It was 7 3/4 years ago that I modified my value investing method to incorporate industry rotation.? That was probably the most significant change to my methods that I made in the last 16 years.? I did it reluctantly, after an analysis of where I had done best over the prior eight years.? I had many significant wins when I had gotten the industry cycle correct.
I commented recently on industry selection.? I want to make two additional points on that here.
1)? Analyze where an industry gets its demand.? Is it domestic or foreign?? If foreign, then use the global playbook.? Instead of looking at GDP growth, look at the growth from foreign demand.? Decouple your reasoning from the traditional view, because in a global economy, things get messy.
2) Even if an industry is driven primarily by domestic demand, often portfolio managers using the playbook may trash the valuation to levels that should be below trough valuations.? These are long-term opportunities, and should be bought.? VIce-versa for companies that have favorable future growth prospects, but the valuation discounts those prospects, and then some.? Those should be sold, even if they are in industries with good prospects.
That’s all for the evening.? I wrote this piece because active managers haven’t been doing well lately.? Uh, in order to do well, one must be willing to brave the possibility of failing (you can’t hug the benchmark), by taking opportunities that others find distasteful.? I benefit because I don’t care about tracking error; I just buy cheap stocks, in industries where the long run value is not appreciated by most investors.
1) They had no choice, they had to do it.? Their debt has liquid markets — those are level 1 and at worst level 2? liabilities.
2) Many of the assets that they carry have credit risk also.? The pressures that are leading the prices of their debt to fall, are also causing the carrying value of some of their assets to fall as well.
3) If credit markets for their debt improve, they will have to write those liabilities up to higher values.? Even if creditworthiness stays the same, the passage of time will make the liabilities rises in value as they get closer to the ultimate payoff.
4) In bankruptcy, their obligation to pay par does not change.? It is not as if they can pay the reduced market? value to pay off their debt, except through a deal agreed to by the court and plaintiffs.
Look, I don’t like the confusion SFAS 159 creates at this point any more than the next guy, but the gains here will likely reverse over time, absent bankruptcy.? As an analyst, I strip those gains out of income, and I should strip out losses on the asset side that I think will reverse as well.
We can change the way that gains and losses are reported — book, market, model, hybrid… but we can’t change the ultimate cash flows from the business, which is what will ultimately drive the value of the firm.? Be careful and conservative here, as accrual entries get more subjective, they become less trustworthy, and managements on average release more into income from accrual entries than they ought to.
Late last week, I had two rebalancing sells, Charlotte Russe and Smithfield. Today, two more, Honda Motor and Nam Tai Electronics. As the market has risen (or, some of my stocks at least), cash has been building up, and I have added some of my own free cash to the Broad Market portfolio. I’m at about 14% cash.
So, it’s time to buy something, though I am waiting on the market to show a little more weakness before I act. But, though dinner may wait, perhaps an appetizer is in order: today I added to my position in Reinsurance Group of America. MetLife finally decides to shed this noncore asset in a tax-free stock swap, allowing current MetLife shareholders to swap their MetLife shares for shares in RGA.
RGA should get a higher multiple as a “pure play” life reinsurer; that will come later. Today was the selling pressure in advance of the new supply. I like the management team at RGA, and think this will allow them the freedom to add value on their own. One other odd kicker… it might allow them to do more reinsurance business with MetLife, because they will be independent and thus truly be a third party.
Position: long CHIC SFD HMC NTE RGA
A few additional notes, for me long only means running with 0-20% cash. I don’t go above 20%; I don’t borrow. Under normal conditions, I like running around 5-7% cash. If the NAHC stake is counted in, (arbitrage gets a pseudo-cash return) then we are at that 20% upper limit.
That leads me to take a few actions — I have bumped up my central band for my holdings by 16%. Translated, the points at which I do buy and sell rebalancing trades has risen 16%, as has my normal position size. Looking back through the years, back to 1992 when I started value investing, my position sizes were 5% of what they are today, and back then I had 10 positions, not 35. There’s been growth. 🙂
My second action was a temporary purchase of some RGA. I doubled my position temporarily, because I think most analysts will smile on the deal, and RGA has always been a good buy at book value.
No telling whether buying at 1.0x book will continue to be a good idea in the future. RGA is a well-run company in an oligopolistic industry. The management is smart and conservative. They have international growth opportunities, and now, possible new business from MetLIfe. The moat is wide here. You can’t reverse engineer the #2 life reinsurer in the US and the World.
So, I’m happy with my position here. That said, I may trade away the speculative part of my holdings in the short run, and I may buy some MetLife as well. MetLife is cheap, though not as cheap as RGA, but I suspect when MetLife offers RGA shares in exchange for MetLife shares, they will have to make the tradeoff sweet in order to get some flexible institutional investors to do the swap. Why? MetLife is a large cap stock that is very diversified. RGA is a midcap that is not as diversified. MetLife is a well-respected brand name. RGA? Who?
Insurance is opaque; reinsurance is doubly so. There are no comparables for RGA. MetLife has Pru, Principal, Lincoln National, and a few more. So, I may speculate on MetLife in order to get some cheap RGA. Most likely, I’ll need to see the terms, but if RGA is up a lot tomorrow, and MetLife is not, I may just do the swap.
Note to my readers: one odd thing about my blog is that I write about a wide number of issues. I know I have been doing more on my stock investing lately, but that is partially due to the lack of news on the macro front. That’s the nature of what I do. I am an investor that pays attention to the global economy. I’m trying to make money off my insights, and not merely report on what is happening. I hope some of it rubs off on my readers also, and that you personally benefit from it. For those who find my blog to be a confusing melange — well, that’s who I am, a generalist whose interests are broad.
But, if you like the individual stock coverage, let me know. If you hate it, let me know also.
Full disclosure: long CHIC SFD HMC NTE RGA NAHC LNC
