Bargain hunters might want to pay attention to an often-overlooked number - retained earnings - among the beaten down rubble in the stock market. It's a somewhat dry term for the cash a company has left after covering all its costs, including dividends paid to shareholders. Companies that report retained earnings show they are generating extra cash they can use to reinvest in their business, a positive sign about management performance, especially in turbulent economic times such as now when cash on hand and cash generation seem more important than ever.
The volatile stock market may be uncovering an opportunity for investors who have been on the lookout for deeply discounted stocks.
Deep value investing is a concept developed by Benjamin Graham, whose work helped inspire generations of investors including Warren Buffett. His idea was to pick stocks with prices that were significantly lower than their economic value. That doesn't mean the cheapest stocks in the market, necessarily. Instead, it is a comparison of a stock's trading price to an assessment of its intrinsic value.
In Berkshire Hathaway's 2019 annual letter released on February 22, 2020, Warren Buffett wrote the following about the criteria he and Charlie Munger use when looking to buy entire companies and stocks. Buffett writes: "We constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.
For billionaire investor Warren Buffett, one unlikely stock has dominated his strategy for the last four years. It's an American technology company famous for its sleek gadgets and unwavering customer loyalty. That's right, Buffett, who once famously shied away from tech stocks because he didn't understand them, has not so quietly become the second-biggest shareholder in Apple (AAPL) by way of his conglomerate, Berkshire Hathaway.
Warren Buffett has made enough money by investing over the decades to warrant the attention he gets. But why haven't others been able to generate the billions of dollars of personal wealth he has amassed using the same techniques?
With the U.S. stock market reaching all-time records, thoughts turn to next year, and whether the long-awaited shift to value stocks has arrived.
Value investors haven't had much good news to keep them going in the past few years. Low interest rates and slow economic growth worked against the strategy. Growth-oriented stocks, particularly in the technology sector, have dominated the headlines. But then it happened. There was a surge in value stocks starting in late August, stoking hope that the shift away from highly valued technology stocks toward undervalued companies was beginning.
It's difficult for investors to accept that sometimes they have to lose the battle to win over the long-term. Short-term underperformance should be expected once in a while, even by the top-rated managers, according to the prevailing research. Indeed, in 2016, Newfound Research found that the probability in a five-year time that a manager will have a year of 10% underperformance was something like 60%.
It's not surprising that everyone thinks the value investing model is broken. So-called value stocks, selected because they have cheap book values relative to others, have badly underperformed the broader market during this decade-long bull run. Instead, growth-oriented and large cap technology stocks have grabbed all the headlines. It's enough to forget that over the much longer-term, value stocks have beaten other investing styles and the market as a whole. But there is a belief in the markets these days that the value model is broken.
If the dizzying swings in the stock market over the past few days offer any lesson at all, it's that sticking to your investing process isn't always as easy as it sounds during calmer times. As experienced investor Joel Greenblatt would say, the market will eventually agree with you, it's just not always possible to pinpoint when.
With stocks hitting new record highs and the bull market nearly a decade old, it may seem like an odd time to think about the next downturn. But as the old saying goes, hope for the best and prepare for the worst. The S&P 500 is up more than 380 per cent, including reinvested dividends, since the depths of the financial crisis in March of 2009. The Dow Jones Industrial Average topped 27,000 recently. Despite some warnings of an economic slowdown ahead, investors are pushing stocks higher. It's important not to get complacent, though. Since there is no easy way to predict with certainty the coming of a bear market, it's best to start thinking about the next one long before conditions start to deteriorate.
Some people have all the luck. They win the lottery or find a $10 bill in the pocket of a pair of pants they haven't worn since last winter. They invest in a stock just as it takes off. They put seemingly no effort into their success. Investors should remember that they can't count on being lucky. This temptation is hard to avoid. Most people with any experience in the stock market know there's no sure-fire way to beat it in the short term, but there are always one or two investors who make winning look easy. They grab the headlines, and everyone else is left to wonder where they went wrong.
