Value and Glamour Investing, Re-Envisioned

Did you know that the best performing glamour stocks outperform the best performing value stocks? Sounds exciting, right? Well it may be, but expensive stocks still stink. In this piece I visualize the performance of value and glamour stocks in a new way to make the point once more that value trumps everything. 

Why in the world do people buy expensive stocks? Every shred of academic evidence shows that they underperform over the long term, and yet we keep buying.

We do this because we are so focused on the spectacular possible outcomes when we should instead be focused on the more sobering probable outcomes. I’ve referred to expensive stocks as lottery tickets in the past, because while investing in a group of expensive stocks (or lottery tickets) is usually a bad idea, sometimes you’ll get a winning ticket.

In the case of glamour stocks, these winning tickets have yielded incredible returns. Last October, Tesla and Cheniere Energy were the two most expensive large stocks trading in the U.S. Tesla was priced at 15 times its sales, Cheniere at 35 times sales. And yet over the next year, Tesla was up +51% and Cheniere +88%. People see results like this and think “valuations be damned.”

I define glamour stocks as the most expensive 10% of the market (rebalanced annually) by measures like p/sales and p/earnings. Glamour stocks as a group do poorly, but digging a little deeper we see that some are huge winners. Within the glamour stock universe, I sort stocks based on their forward 12 month return into ten equal groups.  The average results are illuminating:

You notice that the best performing glamour stocks beat all stocks by an average of 115% over the coming year. Talk about winning the lottery. But here is the problem: the median glamour stocks lost to the market by -11%, on average and the worst glamour stocks lost by 75%. Over and over again, we are seduced by the possibility of earning huge excess returns and blinded to the probability that we will underperform the market. Probabilities are boring, possibilities are exciting. But probabilities are all that matter in an uncertain world.

The first lesson, as always: some expensive stocks kill it, but the category stinks.

There is a flip-side which is much more enticing. Howard Mark’s (and many others successful investors) always highlight the importance of asymmetry in the investing process. The best way to succeed is to follow a strategy which is skewed in your favor on the upside.

In a recent memo, Marks said, “The goal in investing is asymmetry: to expose yourself to return in a way that doesn’t expose you commensurately to risk, and to participate in gains when the market rises to a greater extent than you participate in losses when it falls.  But that doesn’t mean the avoidance of all losses is a reasonable objective.  Take another look at the goal of asymmetry set out above: it talks about achieving a preponderance of gain over loss, not avoiding all chance of loss.” (his emphasis)

With that in mind, check out the same results for the value portfolio:

This shows that value investing offers the right kind of asymmetry that investor should seek: on average there is more to gain than to lose, because while some value stocks get killed, the average ones significantly outperform the market on an annual basis.

Glamour/lottery stocks, by contrast, have the wrong kind of asymmetry: some do exceptionally well, but the average ones significantly underperform the market.

It is fascinating that if you could see the future, you’d do the best if you bought the best of the glamour stocks: the best performing glamour stocks outperform the best performing cheap stocks. But you can’t predict the future, so don’t try. Forget the splendiferous possibilities of glamour stocks and focus your portfolio in value stocks that offer the highest probability of success. 

Favorite Interviews

Interviews are my favorite. Lighter than presentations and easier than long pieces of text, interviews can provide fun and digestible insight into a topic--just look at the rise of the podcast!

Here are my favorite interviews so far:

Talking all things investing (whether you are a millennial or not) with the great Morgan Housel of the Motley Fool and Wall Street Journal

Talking millennials and money on Squawk Box

A wide ranging discussion with Carol Massar on Bloomberg Radio

Have a great weekend!


How Much Capital is Needed To Produce Sales?

How much capital is required to produce sales? I think this is an interesting question across U.S. economic sectors. Some sectors require boatloads of capital, others very little. Below are two looks at capital intensity (using capex-to-sales and assets-to-sales). For both, higher numbers indicate more capital intensive businesses. 

Utilities and Telecoms are traditionally the most capital intensive sectors, requiring tons of assets and capex to produce sales. Conversely, Consumer stocks have traditionally required far fewer assets to produce sales. Of note is the major rise in Capex/Sales for the energy sector, as more expensive means of extracting fossil fuels (tar sands, shale, etc) have become more important. 

 In a future post I'll analyze whether or not these have been useful factors for stock selection, both within and across sectors. 

