Value rules... U.S. companies investing more... 'Most important country' is about to collapse... Investors are in love with the U.S. dollar... Investors are falling out of love with Facebook...
I (Dan Ferris) got into a conversation a few weeks ago in Omaha, Nebraska about value investing – the strategy of assessing a company's inherent worth and buying shares only when they represent a discount to that value. During a cocktail party on the first night of the Value Investing Congress, a successful fund manager asked me if I thought the outperformance of value investing would persist. He asked the question in a more technical manner, but that was the clear gist of it.
I said, yes, for one simple reason. Human nature isn't going to change any time soon. And human beings are naturally, genetically impatient. That's why in any given year, you can buy the cheapest U.S. stocks – based on metrics like price to book value and price to earnings – and make money over the next few years. At least, that's what many studies have shown.
The Brandes Institute, a research firm founded by the dyed-in-the-wool value-oriented money manager Charles Brandes, conducted one such study. The researchers cut the U.S. stock market into 10 equal pieces based on price-to-book value. From 1980 to 2010, the cheapest one-tenth of the market consistently outperformed the most expensive tenth. Nobel Laureate Ken French performed a similar study using price-to-book-value for stocks from 1963-1990. French found the cheapest stocks made more than 21% a year, while the high-growth expensive stocks made only 8% a year. Value rules.
If you want a simple example... take Berkshire Hathaway, the conglomerate created by the historically successful value investor Warren Buffett. The worst three years for Berkshire's stock were in 1967, 1980, and 1999. In the three-year periods that followed each of those years, Berkshire beat the benchmark S&P 500 stock index by 49%, 102%, and 48%, respectively.
These days, Berkshire's intrinsic value is around $180,000 per "A" share, based on its pretax earnings and the value of its investments. And the stock is selling for less than $120,000, a 33% discount to intrinsic value. (For comparison, Berkshire's discount to value in 1999 was a mere 4%.) The whole world knows about Berkshire. There's no way it should ever get this cheap. But here it is, staring us all in the face, cheap as ever, ready to generate another few years of big gains for patient, value-oriented investors.
The investor probably looks at the share price, which has underperformed the S&P 500 the last couple years, and figures it's a bad buy. But the business is a relentless value-creator, gushing billions of dollars in earnings each year and sporting one of the strongest financial fortress balance sheets in the world. Berkshire Hathaway at current prices is among the safest, cheapest stocks in the world today.
Berkshire Hathaway isn't the only dirt-cheap business that's loaded with value. In an e-mail I sent today to subscribers of my Extreme Value advisory, I highlighted 16 businesses trading for far less than what they're obviously worth. They're all either safe, cash-gushing franchises or smaller, well-run businesses with balance sheets solid enough to ride out tough times...
Riding out tough times is what the average investor refuses to do. It's the reason I told the fund manager in Omaha that value investing will always outperform other strategies over time.
If you want to find out where to find great value today, and which stocks should outperform the market by a wide margin over the next two to three years, you might consider checking out Extreme Value. My research partner, Mike Barrett, and I are dedicated to finding the best value-stock situations... the best businesses and the most valuable assets, trading at deep discounts to their true value.
If you're one of those impatient people, you probably won't be happy with an Extreme Value subscription. We don't pick a new stock every 30 days like clockwork. We are extremely picky, and we reject 99% of all the stocks we research. So when we find one worth recommending, you know it's loaded with value and has an excellent management team, too.
If you're patient, you'll be very satisfied with your results over the long term... even if you feel a little bored in the short term sometimes. But just remember, boredom is why value investing works and why most people fail to make money in the stock market. When other people are getting impatient, we're finding value – just like the Brandes and French studies showed you can... and just like Berkshire Hathaway shareholders have found it for years. If you want to subscribe to Extreme Value (without watching a long promotional video) and discover the secrets of value investing (and learn how to make money while others are losing it)... click here.
American corporations are buying back less stock and investing more in their businesses... Companies announced $1.1 billion a day, on average, in repurchases during the earnings season in April and May, the lowest level since mid-2009, according to data compiled by Bloomberg and TrimTabs Investment Research.
After the biggest first-quarter gain for the S&P 500 since 1998, bears say the 58% decline in buybacks removes key support for equities amid Europe's debt crisis and a weakening U.S. recovery. While orders for capital equipment fell last month, bulls say the two-year gain in business investment shows CEOs are growing more optimistic, spending money to raise profits instead of reducing stock to boost per-share earnings.
Capital spending in the U.S. has been rising since 2010 and reached $63.6 billion in March. Oil and gas producer Devon Energy Corp. (DVN) eliminated buybacks and boosted exploration and production spending 18%. Shipping giant UPS cut repurchases in order to buy TNT Express NV.
"Investors and corporations themselves are best served when the cash is applied to improving capital investment, as opposed to buying stock back," Bruce Bittles, chief investment strategist at Milwaukee-based money-management firm Robert W. Baird & Co., which oversees $85 billion, said in a May 22 phone interview. "That would be much more bullish."
The "most important country in the world" is about to collapse...
We're talking about Spain, of course. It stole the title from Greece because it's what the financial press is yelling about most loudly these days. Never mind its GDP is smaller than the assets of JPMorgan Chase, Bank of America, or Citigroup. (Or perhaps I should be complaining that these three banks' assets are bigger than the productive output of one of the biggest countries in Europe?)