For bargain-hunting value investors, watching the stock market's more or less steady climb higher over the past few years must have felt like finding a stray $20 bill on the ground - right next to a grizzly bear. Buying stocks when their prices are on an upswing would seem to be just as risky as reaching near the grizzly for that $20 bill. But many value investors have been able to make up for underperforming value strategies by taking the plunge into momentum investing for part of their portfolios.
Earlier this month, Warren Buffett revealed to the world that Berkshire Hathaway Inc. had taken on its first stake in the e-commerce juggernaut Amazon.com Inc. A regulatory filing on Wednesday confirmed how much: 483,300 shares, or US$860.6-million worth of stock, as of March 31. For years, the billionaire value investor famously avoided high-flying tech stocks such as Amazon, which have dominated index returns for the past year-and-a-half. But he seems to have come around to a new way of thinking about what it means to be a value investor.
Dividend investors may be leaving some money on the table. Picking stocks based on their dividend payouts is a time-tested strategy, boosting returns for investors compared with the broad market and providing steady income. Bank and utility stocks come to mind. The companies generate a steady-enough amount of cash that management feels comfortable paying it back to shareholders in a predictable way. But company managements are increasingly using the share buyback as a way to return capital to shareholders, and strict dividend investing doesn't capture that activity.
Avoid overpaying for stocks. That's the consistent message from the world's most successful investors. This rule applies under any market condition, including the current long-running bull market. December's rout cleared out some room for bargain hunters until the rebound so far this year reclaimed the lost ground, but there still are ways to spot the good opportunities while eliminating some of the guesswork. Warren Buffett's technique is to buy well-priced stocks of quality companies. It is a slight twist on the view of Benjamin Graham, the father of value investing, who looked for stocks that were trading cheaply relative to others and the value of the underlying businesses.
Investors in emerging markets had their heads handed to them in 2018, losing roughly 18% of their value on the year. If that wasn't bad enough, just days before the World Economic Forum was slated to begin in Davos, Switzerland, the International Monetary Fund released its World Economic Report for 2019 and 2020. And, the forecast wasn't great.
After letting off steam late last year, stocks have bounced back in a post-holiday rally that gives some rays of hope for investors. While companies are resetting earnings growth expectations lower this year, last year's stock sell-off means there are likely some real bargains out there. One of the most widely used yardsticks used by investors to judge whether a stock is overpriced or undervalued is the price-to-earnings ratio, or earnings multiple. It is supposed to reflect how much investors are willing to pay for $1 of a company's earnings.
Commodities prices for basic materials (gold, silver and copper) and agriculture and livestock products (wheat, hogs, and cattle) have been in the doldrums for more than a year now. And, energy (oil and gas) has been in contango since June 2008. Contango is futures trader's jargon for the equivalent of an inverted yield curve, where the further out into the future you look, the lower price gets. The pain in the commodity trade may be about to change though.
Companies started this year with plenty of cash, thanks to a big tax cut, and they've put that money to work in the market. Specifically, they've been buying their own stock. Even Warren Buffett's Berkshire Hathaway joined the crowd, announcing recently it had acquired nearly US$1-billion of its own shares in the last few months. Through November, U.S. companies bought a record US$957-billion of their own stock and were on pace to top the US$1-trillion mark for the year, according to San Francisco-based TrimTabs Investment Research, though the activity does tend to slow in the last weeks of December.
Berkshire Hathaway (BRK.A), the global conglomerate headed by legendary investment guru Warren Buffett announced last week that it went into the open market earlier this summer and bought $928 million of its own stock. The market viewed it as big news, and Berkshire's stock was up 5% on the day of the announcement. The buyback was the tangible result of the company's recent change in its repurchase policy that allows Buffett and Berkshire Vice Chairman, Charlie Munger more flexibility in stock repurchases. It also shed further light on how differently Berkshire Hathaway views its cash--and its stock--than other public companies do.