How do you think capital intensity should factor into the investing process? I'd love to hear your thoughts below on the utility of these factors. 

How Concentrated Should You Make Your Value Portfolio?

To take advantage of value investing, you need a smaller portfolio than you may think. I was curious to see what different levels of portfolio concentration would have produced in a value-only portfolio over the past 50 years, and report the results here.  

I set up portfolios which bought the absolute cheapest stocks trading in the U.S. (including ADRs). Portfolios ranged from 1 stock to 100 stocks, and stocks needed to have a minimum market cap of $200MM (inflation adjusted). Cheapness is defined as an equal weighted combination of a stock’s price/earnings, price/sales, EBITDA/EV, Free Cash Flow/EV and total (shareholder) yield. Each portfolio was rebalanced on a rolling annual basis (meaning 1/12 of the portfolio is rebalanced every month.  Think of it like maintaining 12 separate, annually rebalanced portfolios). This means that the “one stock portfolio” will have more than one stock, because different stocks rise to the top through the months. This process removes any seasonal biases and makes the test more robust.

Here are the results, including return and Sharpe ratio. The best returns came from a 5 stock (!) portfolio. The best Sharpe ratio came from the 15 stock version. Both return and Sharpe degrade after 15 stocks.

The same is true of glamour portfolios. The concentrated glamour portfolios have bad returns and are incredibly volatile.  The 1-stock version had an annual standard deviation of 50% and the 5 stock version had a standard deviation of 40% (hint, I wouldn’t short these!).

I’ve written before about overdiversification. I’m also a huge believe in high active share, and that to beat the market you must dare to be great (that is, different). These results are further evidence support these beliefs. 

The Contrarian (Sociopathic?) Mindset

Expensive stocks suck. Cheap stocks are great. If you had followed these basic concepts through history, your results would have been incredible. Look below at the disastrous returns you’d missed by avoiding expensive stocks! And the huge returns you would have earned buying cheap stocks! On paper these results are enticing. But achieving results like this in the future would require a resilient and contrary mindset. Do you have what it takes?

These results are for the cheapest and most expensive large, non-financial stocks in the U.S. based on their EBITDA/EV ratios (rebalanced on a rolling annual basis). But “expensive” and “cheap” are not really the right words to be using to describe these two types of stocks. More accurate would be “exciting” and “terrifying.”  Stocks at these market extremes are those for which the market has the greatest consensus—both positive and negative.

In the case of exciting stocks, the consensus opinion is that the future is bright. It helps to replace the word “valuation” with “expectation.” High expectations—for companies like Tesla—lead to “exciting” prices. In the case of terrifying stocks, the consensus opinion is that the future is bleak or non-existent. Again using “expectation” instead of “valuation,” low consensus expectations lead to “terrifying” prices.

To buy into a terrifying portfolio, you need to have a contrary mindset. This mindset is almost sociopathic, because it requires not just ignoring the crowd, but actively trading against it. This flow chart below illustrates the counter-flow required to be a successful contrarian investor:

Case in point: today, 12 of the cheapest (most terrifying) 25 large stocks are large energy stocks. Would you buy a portfolio that was 50% energy right now? Oil has been in free fall. Because the energy sector has gotten more and more capital intensive over time, it requires higher energy prices to be very profitable. These companies may not be able to pay dividends in the future. If energy prices continue to fall, who knows what will happen to these stocks. It is easy to build a bleak narrative for energy stocks.

Let’s say you can stomach lots of energy stocks today. Would you then be able face similarly scary portfolios every year for the rest of your investing career? Remember, this isn’t a one-and-done trade. It is a constant cycling into the most hated stocks out there. This is not easy stuff.

One of the best books I’ve ever read is The Tiger by John Vaillant, which chronicles the search for a man-eating tiger in the Russian wilderness. This passage from the book (with my emphasis added) highlights aspects of the mental fortitude it takes to be a truly contrarian investor.

“The most terrifying and important test for a human being is to be in absolute isolation...A human being is a very social creature, and ninety percent of what he does is done only because other people are watching. Alone, with no witnesses, he starts to learn about himself—who is he really? Sometimes, this brings staggering discoveries. Because nobody’s watching, you can easily become an animal: it is not necessary to shave, or to wash, or to keep your winter quarters clean—you can live in shit and no one will see. You can shoot tigers, or choose not to shoot. You can run in fear and nobody will know. You have to have something—some force, which allows and helps you to survive without witnesses…Once you have passed the solitude test you have absolute confidence in yourself, and there is nothing that can break you afterward.”

