What a Time to Be a Value Investor

Includes: DIA, QQQ, SPY
by: Todd Kenyon, CFA

It's a value bonanza out there!Aren't you feeling joyous about the stock market? If you're a value investor, you should be. If however you're a normal human being you are probably in a deep state of depression.

There is simply nothing to be optimistic about right now. Times are tough and look to be getting nothing but tougher. Forget about the quarter, let's look at year to date stock performance. It's awful. We all know why, there is no need to spend much time on the contributing factors: energy prices, commodity prices, credit crunch, and housing crisis. If you have been brave (stupid?) enough to buy stocks this year (excluding energy or commodity related stocks) you have likely lost notable amounts of money. I know I have.

Or have I? My portfolio has declined slightly more than the market YTD, or 14% - very painful. But I don't consider these permanent declines and hence I am not selling for the most part. Mr. Market is in no mood to pay me what I think my companies are worth, so I'll hold them until he is. In fact, I'll hold them until he wants them so bad he can taste it. Right now, no one wants to buy anything other than energy or commodities. There is way too much near-term uncertainty, and things that look cheap just get cheaper. Most of Wall Street lives and dies on short-term performance, so it's just not worth it to buy anything - or to put a "buy" rating on a cheap stock if you're an analyst - heck it might be down more at the end of the next quarter, and that could cost you your job.

This is precisely the type of environment where long-term value investors become giddy. Which is precisely the reason that value investors are freaks. They have to be able to go against their human nature, ignore emotions, and ignore the crowd. They have to rely on their own conviction that they are right while the market tells them (at length) that they are wrong. They have to be able to withstand looking like an idiot for long periods of time. This is precisely why there are so few truly great value investors.

Seth Klarman of the Baupost Group certainly qualifies. His $12B fund has returned almost 20% annually to investors since 1982. Although it's a "hedge fund", he uses no leverage, and shorts very little. His returns have come through buying good value with large margins of safety.

In a recent interview, Mr, Klarman succinctly described the lot of a value investor:

"We as a firm are always going to buy too soon and sell too soon. And I'm very at peace with that. If we wait for the absolute bottom, we won't buy very much. And when everybody's selling, there tends to be tremendous dislocation in the markets."

When asked why some managers fail:

"Their clients are pressuring them for short-term results, or they think their clients want short-term results. That's probably the biggest problem for professional money managers. It makes it very, very hard for an investor to hold a stock that's going down, to take a contrary viewpoint."


"But human nature makes it hard for the markets to be efficient... So the question is not, Are people smart, are people sophisticated, do they have clever ways of looking at things, are they looking in the right areas? The question is, Are there periods when none of that matters because their human natures get the best of them?"

I think this is definitely one of those periods. Like Seth, I bought too early in many cases, but I am largely fully invested now. I don't have a clue when the market will bottom, only that it WILL bottom. I bought what I think are good companies at what I thought were very good prices. Time will tell if I was right. Let's not forget that my Vestopia portfolio is my own money, so I feel the pain directly. The problem now is that my portfolio is largely anti-oil, anti-commodities, anti-recession, and anti-credit crisis, because that's the stuff no one wants and hence it's cheap. Hard to believe that it's not down a lot more than the market in light of that actually.