Tuesday, August 18, 2009 7 comments ++[ CLICK TO COMMENT ]++

Opinion: So few amateur value investors around... for a good reason

I have suggested in the past—and this isn't anything unique from me—that there are very few value investors in the institutional world because of the institutional imperative. It simply isn't possible for the majority of the fund managers to become value investors. They would literally get fired after a few poor quarters. In fact, if I were a fund manager, I think I would follow more of the crowd.

But how about amateur investors? Well, I think there are very few amateur value investors as well. Some who call themselves value investors really aren't in my opinion (my definition of value investing is a bottom-up approach to investing with heavy emphasis on fundamental analysis—not everyone follows this definition.)

I definitely don't consider myself a value investor and anyone reading this blog for very long would know it as well (although some people lump me into the value investor camp :) ). For instance, it's hard to consider anyone that is influenced by Marc Faber to be much of a value investor.

If the institutional environment prevents the professionals from being true value investors, how come the amateurs, who have no institutional pressures, don't seem to follow value investing?

I think the main reason is because value investing is really tough! Sure, part of it is also difficulties with overcoming psychology—humans are communal creatures and hence love to follow the crowd—but the main reason is because fundamental analysis is tough. It just takes a lot of work and continuous learning. How many can read dozens of annual reports and not feel discouraged when they don't end up investing? How many are willing to fully read the annual reports, including financial statment footnotes? The ironic thing is that value investing techniques are much simpler than other strategies. I'm not an expert on investing but the model that quantitative investors build involves far more complexity than anything a value investor does. Similarly, growth investors—some value investors do not think there is such a thing as growth investing—build out complex spreadsheets with scenario analysis, competitor comparison, and so on.

You can see how there are few value investors in the amateur world by looking at blogs or reading investing message boards. For instance, try going to SeekingAlpha, which is an investing blog aggregator, and pay attention to the number of blog entries dealing with fundamental analysis. Practically all the blogs out there deal with technical analysis (which probably falls under momentum investing), macro investing, and speculation.

I suspect these strategies are popular, not because they work, but because they are easy for anyone to follow. For instance, almost anyone can write about macro investing. Yet very few really provide anything useful. I write a macro-oriented blog so I'm dissing myself as well. I like macro stuff but the fact of the matter is that half the stuff out there are complete nonsense. The worst are the macro views that are completely erroneous. Yes, macro investing involves speculation about the future. But there are many macro-oriented investors that pass off pure speculation as facts. I try to be clear when I am presenting a speculative view and when I'm just repeating history or some academic study or whatever. But you need to be careful—on other blogs, as well as here.

Another issue with macro-oriented blogs is how some amateurs mix up economists and investors. Except for some rare exceptions—John Keynes for instance—most economists are not good investors. Macro views come out of economics but it's up to the investor to interpret and come to their own conclusion.

Technical-analysis-oriented blogs, articles, websites, newsletters, and so on, are another popular strategy. Nothing wrong with it but it is another skill that almost anyone can write about. Just like the case with macro strategies, half the stuff out there are completely useless, often contradicting each other and not providing much of a forward-looking view.

In contrast, I see very few value-investing-oriented blogs. I have a whole bunch on my websites links page but I have to admit that many of them don't perform much analysis. No offense to anyone but someone who blindly follows Warren Buffett and invests in, say, Kraft is not a value investor to me. If they do the analysis and can show why Kraft is good, then they are; but most can't justify any of their picks. In fact, many investors probably can't even tell half the products Kraft sells—how is this different from a trader who generally doesn't know much about what the underlying security represents?

Do note that you may still be a value investor for the most part but some of your investments may not be. Let me pick an example with Mohnish Pabri since it came to mind after some comment on GuruFocus. Once, Pabri said that holding Berkshire Hathaway shares is equivalent to cash. In other words, he was parking his money in Berkshire shares instead of in cash. That is just pure shoddy analysis and thinking. Yes, I'm just some guy off the street with a dubious record and I'm attacking a really good investor but consider my argument. How could anyone consider a listed security to be equivalent to cash? Furthermore, how can someone be certain that the market is not going to mark down the security price—not just today or tomorrow but for the next 10 years! Such thing is pure speculation; it has nothing to do with what I perceive as value investing. In a similar light, a lot of people who pass themselves off as value investors really are not. There is nothing wrong with that but just know what you are. If you are speculating, make sure you know it!