Contrarian investing will require that you be “alone” almost all the time. The rewards can be great, but the journey is arduous. As Joesph Campbell said, "the cave you fear to enter holds the treasure you seek."

The Value Convergence

The valuation difference between the market's cheapest stocks and its most expensive has always fascinated me. Here are the EBITDA yields (EBITDA/EV, higher=cheaper) at different break points since the early 1960s.

At the market extremes (99th and 1st percentiles), things have converged a great deal. The cheapest percentile (25 or so stocks) are much more expensive (lower yields) than they were in 2009. The most expensive percentile is less expensive (although still has a negative EBITDA, just less so relative to its enterprise value). 

No matter which breakpoints you choose, spreads have come in and sit near all-time lows. Are narrower spreads a sign of market complacency? Spreads have peaked at times of peak uncertainty (2009, aftermath of tech-wreck, early 80's). 

The years teach much which the days never know

Here are the monthly returns for the S&P 500 since 1871. Chaotic. Sometimes terrifying. Sometimes very exciting. This is the market in which we live. These are the sometimes great and sometimes awful returns that make us greedy, euphoric, panicked, and fearful. These returns do not matter. 

Source: Raw returns from Global Financial Data. 

Here is what happens when you take these same monthly returns and compound them over 20-, 30-, and 40- years. These returns are hard to feel but they are the only ones that matter. If you are young, and you are a real investor, remind yourself that these long-term numbers are all that matter. This reminder is especially important on days like today, when the market is down 2.5%. 

Source: Raw returns from Global Financial Data. 

Frame things right, and you'll navigate the tough times just fine. Emerson said it best: "The years teach much which the days never know."

The Millennial Way Forward

If nothing changed about your current retirement plan, would you be able to easily support yourself and your loved ones come age 65? For many of my fellow millennials this is a sobering question. On the one hand, it is hard to think and plan four decades ahead. We are still young — scraping our way to better careers and salaries — so our focus is not on our twilight years, but on the here and now. On the other hand, we are cautious and worried about money because we have come of age during a rotten economy, and have watched the housing and stock markets crash, bringing financial ruin to those we love.

We are a generation obsessed with self-improvement. Most wake up in the morning and think, how can I improve my lot in life? Very few are just satisfied. Self-improvement is hard work, but luckily improving one’s personal financial situation is straightforward. It is one of the easiest ways to get better right away. The cruel irony is that we work tirelessly in our 20’s and 30’s to improve our careers and ourselves, but then spend so little time thinking about how to put our money and success to good use.

So far, a nice chunk of the millennial population has done something about long term financial planning: 43% of millennials have a 401(k) and 23% have an IRA. That is a good start, but it’s not enough. So how can millennials get started? The key is an education on the basics of money, personal finance, and investing.

Reaching millennials is tough because fully one quarter of them “trust no one” on money matters. Still, a large percentage — about one third — say that they trust their parents for advice on money. By laying some basic groundwork — either on their own or with encouragement from their parents — millennials can get off on the right foot and set themselves up for success.

The easiest way to understand the power of starting young is to focus on is the potential of every single one of your dollars.

The Potential of Each Dollar

What can every invested dollar grow to by the time you retire? The answer varies greatly depending on where and when you invest.

Those millennials that have saved and invested are very conservative with their money — opting for cash over stocks. The aforementioned stock market and housing crashes have been imprinted on our brains, and made us wary of “risky” investments like stocks. Because of our biological wiring, we are about twice as sensitive to losses as we are to gains. Once burned, twice shy as the saying goes — and we've been burned several times.

This biological imperative to be extra-sensitive to danger works great in a primitive, survival setting, but it wreaks havoc on our investments. Human nature compels us to sell after market crashes and buy at market peaks, even though we are supposed to be doing the opposite. These emotional reactions are very short-term in nature: our emotions make us avoid immediate dangers and pursue immediate opportunities.

The remedy is to redefine risk as a long-term rather than short-term concept. Here are four key lessons about the potency of your dollars.

The potential of every dollar fades quickly with time. If you start investing younger, you will harness the most important variable in the investing equation: time in the market. $1 invested in the stock market at age 25 has typically grown to $15 by retirement. The same dollar invested at age 40 has typically grown to $5 by retirement. Read that again. Dollars have typically had three times the potential when invested at age 25 versus age 40. Warren Buffett wasn’t a billionaire until he was sixty years old. He started investing when he was eleven. Step one, start young.