When it comes to elections or economic issues, there's always a group of experts everyone turns to for predictions and forecasts. They aren't always right. Forecasting is difficult even with the best available data. Few people predicted the election of Donald Trump in 2016, and yet, here we are halfway through his presidential term. Last week's midterm elections, throwing the U.S. House of Representatives back to the control of the Democrats, was in keeping with the expected outcome, but few could have foreseen the turbulence in the markets leading up to polling day.
The Federal Open Market Committee, the monetary policymaking arm of the Federal Reserve, is scheduled to meet next on November 7. Those who watch the Fed closely don't expect to see any increase in the Fed Funds rate at that meeting. Nevertheless, the consensus view is that interest rates will continue to rise into 2020. The risks or benefits of higher interest rates are in the eye of the beholder. For borrowers, higher interest rates are a net negative. For savers, the reverse is the case. For banks, they are an absolute positive.
To paraphrase Rudyard Kipling, the world belongs to those who remain calm when others around them are losing their heads. That may be how we remember what transpired in the month of October. Most major indices corrected or came close to correction territory, and underneath the surface there was a lot of pain in many individual stocks. In general, bull markets climb a wall of worry and bear markets slide down a slope of hope. If all you looked at is the performance of stocks in October, there would seem there's much to worry about.
In South Carolina last week, someone or a group of people won the US$1.5-billion lottery jackpot, the largest in U.S. history. And believe it or not, two winners will share another jackpot of almost US$700-million. Imagine winning both. For nearly everyone, those odds are impossible to beat. But of course, there is eventually always a winner. If you pick your own numbers, you might be tempted to attribute your lottery success to skill, but there certainly is a lot of luck involved. The same holds true for investing, at least in the short term.
If there's one lesson to be learned from observing the habits of some of the most successful investors over the years, it's discipline. This sounds a lot easier than it is in practice. Human nature is emotional, and its instinct is to flee danger. Despite good intentions, it's easy for investors to chase hot stocks, react impulsively to market swings and make rash decisions that end up being costly mistakes. Along the way, long-term goals get kicked to the side and the most carefully constructed plan can get derailed. Investing for the long-term means resisting short-term reactions.
Performance Disclaimer: Returns presented on Validea.com are model returns and do not represent actual trading. As a result, they do not incorporate any commissions or other trading costs or fees. Model portfolios with inception dates on or after 12/30/2005 include a combination of back tested and live model returns. The back-tested performance results shown are hypothetical and are not the result of real-time management of actual accounts. The back-testing of performance differs from actual account performance because the investment strategy may be adjusted at any time, for any reason and can continue to be changed until desired or better performance results are achieved. Back-tested returns are presented to provide general information regarding how the underlying strategy behind the portfolio performed in our historical testing. A back-tested strategy has the benefit of hindsight and the results do not reflect the impact that material economic or market factors may have had on advisor's decision-making if actual client assets were being managed using this approach.
Optimal portfolios presented on Validea.com represent the rebalancing period that has led to the best historical performance for each of our equity models. Each optimal portfolio was determined after the fact with performance information that was not available at portfolio inception. As a result, an investor could not have invested in the
optimal portfolio since its inception. Optimal portfolios are presented to allow investors to quickly determine the portfolio size and rebalancing period that has performed best for each of our models in our historical testing.
Both the model portfolio and benchmark returns presented for all equity portfolios on Validea.com are not inclusive of dividends. Returns for our ETF portfolios and trend following system, and the benchmarks they are compared to, are inclusive of dividends. The S&P 500 is presented as a benchmark because it is the most widely followed benchmark of the overall US market and is most often used by investors for return comparison purposes. As with any investment strategy, there is potential for profit as well as the possibility of loss and investors may incur a loss despite a past history of gains. Past performance does not guarantee future results. Results will vary with economic and market conditions.