Old School Value Nugget Fest (October 9th Edition)
I’m sending fewer links this week because I consider more of them to be “must-reads,” and they’re on the longer side. I also put a bit more commentary down below in the links, so I’ll keep it short and sweet up here.
Markets & Investing
This is a must-read. It’s a really sharp analysis of the most common arguments for why we’re in a bubble with data-driven counter-arguments. A few nuggets:
- “Notice that while stocks have climbed 230% in the ten-year period since January 1, 2009, earnings have risen 212% over the same period, and cash flows have almost kept track, rising 188%.”
- Stocks may be relatively expensive today and this may imply lower future returns, but compared to alternatives, they are still much better. In the past, bond yields were similar to earnings yields, so it made more sense to potentially adjust your allocation.
If you’re at all interested in machine learning or in thinking about the details of Old School Value’s Action Score System, this is a great read.
The author plots Gross Profitability to Assets vs. ROE, creates clusters (which are essentially just the 4 quadrants of a 2×2), and shows that the high GP/A and high ROE box typically results in a higher P/B. I.e., the market pays more for the best-returning, most profitable stocks, and pays less for the worst.
If you then select the cheapest 10% of stocks from each of the quadrants, your returns beat the S&P. And it improves if you filter out more stocks based on simple quality measures.
An astute observer would note that GP/A is one of the core metrics in our Growth Rating, and ROE is pretty correlated with CROIC, a key input in our Quality Rating. On top of that, we use more measures of Value than just P/B, which OSAM has shown produces better results. We also include other quality filters, similar to OSAM. This, then, begins to build one’s intuition around why the best Action Score stocks will outperform on average.
More PDF Reports
- The Trouble with Earnings and Price/Earnings Multiples – Alfred Rappaport and Michael J. Mauboussin (PDF) – From 2001, but making the rounds again. Note that our Reverse DCF tool helps you understand the price implied expectations.
- Guide to the Markets 4Q19 – JP Morgan (PDF) – A nice companion to the charts in Aswath Damodaran’s post.
- Q3 2019 Letters & Report (Reddit)
Three Big Things: The Most Important Forces Shaping the World (Collaborative Fund)
Here’s your second “must-read” of the week. To preface, Morgan Housel talks about how so much of what’s happening today can be traced to World War II. He then asks (and answers), what else is like that?
This letter is from 2000, but it was making the rounds on Twitter and I’d never read it. There’s a whole series. For those of you interested in improving your strategic analysis skills, pretty much all 6 letters written over 7 years are required reading. Just search for letters II – VI.
Podcast of the Week
A nice follow-on to the NYTimes piece we recommended a couple of weeks ago.