend: The Stock Market’s Shiller P/E (.pdf)” dealing with some of the “current controversy” around the Shiller PE, most notably that the real earnings used in the Shiller PE are lower than they would otherwise be because of two serious earnings recessions: the tail end of the 2000-2002 recession, and the monster 2008 financial crisis.

The Shiller P/E represents what an investor pays for the last 10 years’ average real S&P 500 earnings. The ten-year average is believed to be a more stable measure than a P/E based on a single year of earnings, and therefore more predictive of long-term future stock returns and earnings. Asness notes that the selection of a ten-year average is arbitrary (“You would be hard-pressed to find a theoretical argument favoring it over, say, nine or 12 years”), but believes that it is “reasonable and intuitive.”

Asness asks, “[W]hy do some people dismiss today’s high Shiller P/E, saying it’s not a problem? Why do they forecast much higher long-term real stock returns than implied by the Shiller P/E?”:

They point out that we had two serious earnings recessions recently (though only the tail end of the 2000-2002 event makes it into today’s Shiller P/E), including one that was a doozy following the 2008 financial crisis.

So we have to ask ourselves, is the argument against using the Shiller P/E today right? Are the past 10 years of real earnings too low to be meaningful going forward (meaning the current Shiller P/E is biased too high)?

Asness shows the following chart of a rolling average of 10-year real S&P 500 earnings (a backwards looking 10-year average):

Asness 10 Year Rolling Average

The chart demonstrates that 10-year real earnings used in the Shiller P/E are currently slightly above their long-term trend. At their low after the financial crisis, they fell back to approximately long-term trend. Asness comments:

It has not, in fact, been a bad prior decade for real earnings! The core argument of today’s Shiller P/E critics is just wrong.

While the graph speaks for itself, there is some logic to go with the picture. Critics of the Shiller P/E point to the earnings destruction right after 2008 and ask how we can average in that period and think we have a meaningful number? After all, aren’t we averaging in a once-in-a-hundred-year event? But they usually do not object at all to the very high earnings, for several years, right before the bubble popped in 2008. One view of earnings is that the 2008 event stands alone. It didn’t have to happen, and doesn’t have relevance to the future and should be excluded from our calculations lest it bias us to be sour pusses. That is not my view (granted I’m a bit biased to sour puss in general). Another very different view is that the earnings destruction post 2008 was making up for some earnings that, for several years prior, were “too high”, essentially borrowed from the future. In this case, the post 2008 destruction is valid for inclusion as it’s simply correcting a past wrong. Rather than invalidate the Shiller method, the 2008 earnings destruction following the prior earnings boom is precisely why the CAPE was created! Not surprisingly I fall into this latter camp.

I think the above graph is a TKO. Those who say the Shiller P/E is currently “broken” have been knocked out.

So, according to Cliff Asness, despite the recessions in 2000-2002 and 2008, the real ten-year average of earnings used in the Shiller PE is slightly above its long-term trend.  Note that the current Shiller PE multiple of 23.5 is also about 42 percent above its long-term average of 16.5. Together, these two observations make the market look very expensive indeed.

Read An Old Friend: The Stock Market’s Shiller P/E (.pdf).

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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