So I headed up to Manhattan recently with Dan Amoss, who writes the Strategic Short Report. We met in Baltimore and caught a train north to attend the 2008 Columbia Investment Management Conference. There, an all-star cast of successful investors assembled to speak about this crazy craft we all find irresistible — and to offer some ideas.

Richard Pzena’s opening talk was the most interesting to me. In part, because what he had to say was timely, yet full of timeless wisdom. His title: “Surviving the Cycles of Investing.”

Good topic, considering the stomach-churning price action on Wall Street lately. And with the cloud of recession thick in the air, investors seem awfully full of worry. Pzena had some soothing words.

Pzena says there were only eight years in the last 40 when you would’ve been down 20% using a simple value approach. (For purposes of his discussion, he used a simple value strategy of buying stocks only in the lowest quartile of the market ranked by price to book. But the point applies to all us cost-conscious investors.) One obvious conclusion from looking at his data — if you are a value-minded sort like me — is to shrug off the bad times and say, “Who cares?”

“The problem is,” Pzena notes, “when you’re losing 20%, it doesn’t feel very good.” It’s no accident, therefore, that most people can name the big bear market lows of the last four decades (1974, 1982, 1990…). That’s because these lows are relatively infrequent, but very painful. Amidst the pain of a prolonged bear market, Pzena relates, “you start to question what you’re doing. You start to wonder, Can I avoid those 20% down periods? Should I avoid them?”

To the first question, Pzena rolls out the shopworn, but time-honored wisdom that trying to predict exactly when these downdrafts will happen is impossible. And selling after the market has already taken its tumble is a sure loser.

Therefore, “riding through them is the smarter thing to do,” he advises. “The quest to get the timing right is what trips up most investors,” Pzena says. The best investors buy value when it’s offered and don’t worry about timing the market or fretting about recessions.

Many investors think that with a recession looming, or already here, it may be best to sit on the sidelines. One problem with this tactic is that economic health is extremely difficult to gauge. It’s not as if you can slap on a pair of latex gloves and say to the economy, “Turn left and cough.” So it’s very possible we would not know we were in a recession until it was almost over.

Furthermore, recessions tend to be good times for investors to buy value stocks. “How do you explain this phenomenon?” Pzena asks.

Here’s his answer: At the beginning of recessions, investors tend to continue buying the stocks that were acting well when the economy was growing. That means momentum stocks, or stocks that have gone up. But as you get into the recession, people start to think about valuation again. Momentum stuff starts to not make sense.

Are we in a recession now? Pzena didn’t hesitate to make a guess. “Anecdotally, yes. Toward the end of 2007, we had, at least, a major slowdown.”

And, not surprisingly, the stock market is beginning to offer some attractive bargains. Pzena points to price-to-book indicators. Right before 2007, there was a narrow gap between the lowest-valued quartile of stocks (based on their price-to-book) and the S&P 500. Meaning, the cheapest price-to-book stocks were only slightly cheaper than the rest of the market. But now, that gap is wide, Pzena says.

So parts of the market look attractive again. But what about those ugly headlines, you say? “This is why value works,” Pzena says. “Because when you see the list of stocks you own, you want to throw up.” It’s what gets you the pricing you want.

The savvy group at the conference was excited about the opportunities the market has given them. They are not alone. Several great mutual funds, long closed to investors, are now open again for new investors. These include the Tweedy Browne Global Value Fund, the Longleaf Partners Fund, the First Eagle Global and Overseas funds, the Third Avenue International Value Fund and the First Pacific Crescent Fund. They’re open because they have more ideas than they have money. They want to buy.

I’d give these funds a look, because they don’t tend to stay open for long. The opening of these funds, captained by investors with long track records of success, is also an indicator that the smart money is buying.

Sincerely,

Chris Mayer
March 28, 2008

Value Investors are Back with Big Plans was originally featured in the Penny Sleuth.

It’s not uncommon for me to sit on a mall bench with a book while she peruses store to store, negotiating a discount. “You’ll be so proud,” she says on a routine stop to my home base. “Neiman Marcus has a stunning Monique Lhuillier dress for half price, and I convinced the lady to take off another 10%.”

I, of course, say to myself (and let me stress “myself”) that 50% off at Neiman Marcus is still 50% more than at most places. But my thought more often than not remains, well, just a thought.

