Not a member?
Register now to start earning Momentum Alert profits right away!
Already a member?
TAG | Valuation
by Alexander Green, Investment U’s Chief Investment Strategist
Monday, April 25, 2011: Issue #1498
“Buy Japan now?” a friend asked recently. “Are you nuts?”
His sentiment is understandable. Aside from the unfathomable human suffering in Japan over the past several weeks, there have been enormous economic setbacks as well.
Sendai, the biggest port in northeast Japan and a major exporter of auto parts, machinery and marine products, was virtually wiped off the map. Half a dozen oil refineries in the same area, representing a third of the nation’s entire refining capacity, are shut down. Roads, bridges, railways and other major infrastructure have been destroyed. And the Japanese economy – already limping along for most of the past two decades – is also beset with the world’s highest public debt relative to GDP (225%) and a rapidly aging population.
Why would anyone want to invest here?
In my experience, those words accompany virtually every great buying situation. But it takes more than just a lack of interest to create a true contrarian opportunity. Both sentiment and valuations have to be at an extreme.
And that’s certainly the case here…
Japanese Stock Prices Are Less Than Book Value
The average Japanese stock is selling for less than 14 times its annual profit. That’s cheap, and Japanese accounting methods also tend to understate earnings. An even better indicator is found in book values (assets minus liabilities). Stocks around the world (including the United States, Europe and China) currently sell for approximately two times book value. In Japan, they sell for less than book value. By this measure, U.S. stocks are twice as expensive as Japanese stocks.
What will turn Japan’s market around? For starters, the enormous rebuilding that will be required over the next few years. Devastated areas account for seven percent of Japan’s economy and a substantial portion of its land mass. A lot of businesses will receive substantial contracts as a result of the catastrophe.
History shows that Japan is adept at rebounding from catastrophe. (Take World War II or the 1995 Kobe earthquake as examples.) And when Tokyo enters a bull market, it can look like the Silver Spurs Rodeo. For example, if you invested $10,000 in the S&P 500 in 1970, two decades later it would have been worth more than $76,000. Not bad.
But the same amount invested in the Nikkei 225 would have turned into more than $600,000.
How to Buy into Japan’s Advanced Economic Power
Although China’s economy has now eclipsed Japan’s in size, Japan is still Asia’s most advanced economic power, with world-leading technologies and an unmatched infrastructure.
The cost of doing business in Japan has decreased dramatically in recent years, as well. Land prices, office rents and labor costs have come way down. So have taxes and tariffs. And the government has instituted serious banking reforms.
The nation also sits on a mountain of personal financial assets – more than $100,000 for every man, woman and child. After a decade of negative stock market returns, most of this capital is sitting in low-yielding bank deposits. Even a small fraction of these assets returning to the equity market could give it a serious jolt.
So how do you play a rebound? Consider a Japan ETF or some of the country’s unloved blue chips like Toyota (NYSE: TM), Mitsubishi Financial (NYSE: MTU), Canon (NYSE: CAJ), or NTT DOCOMO (NYSE: DCM).
The healing there will take time, of course. But just as the U.S. stock market rebounded from the recent financial crisis quicker than almost anyone expected, things in Japan may look dramatically different in six to 12 months from now.
Of course, very few people believe that. But, in one sense, that’s a good thing. Negative sentiment and low valuations are the defining characteristics of contrarian investing.
Bottom fishermen, cast your nets.
Good investing,
Alexander Green
18
Why Value Investing and Trading Don’t Mix
0 Comments | Posted by Alexander Green in Alexander Green
Why Value Investing and Trading Don’t Mix
by Alexander Green, Chief Investment Strategist
Tuesday, May 18, 2010: Issue #1262
Last week, I spoke at a special conference on value investing at the beautiful Driskill Hotel in Austin, TX.
Virtually every stock market investor talks about “recognizing value.” I’ve found that interest in value investing ebbs and flows depending on the market. No one wants to overpay for a stock, or keep holding one if the price gets nutty.
And that leads to a basic question: How do you find value in the stock market?
It depends whom you ask…
The Fathers of Value Investing
The fathers of value investing, of course, were Ben Graham and David Dodd, two teachers at Columbia Business School who wrote the investment classic, Security Analysis.
