Abandon the Playbook; Adopt the Global Playbook; Adjust the Playbooks for Valuations
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.
