Friday, November 4, 2022
Volume 3, Issue 53
Quote of the Week
“If we assume that it is the habit of the market to overvalue common stocks which have been showing excellent growth or are glamorous for some other reason, it is logical to expect that it will undervalue — relatively, at least — companies that are out of favor because of unsatisfactory developments of a temporary nature. This may be set down as a fundamental law of the stock market, and it suggests an investment approach that should prove both conservative and promising.”
— Benjamin Graham, The Intelligent Investor
Unpopular Large Companies
Two months ago, I wrote about the perennial debate over whether growth or value investing represents the best way to achieve market-beating returns. Whenever the question of growth and value comes up, Benjamin Graham is usually mentioned as a proponent of “deep value” strategies. Most investors associate Graham’s style with “cigar butt” investing — that is, searching for businesses that might be dying but are trading at such cheap levels that a buyer might still get a few puffs out of it.
The reality is that Graham’s investing style was never one dimensional. Many investors either do not know or have forgotten that he advocated a passive approach for most people. Only enterprising investors, those who are willing to do the hard work involved in security selection, should deviate from a passive strategy.
For those who take an active approach, Graham suggested three distinct strategies:
- The Relatively Unpopular Large Company
- Purchase of Bargain Issues
- Special Situations or Workouts
Looking for bargain issues is what we would refer to as “cigar butt” investing which often means looking for stocks selling under net current asset value. In most market environments, such opportunities are relatively rare. Special situation investing might involve taking a position in an overcapitalized business such as Dempster Mill Manufacturing Company in the 1960s or George Risk Industries in the early 2010s. Special situations also include merger arbitrage and related ideas.
For some reason, investors rarely discuss Graham’s recommendation to look at unpopular large companies. I first wrote about this approach in 2010 after one of my periodic re-reads of The Intelligent Investor. There are many reasons to look at unpopular large companies. The most important benefit is that there are almost always plenty of unpopular large companies in any market environment. Favoring large companies might also involve a larger margin of safety, as Graham describes:
“The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. While small companies may also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.”
Of course, if a well-known large company is out of favor, there are usually very good reasons for the unpopularity. In the October 14 Weekly Digest, I linked to an article that compared the sentiment surrounding Meta Platforms with the negative consensus outlook for Microsoft in the early 2010s. Since mid-October, Meta shares have collapsed another 30% and are trading under $90 as I am typing these words.
Meta’s third quarter financial results were greeted negatively by investors concerned about the health of the company’s core advertising business and the ongoing operating losses at the Reality Labs segment charged with the company’s metaverse initiatives. There is no doubt that Meta is a large company, with a market capitalization of $238 billion, and there is no doubt that it is unpopular with a stock price that has collapsed nearly 75% from its 52 week high.
But just because a large company is unpopular and trading at a modest multiple of trailing earnings does not mean that it qualifies as an intelligent investment by Graham’s standards. The key caveat in Graham’s approach is that the problems facing the company must be temporary. In the case of Meta, CEO Mark Zuckerberg is determined to continue plowing cash into the Reality Labs segment and he has provided no real insight into when these investments might pay off. There is no prospect of outside investors forcing a change in strategy. Mark Zuckerberg has an unassailable controlling interest due to his ownership of super-voting shares.
Meta is a widely held stock that appears in many of the super-investor portfolios tracked by dataroma.com. As we approach the deadline for large institutional investors to file 13-F reports with the Securities and Exchange Commission for their portfolios as of September 30, it will be interesting to see how many value-oriented managers took positions in Meta during the third quarter.
Disclosure: No position in Meta.