They argued that value investing is about buying companies that are selling below their intrinsic value.
How do you determine that? According to Graham & Dodd, that means buying companies that…
- Trade at significant discounts to book value.
- Have high dividend yields.
- Have low price-to-earnings (P/E) ratios.
Buying this way is not only supposed to lead to higher returns. It’s also designed to provide a significant “margin of safety.” The idea is that if you buy a security right, your downside is limited.
A number of academic studies have shown that if you follow the principles of Graham and Dodd, you should do very well over the long term.
But there are potential problems with this approach…
Don’t Let a Cheap Stock Suck You In
First of all, stocks are rarely as cheap as they were back in the 1930s when Security Analysis was written. Or even as cheap as they were back in 1982 when the typical stock sold for less than book value and eight times earnings and yielded more than 6%.
And if you sat out the last 28 years out because stocks were too expensive, you missed an awful lot of opportunities.
When you do find a stock that does meets Graham and Dodd’s stringent requirements, you also need to be patient. Why? Because companies that are very cheap are out of favor for a reason. Sales are often flat or down. Earnings are weak. Profit margins are low.
You can’t succeed just by buying a company that’s cheap. (It can always become cheaper.) You have to buy a company that will someday – and perhaps not too far off – be dear to others. Otherwise, when will you take profits?
So maybe Graham and Dodd’s message needs modifying. (Warren Buffett, Graham’s most famous student, has certainly found ways to modify it.)
The Problem With Defining “Value”
I’ve found that the definition of value and the tools to achieve a margin of safety are flexible. And The Oxford Club has found successful ways to bend them.
To my mind, any stock that goes from $10 to $50 was a “value” at $10. I don’t care what the P/E or price-to-book was at the time. With the luxury of hindsight, it was clearly a bargain. Why quibble?
But die-hard value investors will argue that if the stock was “overvalued” at $10, it’s only more grossly so at $50 – and therefore, you’re at great risk holding it.
I disagree. If you use our customary trailing stops, your upside is unlimited and your profits fully protected. As long as a stock keeps trending up, we’re content to hold on – no matter what the valuation. When the stock eventually turns, as all do eventually, our stops will keep the profits from slipping through our fingers.
As for value analysis, quite frankly, we don’t spend a lot of time poring over P/Es and book values. We’re just interested in identifying companies that are likely to show dramatic, better-than-expected growth in the quarters ahead. These stocks tend to be more expensive than average, just as companies that will show little or no growth tend to be cheaper than average.
This method works, too…
Do You Have the Key Traits to Profit From This Approach?
The independent Hulbert Financial Digest has ranked our Communiqué among the top five newsletters in the United States for 10-year performance.
And our approach has one significant advantage over value investing. It works quickly.
- Growth stocks tend to sprint.
- Profits often come sooner rather than later.
As someone who spent 16 years as a money manager, I know that most investors don’t have the patience to be good value investors. (John Templeton, for instance, held companies in his flagship Templeton Growth Fund an average of 7.5 years.)
Yet clients will start to grouse if a stock doesn’t move for six months. They call it “dead money” and start itching to move it elsewhere.
I understand this instinct. But deep value investing and rapid trading don’t mix.
If you’re a patient, truly long-term oriented investor, value investing can work wonders. If you’re not, you’ll be better off searching for companies that are set to smash estimates.
When a stock doubles or triples – or rises 50-fold or more like Apple (Nasdaq: AAPL) and Amazon (Nasdaq: AMZN) – don’t worry, other investors will concede it was a “value” before.
Good investing,
Alexander Green
P.S. If it’s value you’re looking for, look no further than The Oxford Club. For just $79, you’ll receive a whole year’s worth of our experts’ top stock recommendations, investment ideas and strategies that you can use to amass profits and build wealth.
You’ll see exactly why The Hulbert Financial Digest has ranked The Communiqué newsletter in the top five in the United States over the past 10 years and have a portfolio of your own that can weather the market’s storms, but thrive, too.
Take the guesswork out of the investing process and let some of the best, most successful analysts do the work for you. Sign up (risk-free) to The Oxford Club today.
