#79- Value Punks
Notes from the podcast featuring the Value Punks - Daye Deng and Balkar Sivia
While my worn-out Value Investing by James Montier sits pretty in my library, I like to keep exploring other avenues of reading on the strategy while occasionally going to the former. I came across the podcast by Value Punks on Stocks for Beginners and I am glad I did. Sharing my notes.
Value Investing
In common parlance value investing is buying a dollar for 50 cents and hoping the price & value will eventually converge as made famous by Ben Graham. However, value investing is effectively creating a buffer for your own ignorance otherwise known as the margin of safety - protect the downside even when you’re wrong.
Value investing has evolved over time. Earlier it was buying a dollar for 50 cents. Now people buying high-growth tech stocks is also value investing. A stock growing at 50% a year and at 10-20x earnings is also value investing.
I think, again, different people can have different definitions of value investing, but I think the core is that you're buying something where the expectations are so low that you know anything incrementally positive is good for you, gives you a return, and something incrementally negative hopefully is all priced in and doesn't affect you on the downside.
Most value investors are not optimistic.
A lot of beginners, or even people who've been in this field for many, many years, take these Warren Buffet quotes and treat them as hard truths without realizing that in practice, a lot of the time these concepts are very nuanced. And Warren Buffet himself knows all these nuances. He has thought through these nuances over his 60 or 70 year career. But the problem is that a lot of people haven't, they're not Warren Buffet. So we see people get burned using these concepts, even though they're supposed to help you. All while they think that they're following the right philosophies.
The Market Commentator
When markets go up, market commentators attribute reasons X, Y, & Z for it to go up. And when the markets go down, they again have reasons for it to go down.
We see 10, 20% daily moves in stocks, but the business value is not going up and down that much in a day.
But at the end of the day, there are buyers and sellers on both sides of every transaction. (Hence) It is dangerous when people allow market narratives to sway them in and out of their positions. Having a process & philosophy is very, very important.
Is volatility your friend?
There is a common saying that volatility is your friend because it enables you to buy something for a low price when markets move quickly. But the reality is price drives narrative a lot of the time causing you to:
Think optimistically when prices rise
Think pessimistically when prices fall
People are not taught properly to think of volatility as a risk. The problem with this is that they don't demand to be compensated for taking on that extra volatility, which is a problem. Volatility is not bad but if a stock is going to be very, very volatile, you better demand to be compensated for taking on that.
Position sizing
To manage the risk of a volatile position, you have to limit its size. It has to be a small part of your portfolio. If a volatile position is a large part of your portfolio, it is psychologically difficult to either take the drawdown or add more.
If you believe in the stock, you can buy more when it comes down. But what if it keeps going down, do you keep buying? Where do you draw that line? Position sizing can help.
Diversification or Diworsification?
Diversification is for the know-nothing investor; it's not for the professional
Diversification was the rage when it came out in academia decades ago. But its true standing should be relegated to academia itself. It's not applicable to the real investors in the world who really study businesses and who have conviction and who, who have really done their homework.
Mindless diversification for the sake of doing that alone doesn't make sense. But the anti-diversification view has gone been kind of pushed to an unhealthy extreme.
Buffet or Munger say 5-8 stocks is enough diversification. But then they’re extremely smart investors who know what they’re doing and make it look very easy.
Many people buy random eight stocks where they won’t be diversified enough (eg: buying a technology bucket). So when technology is not in vogue, in certain quarters or years, then you can see the whole portfolio go down.
You need some uncorrelated stocks in the portfolio. When technology goes down, you have precious metals and or industrials (which will not go down) and you can shave some of that growing portfolio and reallocate to what’s down. But if everything's down, then what are you gonna buy?
Conviction is key
Choosing random, uncorrelated eight stocks doesn't really speak to conviction. Conviction comes from really understanding those financial reports much more than an ordinary retail investor would.
Conviction tends to be a word that's probably overused in the investing community. Investors really love talking about their high-conviction ideas.
But conviction is a double-edged sword. How to protect yourself from your own conviction should be talked about more than talking about the ideas where you have high conviction. The human brain is very good at creating narratives to fool yourself.
Sometimes conviction makes you double down on the wrong stuff. You think the price falls by 50% and there is a chance to buy more of this stock that you really like only for it to fall even more and you to exit at the lowest point.
Mr Market
Mr Market is essentially a term that was coined by Benjamin Graham to personify the market.
Mr Market can give you whatever offers it wants, you don't have to swing, right? Investing is a baseball game where there are no strikes. It can give you Amazon at X price, it can give you Microsoft at Y price and you can just stand there with your capital. You have to do nothing. And when Mr Market is really depressed, that's when you swing.
Is Mr Market irrational? Investors take this literally without thinking about the nuances. So one way is that this could really turn into a slippery slope for investors when they really start to default to the assumption that Mr Market can only be rational when he agrees with me.
People should think of themselves as stupid and that the market is smart rather than the very opposite.
To make money in the market, you have to have a differentiated view compared to the market, right? You have to say, right now something is priced too high, or right now something is priced too wrong, right? But sometimes, you know, you think something's priced too high and it keeps going up or vice versa. And many investors kind of stubbornly stick to their views and say, you know what? I'm right market's wrong. Eventually the market will come to my view. Hmm. And I think what, what we are trying to say is, you know, maybe the market is right and maybe you are wrong. And I think at that point when something is moving against you instead of kind of doubling down on your position, I think for a rational investor it makes sense to kind of go back to the drawing board and say, okay, where can I be wrong?
Moats
Everyone wants to find moats - i.e. competitive advantages which help a business protect its economics. If investors invest in a business without moats, a competitor can come in to either outprice or outsize and take away the economics of the invested business causing limited or negative returns.
But increasingly, we find these moats are already priced into the stock prices.
You can write a long report on why, you know, this company has a big moat and you know, therefore you should invest in the company. But you also have to think about to what extent is it already priced. You also have to think about whether the moat is stagnant, getting narrower or wider.
A lot of value investors in the last 15 years have made some mistakes where they've invested in old economy companies, assuming that the moats will at a minimum stay stable. Rapid technology technological progress has made moats narrow very, very quickly. And when moats narrow the earnings power that you think the company has five years from today ceases to exist. Analysis of and the rate of change of mode are more important than just determining if a company has a moat or not.
If you look at the composition of the top, you know, 30, 40, 50 stocks on the US market, how much they've changed since the 1980s and how few companies are still there. That's right. Then you would've assumed that they would've had very, very wide moats.
(Buffet) looks at kind of beginning of every, every decade and the, at the end of every decade, he looks at what the top companies are, right? And to your point, it's interesting that many of those companies change every decade, you know? Therefore, I think the point is that it, it's a very difficult job to predict if a company will remain relevant and large and moated 10 years from today. And evidence is that it's very difficult and most companies don't.
Expectations Investing
Historically public equity market returns have been 8-10%.
One of the differences between professional and amateur investors is that oftentimes a professional investor has a better sense of the return expectation in the equity market. If one has a 20% return in a year, usually the pros know that that is a pretty good return and that kind of return which can not be repeated every year. But oftentimes newer investors don't have that context and they think that kind of returns can keep happening.
People entering markets for the first time should have realistic expectations because it is not easy to make a ton of money.
Many people now invest just in simple index-hugging ETFs because to get those kind of returns, and even Warren Buffett is recommending his own family when he passes just to invest in ETFs.