August 27, 1998
The Task at Hand
Be a Buyer
by Alex Schay ([email protected])
(From the 7/2/98 Evening News)
John Spears, Chris Browne and Will Browne, the partners that run Tweedy Browne's Global Value Fund, believe that the fund's best bargains have been found while sifting through the rubble in Japan -- where the cheapest 10% of companies trade at 60% of book value. However, the "problem" with Japan, which has positively rewarded value investors historically, is that in its recent history the country has shown no sign of returning to growth at all, either positive or negative. The number of analysts that have unsuccessfully attempted to call a turnaround in Japan over the last couple years could probably fill a good-sized Caribbean island.
Today's announcement that Japan intends to get its debt-ridden pagoda in order by implementing a state-owned "bridge bank" scheme has been met with a mixed response. Many feel that the 13 trillion yen (2 million of which has already been used) earmarked for the bridge bank project is simply not enough to boost lending and revive growth since Japanese banks have some estimated 77 trillion yen in bad loans. However, this column's focus is not on the relative merits of the project, or even on speculation surrounding the time it will take for a recovery, but rather, on equity "style" investing and how the economic climate in Japan can provide some insight into the analysis.
To begin with, many of the so-called "distinctions" between value and growth investing are bunk. Often, value investing is done an injustice by casting the terms of the debate within a framework dominated by timing concerns, like the typical earnings expectation life cycle (normally presented in a circle but is presented here in a linear fashion):
Growth
FALLING Torpedoed
I
I Negative Surprise Models
I
V Estimate Revisions
I
I Dogs
I
I Neglect
I
LOW Contrarians
I
I Positive Surprise
V
I Positive Surprise Models
I
RISING Estimate Revision
I
V EPS Momentum
I
HIGH "Growth"
I
I
V
Within this framework, unskilled value investors are said to purchase companies too early -- that is, somewhere near the period of estimate revisions to the period of neglect. In this case, value investors needlessly expose themselves to stocks that might languish during extended periods of underperformance before eventually picking up, or perhaps, they might never even pick up at all. Meanwhile, good growth investors purchase companies during the period between positive surprises and EPS momentum, catching their companies on the way up.
Under this earnings-centric growth timeline, the partners at the Global Value Fund would be chided for buying a company like Toya Tec Co. Ltd., a security guard business trading at around 708 yen. At this level -- at less than half of its 1687 yen book value -- the company has been earning pre-tax operating income of 91 yen while at the same time carrying 1168 yen in cash per share net of debt. Then there's Shikoku Coca Cola Bottling Co., another bad equity investment by the Global Value Fund, which trades at around 1400 yen while simultaneously carrying 600 yen in cash per share, which puts the company at four times pre-tax earnings (with the cash removed), which is actually a pretty nice discount to the 10-12 times earnings before interest, taxes, depreciation and amortization (EBITDA) at which U.S. bottlers trade.
Right now Japan is an interesting investment laboratory. In some senses time is the variable that is being held constant, and in this controlled environment it is only the value players that are snapping up stocks. Growth investors are rendered inert because they can't do anything until something starts moving through the "earnings expectation life cycle." Meanwhile, funds like Global Value are buying good companies at bargain prices, as well as the occasional "great company" at a good price. And when your time horizon is 10-15 years, or even "forever" if the business is good enough, a couple of years of individual stock underperformance are acceptable. It is only when profit cycles peak and start to decelerate that investors bid up the prices of those companies holding the scarce earnings resources -- and growth investors shine. However, when the profit cycle begins to normalize, value investors come to the fore. If an investor has faith in the long run prospects of market economies -- and historically that's been a good bet -- then it's best to be a net "buyer." As Warren Buffett writes:
"...[S]mile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy.") We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence. In recent years, the actions we took in those decades have been validated..."