How do we know Spain is about to collapse? For one thing, the prime minister just said he's not going to allow it to happen. In an impromptu news conference, Prime Minister Mariano Rajoy said, "We are not going to let any regional government fall, or any bank fall, because they can't... If that happens, the country will fall."
This is sort of like when a government says it won't devalue its currency. They wouldn't say it if it weren't about to happen. It's like saying, "The check is in the mail." Rajoy might as well have said, "Spain is toast."
Rajoy's comments, believe it or not, are an attempt to calm a worried market. Last week, the Spanish government injected 19 billion euros (about $23.6 billion) into Bankia, the country's second-largest bank. And the market isn't buying it...
The share prices of Spain's three largest banks are all down today. Yields on Spanish 10-year debt surged over 6.5%, very close to the 7% levels where Greece, Portugal, and Ireland needed bailouts. Spreads on Spanish 10-year bonds over German bunds hit 5.11%, their widest in the history of the euro. The Spanish government has about $917.5 billion in debt, more than half of it due within the next few years.
Spanish bond yields are rising as investors flee the country's debt... and U.S. bond yields are falling as investors seek the perceived safety of U.S. Treasury debt. The 10-year Treasury bond yield hit 1.75%.
Investors are simply in love with the U.S. dollar. According to a Bloomberg story, the dollar has risen against all 16 of its peer currencies since hitting lows last July. Since 2008, the Federal Reserve has flooded the financial system with more than 2.3 trillion new U.S. dollars. You'd think that would cause its value to plunge. But the dollar index, tracked by the Intercontinental Exchange (a securities exchange based in Atlanta), is higher now than when the Fed started its massive money printing back in 2008. The U.S. dollar is one of only five large-economy currencies with credit default swaps trading for less than 100 basis points (1%), indicating very little risk. There were eight a year ago.
Makes you wonder... what happens when the world starts fearing for the safety and value of the U.S. dollar? For the moment, that doesn't seem to be a problem. But the dollar has consistently lost value for more than a century since the startup of the Federal Reserve in 1913. A nickel's worth of anything back then will cost you about $1.09 today. We have no reason to believe the U.S. dollar will be managed any better over the next 100 years, or that it won't lose another 95% of its value. Though the short term looks just fine for the U.S. dollar... the long term is as horrible as ever. Trouble is, nobody knows when the long term is scheduled to arrive.
And as much as investors love the U.S. dollar, they're starting to dislike Facebook. The stock fell to less than $30 a share today, about 35% below its post-IPO high of $45 a share. Today, Facebook is the opposite of the good value Berkshire Hathaway represents... shares of the social media website trade for around 75 times earnings. So while you're out looking for good value stocks, you might want to think about avoiding Facebook.
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New 52-week highs (as of 5/28/12): Markets were closed for Memorial Day.
In today's mailbag... We're not often mistaken for fans of Wall Street banks and analysts... but there's a first time for everything. Send your accusations to feedback@stansberryresearch.com.
"Late last year you published a piece on the subject of [Wal-Mart's dividend reinventment program]. Given the recent performance of the stock some of your readers might be interested in the slightly longer-term story of a [Wal-Mart investor].
"I started working for a Walmart subsidiary almost three years ago (taking a substantial pay cut from my prior job) and immediately signed up for the company's stock purchase plan. My first WMT share was purchased at $48.54 per share. Given that 15% of the purchase price was paid by the company's matching contribution, my cost was $41.26. At the time the dividend was $1.09 for a stated yield of 2.245%. With the matching contribution my yield was 2.64%.
"With next week's dividend of $0.3975, I will have earned $3.7375 in dividends on this share in just under three years. Subtracting that from the $41.26 cost basis gives an adjusted cost basis of $37.5225. At the current share price my total return is over 73% in under three years. With a current annual dividend of $1.59 the yield on my adjusted cost basis is 4.23% per year and rising every quarter as the cost basis drops.
"If Walmart continues to raise the dividend by 8% per year for the next seven years it will be paying an annual dividend of about $2.72. My cost basis on this first share (after ten year holding period) would be about $22.23 for a yield of over 12% per year.
"For those who are looking for a quick score in the stock market, the pace of dividend compounding seems almost glacial. However, I have no doubt that over time I will average more than a 10% per year return on this program not counting the company's matching contribution up front. With similar results from the rest of my WDDGs maybe I'll be able to retire someday after all." – Paid-up subscriber Rand McDonald
Ferris comment: Rand, thank you so much for writing in. I've been banging the drum on dividends for a few years now and on Wal-Mart since late 2006! But there's no substitute for hearing from a real investor who's seeing the results of compounding in his life, year after year.
"Please thank Jeff Clark for all his amazing analysis. Tell him he is NEVER allowed to retire or quit!" – Paid-up subscriber Jeff Thomson
"In the May 23 S&A Digest you reported Dell as having earnings of $14.4 billion with Wall Street analysts expecting $14.9 billion. On that basis the investing world views Dell as having failed. Isn't it possible that the failure was not Dell's but was, in fact, the analysts? Why should we take the word of a bunch of anonymous analysts over that of Dell. Either one or both could be wrong. Why do you assume that the analysts are always right and the company is always wrong. Where do the analysts get this fantastic credibility?" – Paid-up subscriber Wayne Flaherty
Ferris comment: First of all, when you say "earnings," you really mean "sales." Dell had sales of $14.4 billion, not earnings. But you've misread our words... We don't trust the company or the analysts. That's the point. The analysts get their estimates from guidance and other information put out by the company. But those numbers fell short, so both the analysts and the company were wrong.
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
May 29, 2012