To sum up my view, I think value investing is really tough for amateurs. You can see this by looking around and noticing how it is not very popular. On top of the psychological difficulties, the strategy itself is quite difficult.


7 Response to Opinion: So few amateur value investors around... for a good reason

August 19, 2009 at 3:02 AM

I agree that fundamental analysis is hard for amateurs, but if that is all one needs to be value investor then every accountant/finance major could become one (if he/she wanted to). In my opinion, the real reason why amateurs are not value investors is not that it is technically tough.

The first thing to remember is, as Warren Buffet says, "You either get the concept of value investing in 30 sec or you never get it". I think most amateurs do not get the concept of value investing. They are too swamped with other ideas, technical, momemtum, or macro investing - like you said.

The second thing is that valuation is more an art than a science. As Seth Klarman says, in Margin of Safety, that there is no formulaic approach to valuation. If there was, then the market, in most cases will discount it into the price. Obviously, there are the times when the market is totally irrational but that is an anamoly. If you own a 2003 Toyota Camry can you put a valuation on it to a decimal point by using some formulaic approach? If you think about it, valuing a car requires some amount of imagination. Looking at it from various different perspectives will give you some kind of range of values. Now, try valuing a business. Business is much more complex engine than a car with many more moving parts. The art of valuation requires some amount of experience, not just technical know-how on how to read and interpret the financial statements.

The third thing is having the patience and time to screen through thousands of potential ideas to come up with top 8-10 ideas in a year. Most amateurs are busy with a full-time job, probably not in the field of investments. Also, like me, they are busy replying to post on blogs, like this one. They are spending a lot of time reading information on the internet/TV that is mostly noise. Value investing requires being focused on one company at a time - over and over again for possibly hundreds of companies to find a few good ideas. This is not as exciting or sexy as talking about the future of U.S economy, or policy actions that the current administration should be making and such macroeconomic things. In my opinion, most amateurs will have lost interest or focus in a few months. The ones that actually do this religiously will realize that they have something they can put to use, and will look for ways to become full-time at this by changing their profession. These are the folks who then are no longer amateurs. 

Seth Klarman, in his last chapter of Margin of Safety, says do not try value investing at home. It is best left to experts. Most amateurs do not have the time committment it requires to practice value investing. If you really want to try it, work at it to become full-time at it - don't be an amateur.

August 19, 2009 at 3:17 AM

One more thing - on Mohnish Pabrai. I know he is revered in the world of value investing. I met him at Wesco annual meeting this year, and asked him a few questions. One particular question I asked was "Do you think 2008 exposed some value investors to be swimming naked. Were these guys value pretenders?" He gave me a really lame one liner: "The shorts shouted louder than the ones that were long" And he moved away to talk to somebody else. I could tell he had a lot of people very excited to say hi to him. I am not particularly into idol worship, but I expected something more than a one liner from somebody that has such a reputation.

From what I have understood, from Seth's Margin of Safety, the real test of a value investor is the time of distress. The value investor's portfolio is probably not spared to being marked down, but since he/she has always been aware of permanent loses to capital through business degradation, this mark down should only be temporary. Now, nobody is perfect and one is bound to make a few mistakes, but its the process that is important. Do value "investors" like Mohnish follow the process of "protecting" from permanent loses? The one liner that Mohnish gave me implied that it was only a technical issue that caused such big markdowns in his portfolio, even though most of his markdowns were permanent in nature.

To be fair, in all likihood, he probably didn't want to answer the question, and wanted to be folksy and humorous with the crowd around him when I asked the question. So, I don't want to conclude anything from my one-minute encounter with him.

