It’s no surprise to anyone keeping up with the news that we live in an investing culture that values everything but investing.
Nowadays, everyone sprints for the Next Big Idea that can hand them quick and easy gains. This was the same mentality that pushed a cryptocurrency with no real-world value above $19,000 last year, and shares of a massive e-commerce company up to 572 times earnings.
Quite frankly, I’m sick and tired of this “growth beats value” and “value investing is dead” B.S. that’s been dominating financial TV lately.
At this point, I just want to punch the next smug-looking, slick-haired 25-year-old that recommends buying growth to me or the world at large.
They must have gone to the same school, because they all espouse the exact same inaccurate gibberish. All of these alleged investment geniuses cite numbers showing how badly the value index has underperformed the growth index over the past few years.
Just for kicks, let’s go ahead and dissect that gibberish – and examine just how inaccurate it really is…
The Growth Guys Are Lying to Your Face
The bellwether for value investing in the United States is the Russell 1000 Value Index, which tracks large- and mid-cap companies that “exhibit value characteristics,” per the official website.
As for what exactly those value characteristics are, well… that’s where things start to get moronic.
Per the official website, they’re metrics like price-to-book ratio, which is something I watch like a hawk in companies that cross my radar.
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The Value Index tracks companies in the Russell 1000 with lower price-to-book (P/B) ratios and price-to-earnings (P/E) ratios relative to the entire index’s average. As of this writing, the Index’s average P/B ratio is a little over 2 and the P/E ratio is at 20.
Riddle me this: what kind of slack-jawed anti-genius thinks a P/B ratio over 2 and P/E ratio of 20 are “value characteristics”?
These stocks may be cheaper than the top half of the index, but they are not cheap by any means. For context, the top holdings include Johnson & Johnson (NYSE: JNJ) and AT&T Inc. (NYSE: T). These are mostly blue chips, making them far from the epitome of value investing at today’s market levels.
Let’s dive a little deeper and check out the Russell 200 Index. Again, its average P/B is about 1.53 and average P/E is 16.06.
Those are slightly better than the large-cap value index, but still not cheap in the classic sense of the word. You know, the sense that can net us triple- and quadruple-digit returns as the value of the company’s assets rises to meet their real value.
None of this is real value investing at all.
A company that’s cheaper compared to expensive companies is not a buy. This is called Relative Value Investing, or, as I like to call it, running a con on the public to collect millions in fees to pay for ridiculously overpriced suits.
Are there highly educated, finance-degree-carrying idiots out there who really think Ben Graham, Walter Schloss, and Seth Klarman made all their money buying popular stocks at double-digit P/E ratios or high book values?
I can assure you they did not.
True Value Investing is not done in the middle of the pack. It does not take place in the middle of the bell curve. Real, honest-to-God value types are out on the edges of the tail, scouring for extraordinary opportunities with a high margin of safety.
While that may sound easy, it takes years, even decades, to cultivate an understanding of what exactly constitutes a valuable “buy” opportunity.
I’ve been on that journey for 30 years now, and while I’m nowhere near the smartest guy in the world, my track record of nonstop triple-digit winners since 2013 shows I may know something about what I’m talking about.
And the bulk of my method, believe it or not, boils down to just two simple steps.
Here’s how I thumb my nose at those growth morons…
How to Find the Most Valuable Companies on the Market
To narrow down my list of undervalued “buys,” I run two core value searches every week.
I run a first one based on price-to-tangible-book value, and then a second based on price before earnings, interest, and taxes (EBIT).
Once I have my list, I use some credit and fundamental methods to make sure I have a margin of safety and that the companies in my portfolio don’t end up on the scrap heap of distressed and damaged businesses.
On average over the last decade, there have about 35 stocks that fit the bill at any given time. At the bottom of the credit crisis, 123 companies qualified as strong investments.
Think about that: about 4,500 stocks trade on the U.S. exchanges, pink sheets, and other dark corners of the Nasdaq markets. On any given day, less than 50 usually meet the rigid criteria that represent a real bargain opportunity with an adequate margin of safety.
The average market cap of these firms is less than $1 billion. You could buy every company in the portfolio in its entirety for less than $50 billion. Now consider that Fidelity alone manages almost $2 trillion.
The biggest funds cannot play this game, but you and I can.
And we should, because it pays extremely well.
If you started using this approach 10 years ago, it would have averaged you gains of 15.5% a year. That means $10,000 invested on day one has grown to about $42,250.
If that sounds like the juice isn’t worth the squeeze, consider how investing that same amount in the highly touted S&P 500 would’ve only returned 8.5% a year, turning $10,000 into only $22,730.
We made almost twice as much by focusing on those stocks the others could not afford to touch.
If you want to make money, do what the big money and indexers refuse to do. Or, if you’d prefer to just screw around, go back to worrying about whether or not Amazon.com Inc. (Nasdaq: AMZN) beat earnings estimates. After all, everyone says growth is beating value, so they can’t possibly be wrong.
Unless you use math and numbers to look at the data, that is.
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