Value Library

The following is an excerpt from the ABC Perspective - July 2000 - Pg. 12

Frustration

I recently went to an investment analysts lunch and I bumped into one of my competitor-chums. Bob, like myself, is a "deep value investor" who hunts for grossly under-priced value stocks. "How are you doing?" I asked. Bob nodded and then looked me straight in the eye and shot back, "How's business?" I thought for a few seconds and replied, "Challenging, very challenging."

I explained that while our ABC team often came across cheap undervalued stocks, the market seemed to be fixated on momentum and growth plays with astronomical price to earning ratios, little cash flow and big premiums to book value. "It seems to me," I continued, "that the expensive stocks get more expensive and the cheapies become cheaper."

I guess my extreme candour must have hit a chord with Bob. You see, right after my comments Bob loosened up like a pried-open clam. "I have had a terribly frustrating time," Bob admitted, "…and it's starting to get to me. I find a cheap value stock, do considerable research and after I buy it, it either languishes or declines in price. Then I glance over at Nortel, comprising 30% of the TSE 300 Index, trading at 75 to 100 times price to earnings and ten times book value and it takes off in price at the mere sniff of a rumoured new sales contract. If it wasn't for Nortel and a handful of TSE-listed high tech stocks, the TSE performance benchmark would be considerably different and easier to beat," Bob lamented. "Overall," Bob finally admitted, "this has been the toughest time in my 25 years in the business. I am starting to doubt if I know anything and whether it is even worth my while to do serious analysis." Bob then shook my hand and bolted off to another meeting.

I was stunned. I stood there for several minutes trying to figure the weight of Bob's comments. I had immense respect for Bob as an analyst and portfolio manager. He was a very bright, tough and judicious stock picker. How could this market have gotten to him? Later that afternoon as I rode the subway home I thought deeply about Bob's words.

The present stock market environment is very, very frustrating to all investors. This period of frustration has persisted for an inordinate length of time and it is now starting to enervate people. It is testing everyone's patience and conviction.

The extraordinary weighting of Nortel in the TSE benchmark is also frustrating investors. Nortel has evolved into an 800-pound gorilla representing over 30% of the TSE index. Yet, it is only one out of 300 component stocks. The TSE 300 is now a very difficult benchmark to beat particularly if one is a value investor. Moreover, Nortel is neither a value stock nor a particularly cheap security. To plunk 30% of one's investment portfolio in Nortel in order to match the TSE index weighting is extremely risky, imprudent and verboten considering mutual fund/pension rules. But investor frustration is forcing some to take undue risks lest they wander too far off the benchmark.

It has been a very difficult investment period worldwide. Some well-known investors have lost huge sums and have either closed their shop (Julian Robertson) or substantially scaled back their operations (George Soros). But the fact is that the past 12 to 18 months have seen tremendous changes in the investment industry. The end result has been incredible stress and frustration on many investors, analysts and portfolio managers.

I was really intrigued with a June 27 Financial Post article of a Bloomberg newswire release:

"The big change in the markets…is that they've gone haywire; rational valuations have long since been abandoned in a bubble of new economy flimflam. In an irrational world, rational people can't be expected to operate anymore."

This is a very interesting commentary on a most perplexing financial environment. In my opinion there is no doubt that the securities markets have indeed gone haywire with irrational valuations, IPOs, herd mentality investments, hope-springs-eternal valuations and disjointed index benchmarks. I do believe however, that the rational investor, while temporarily out of synch with this topsy-turvey market, will come out ahead in the end. True, savvy investors like Bob are befuddled and frustrated by the current extreme market volatility and craziness. But I feel the present situation is temporary. I profoundly believe that the basic fundamental analysis of financial and accounting ratios, and serious investigative research are still key to successful investing. The important thing is not to let the present frustration force us to question our work, become impatient or lead to investment inertia.

Irwin A. Michael, CFA