August 19, 2009 at 4:47 AM

I am under the vague impression that most amateurs consider themselves 'value' investors.  I suspect that most of them couldn't define half the items on a balance sheet, but I always thought that there were more amateurs looking at 52 week lows, PE's and dividend yields, than were chasing momentum plays and looking at ocsillators.

I hope that you are right.  Most of the stocks I invest in are too small for the pros, and if the amateurs are looking at technical voodoo while I am trying to find value, then that is my edge right there.

Sivaram Velauthapillai
August 19, 2009 at 4:22 PM

I don't know if Mohnish was trying to be cute with the answer or not but I suspect he was trying to dodge that question. It's probably tough to answer your question when one has had a terrible year. I notice that Warren Buffett dodges questions that way too. Some of the most insightful questions, in my opinion, asked of Buffett, are never answered by him. Charlie Munger, in contrast, is more straightforward and tries to answer all the questions. For example, I have never seen Warren Buffett walk through an investing example, even a hypothetical scenario, in his meetings with students (I am not a student so just going by transcripts I have read.) The most dissapointing to me is PetroChina. He always says it was obvious :(  but it's not obvious to newbies like me. In particular, I'm curious to know how to factored in the political risk. If I'm not mistaken, he said he was looking at Yukos and PetroChina and went with PetroChina. It's still a mystery to me how he considered the risk of Yukos, which ended up being seized by the Russian government with likely bogus charges, and PetroChina, which is solely controlled by a totalitarian government.

I'm not too knowledgeable about Seth Klarman--seems like you are a big fan of him--and haven't read his books. In fact, I'm a bit skeptical of him--not his record but his skill level. I don't think Mohnish Pabri is a bad investor but he doesn't aspire to be a pure value investor like Klarman or Buffett, whom care about capital loss. These two guys, as well as someone like Jean-Marie Eveillard, will absolutely avoid swinging for the fences if there is a chance of a strikeout. Pabri, sort of like Bill Miller, swings for the fences quite often. Even this year, he seems to have bet heavily on commodities. He is probably sitting on massive profits but it could have easily gone the other way.

Sivaram Velauthapillai
August 19, 2009 at 4:35 PM

Guest: "Most amateurs are busy with a full-time job, probably not in the field of investments."

Yep... I'm trying my best right now--I have lots of time due to various reasons--but most people just don't have the time. I think a lot of people without time sort of give up after a while or become passive investors. Quite a number of investors I have encountered on blogs or message boards a few years ago have dissapeared. They probably don't have the time or the skill...

Guest: " Also, like me, they are busy replying to post on blogs, like this one."

I think you waste more time reading my useless blog than replying to it ;)  Your investment success will probably go up 10x, minimum, if you avoided this blog ;)

 Guest: "The ones that actually do this religiously will realize that they have something they can put to use, and will look for ways to become full-time at this by changing their profession."

Or they become financially independent and pursue their interests (art, vacation, volunteering, going back to school, kids, etc.)

Sivaram Velauthapillai
August 19, 2009 at 4:41 PM

MrParkerBohn: "... I always thought that there were more amateurs looking at 52 week lows, PE's and dividend yields, than were chasing momentum plays and looking at ocsillators. "

You must be hanging around in the value investing or some contrarian investing world ;)  I actually think most people are the opposite. There are very few who look at 52wk lows and low P/Es, etc. I certainly don't see too many investing in those companies. Even if someone says they like it, there are very few who do it. It's just too scary for most (most of those low P/E, 52wk low, high div yield, etc, stocks have problems.) Even so-called value investors often invest in, say, Coca-Cola or Burlington Northern Santa Fe, because, well, it's less scary. So, you actually have an advantage.

If you invest in smallcaps and microcaps, I think you have the potential to generate higher returns. Statistically speaking, small-cap value beats other asset combinations. If you can survive in the small-cap arena, you will do really well.

Jae Jun
August 20, 2009 at 3:13 AM

Came to leave a reply but after reading the replies, a lot of the things I wanted to write have already been well articulated.

Good discussion.

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