Meta Myths by Ben Thompson, October 31, 2022. Many investors believe that Meta is dying, but Ben Thompson is doubtful about such a dire point of view. He has identified five “myths” that he believes bearish observers have mistaken as facts. Highly recommended for those interested in Meta. “Forget five lenses: there are five myths about Meta’s business that I suspect are driving this extreme reaction; all of them have a grain of truth, so they feel correct, but the truth is, if not 100% good news, much better than most of those dancing on the company’s apparent grave seem to realize.” (Stratechery)
TransRe-Buffett deal signifies belief in reinsurance amid market turmoil, October 24, 2022. TransRe is a unit of Alleghany Corporation which was acquired by Berkshire Hathaway last month. In this article, Rudiger Skaletz, chief business development officer of TransRe in Europe, comments on the important vote of confidence expressed by Berkshire’s acquisition, the impact of inflation on reinsurance pricing, and other topics. “It is very reassuring to see an investor like Buffett buying into reinsurance because he believes the philosophy of reinsurance has a future. That is reassuring for the whole market and, obviously, for us specifically.” (Intelligent Insurer)
Is Berkshire Hathaway’s Activision Blizzard Arbitrage Play In Trouble? by Kingswell, November 3, 2022. Microsoft’s proposed acquisition of Activision Blizzard could be in trouble based on the wide spread that exists between the stock price and the proposed transaction price. This article provides a good recap of the potential regulatory issues that remain and a warning against blindly coat-tailing Warren Buffett’s merger arbitrage play. (Kingswell)
An Interview with Peter Lynch in 1996, Six Years After Retirement by Conor MacNeil, November 2, 2022. “I think it was just looking at different companies and I always thought if you looked at ten companies, you’d find one that’s interesting, if you’d look at 20, you’d find two, or if you look at hundred you’ll find ten. The person that turns over the most rocks wins the game. And that’s always been my philosophy.” (Investment Talk)
How I Write by Nassim Nicholas Taleb, October 30, 2022. It is hard to believe, but Nassim Taleb initially had a difficult time finding a publisher for Fooled by Randomness: “I remained undeterred by the insults in the rejection letters. Something I experienced even more acutely with The Black Swan, editors were not content in rejecting the book as a wise businessperson would reject an investment, by saying something like it may be great but I do not wish to take the gamble or politely appeal to caution. No; they went out of their way to explain with a lot of precision why it would flop, why nobody would read it.” (Medium)
Cumulative vs. Cyclical Knowledge by Morgan Housel, October 27, 2022. Many lessons in scientific fields are cumulative, but human nature guarantees that people will make the same financial mistakes again and again, failing to learn vicariously from the follies of others. “I can imagine a world in 50 years where things like cancer and heart disease are either non-existent or effectively controlled. I cannot ever imagine a world where economic volatility is tamed and people stop making financial decisions they eventually regret – no matter how much history of past mistakes we have to study.” (Collaborative Fund)
The problem isn’t that Elon Musk owns Twitter – it’s that you don’t by Hamish McKenzie. The co-founder of Substack shares his vision for the platform compared to large social networks like Twitter: “We believe that the next era of the social internet will be about deep relationships over shallow engagement; signal over noise; and ownership over serfdom. When people have the power over platforms, rather than the other way round, we can have more rewarding social experiences and healthier discourse, where we seek to understand our neighbors rather than score points against them. When the network is funded by paid subscriptions, not ads, trust relationships trump viral content.” (On Substack)
Spreadsheet Leadership by David Perell, October 31, 2022. “In-N-Out Burger is what it is today because Snyder was spreadsheet-informed, not spreadsheet-driven. He saved costs with inventions like the drive-thru microphone that we all take for granted now (yep… In-N-Out Burger invented the drive-thru microphone). Snyder also kept a spartan menu. Doubling down on burgers and fries meant he didn’t need to spend money on new equipment or training employees to cook new menu items.” (Monday Musings)
- Related book review: In-N-Out Burger: A Behind-the-Counter Look at the Fast-Food Chain That Breaks All the Rules, January 8, 2011. (The Rational Walk)
On a road trip last week, I had an opportunity to listen to three episodes of Founders, the podcast series hosted by David Senra. Although there are now 275 episodes of Founders, I only came across this podcast recently. Here are the episodes I listened to.
- Mark Leonard’s Shareholder Letters, May 13, 2022. 56 minutes. Mark Leonard is the Founder and President of Constellation Software, a company that I have heard about but never studied. Constellation is a serial acquirer of small software companies operating in specific vertical markets. Since I once worked in the software industry in a small company that made vertical market products, I found the entire discussion of Mark Leonard’s shareholder letters quite interesting.
- Sam Walton: Made In America, February 28, 2022. 1 hour, 55 minutes. I knew that Sam Walton wrote a book, but I never realized that he wrote it in the final months of dying of cancer. Walton was not a man who would have written a book in normal circumstances. He was too driven to take action, but the prospect of his impending death convinced him to write this autobiography. I intend to read it.
- Socrates: A Man for Our Times, June 17, 2022. 47 minutes. While most of the Founders podcasts are about business leaders, there are some exceptions so I had to listen to the episode on Socrates. It is always interesting to think about how philosophical principles can apply to business matters as well as life in general.
Understanding cardiovascular disease risk, cholesterol, and apoB, October 31, 2022. 1 hour, 18 minutes. What’s the most common symptom that a patient with a first heart attack presents with upon arrival at an emergency room? You might be thinking of chest pain or numbness in an arm, but the sad reality is that the most common presentation is sudden death. In this compilation of clips from prior episodes, Peter Attia provides a great overview of the modern plague of heart disease. The discussion does get quite technical at times, but I still found it interesting. (The Drive)
Alan Mulally: The Power Of Working Together, November 1, 2022. 1 hour, 17 minutes. “Mulally is perhaps best known as the former President and CEO of the Ford Motor Company, which was struggling during the late-2000s recession before Mulally used his teamwork-oriented philosophy to save the company. Under Mulally’s leadership from 2006-14, Ford was the only major car manufacturer to avoid a government bailout … Before joining Ford, Mulally spent more than three decades at Boeing …” (Farnam Street)
Photo of the Week
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