“What’s the intrinsic value?” I ask.

My wife tilts her head, raises those eyebrows and without hesitation assures me it’s more than the price. “And furthermore,” in a tone that assures me the discussion ends here, “it’s Saturday. Leave the finance downtown.”

I chuckle.

So goes the wonderful cadence of marriage.

My obsession with intrinsic value got her thinking. The other night, she opened up her brokerage statement. A few minutes later, she says, “Why does my broker have me in Apple? I thought you said Apple was too expensive.”

“Maybe he likes iPods,” I muse. She fails to find the humor.

“Seriously, Apple’s price-to-earnings ratio is well above 30. That’s expensive, right?”

“You should see the price-to-book,” I quip, trying to focus on the latest episode of The Wire. She grabs the remote and pushes pause.

We walk to the bookcase. Thirty minutes later, I find my wife 10 pages deep into Christopher Browne’s latest work, The Little Book of Value Investing.

It’s been three days now. Last night, she started reading an advance copy of Chris Mayer’s latest book, Invest Like a Dealmaker.

So the first thing this morning — and I mean first thing — she asks, “How do you compare EBITDAs around various industries?” Not your typical teeth-brushing conversation, but nonetheless, I’m very proud.

She has what it takes. She focuses on what she may lose well before she considers what she may gain. She sees the business, not the stock. Let me reiterate: I’m very proud.

So this morning, I sent her a recent letter from Third Avenue Management. I highlighted the following:

“Throughout Third Avenue’s more than two decades of existence, we have experienced several bear markets, yet the macro market environment has never influenced the process by which we select investments. To repeat, Third Avenue invests for the long term.

“Third Avenue has faced securities bear markets in the past and no doubt will face others in the future. Yet for long-term fundamental investors such as Third Avenue, the general market is relatively unimportant. In the long run, the performance of Third Avenue’s portfolios will be driven by the merits of the investments themselves, not by general market considerations. As such, we continue to focus on finding securities that meet our ‘safe and cheap’ investment criteria today, allowing for potential long-term growth in the future.”

We, like the better minds at Third Avenue, have no idea which way the market is heading. In the short run, we don’t really care what Mr. Market thinks. We know he’s been wrong before.

As investors, we’re looking to buy businesses that provide a margin of safety… Companies trading near or below their intrinsic value with established earning power. Leave the charts and quarterly earnings reports to traders. They’re playing a different game.

We’re looking to buy a business, not trade it. And as with any good purchase, we never want to pay too much.

Here’s why…

Let’s say you receive a windfall bonus of $10,000. You want to invest your newfound wealth in one of two options. Option A is a government bond yielding 5% annually. Option B is market’s latest highflying growth stock promising returns of 10% or more for the next 20 years.

You naturally assume 10% is better than 5%, so you pour your $10,000 into the highflier.

As it turns out, you bought your golden stock on a 52-week high. The first year is rough…the stock loses 50% of its value over the first 12 months. But you hang on, and sure enough, the stock starts taking off. It grows at a remarkable 10% annual pace.

But even at a growth rate double that of the government bond, it would still take you 17 years to overtake that bond’s return!

Now, I’m sure that tech stocks, swank hedge funds and their excessive fees and other “insider” investments make great stories. They make you feel good when you proudly tell your neighbor that your broker just slipped you into some exclusive nanotechnology company that promises to turn the Earth on its axis, reverse the spin and solve the world’s energy problems all at the same time.

Meanwhile, my wife, the budding value investor, plans to keep a good portion of her money in a first-class company that supplies the world with cement. She notes that shares of the business trade for a very reasonable price. She also notes a recent report suggesting that modernizing urban water, electricity and transportation systems over the next 25 years, according to Booz Allen Hamilton, would require $40 trillion — “a figure roughly equal to the 2006 market capitalization of all shares held in all stock markets in the world.” She’s convinced that’s going to require one massive amount of cement. I agree.

And she’ll make her investments just as everyone should make their investments…with a margin of safety.

Until next time,

Christopher Hancock
January 25, 2008

P.S.: You have probably heard of Chris Mayer a number of times. He is one of the leading experts in value investing. His new book, Invest Like a Dealmaker, will be released on March 3, 2008. Look for more details about it in future editions of Penny Sleuth.

Learning to be a Value Investor was originally featured in the Penny Sleuth.