The potential of every dollar is maximized by spending long periods in the global stock market rather than in cash or bonds. If your time horizon is long enough — which it is if you are a millennial — then stocks have always trumped the alternatives. Millennials have built cash-heavy portfolios thus far, so consider the same potential of each dollar kept in cash (savings accounts, CDs). The average result for $1 invested at age 25 is growth to $1.20—a paltry return compared to the $15 from stocksWe think of bonds as the next safest option after cash, but the average $1 invested in bonds at age 25 has grown to $2.7. The long-term historical record is clear: stocks win out. Step two, if you are young, focus your portfolio in the stock market. Stocks are dangerous in the short term, but we are young so the short term is irrelevant.

The potential of every dollar fades the more often you check your portfolio. You are supposed to buy low and sell high. Most do the opposite. Human nature is great for many things, but investing is not one of them. The less you look at your results, the fewer chances you’ll have to screw yourself up. Step three, ignore short-term fluctuations in markets.

The potential of every dollar will be maximized if you make your investing automatic. Default options are powerful because we are lazy. If you automatically deposit a percentage of your income into your investment accounts (401(k), IRA, brokerage account), then you’ll build wealth without effort. Step four, automate contributions to your investing accounts.

The Way Forward

If you just invest a little bit of time and planning early in your life, you can effect significant change in your long term financial health. You can set yourself up so that your answer to the question “if you changed nothing about your current financial plan, will you retire comfortably?” is a resounding yes. Nothing is as powerful in the world of investing as starting young.

Here is something you can do today: check out companies like WealthfrontLiftoff, and Acorns. These companies sit at the intersection of investing and technology. Sign up today. Focus on stocks. Once you are set up, get out of your own way.

You’ll notice that a lot of this plan is simply protecting your dollars’ potential and letting them grow. But your dollars won’t work for you unless you get things started. Like millennials themselves, these young dollars are full of potential. They just need to be put to work.


For more on how to get started, check out my new book Millennial Money: How Young Investors Can Build a Fortune, which is on shelves today.

Resources For Aspiring Writers

Let me get this out of the way: I am not some great expert on this topic. You aren’t supposed to say that before you try to give advice, but I’ve only been writing here for about 6 months so I felt a disclaimer was necessary. That said, I feel as though I’ve learned a few things that might help someone who wants to start a website (I am and will be forever resistant to the word ‘blog’).

Read books about persuasion and psychology. Writing is sales in disguise. It’s about getting people’s attention, entertaining them, and delivering useful information—all in about 500 words. Instead of getting them to buy something, you are winning them as readers. There are several principles of persuasion and influence that have been very valuable to me when thinking about how to structure and title a post. Here are the best resources:

Influence by Robert Cialdini—the Bible of persuasion. This book explores durable principles like reciprocity. Give people something and they feel obligated to give something back. For example, you could write a helpful post for aspiring writers and hope that in return they pre-order your book ;).

Fascinate: Your 7 Triggers to Persuasion and Captivation by Sally Hogshead – explores the principles of lust, mystique, alarm, power, prestige, vice, and trust. - a good resource site for mental triggers.

Spend as much time on the title and lead paragraph as you do on the rest of the post. Josh Brown took me to lunch right as I started writing. When I asked for his advice, he told me to spend as much time as possible on titles and lead paragraphs. He was right. When I’ve spent lots of time crafting a post’s title, it has almost always paid off.

Scratch my back… I am just okay at this one. I have noticed that the financial writing community is very cooperative. Many of the best writers support others through links, tweets, and references, and get great support in return. I don’t do linkfests, but maybe I should.

Build an email list. This advice is ubiquitous because it’s true. The best engagement comes from readers who respond to you through email. I am blown away by the response I’ve gotten from readers, many of whom are much smarter than me. I also now have a handful of people I write for advice on new posts and other ideas (Steve from Australia, you are my man!). I’ve never met these people, but I trust them.

Try to write evergreen content. It is always tempting to write response pieces to breaking news or hot topics. If you have the energy to do this, god bless you. I don’t. I rely instead on writing things that will still be relevant years from now.

Cross genres. I’ve heard the opposite advice from many writers: “focus on your niche and become a deep and reliable expert.” Yet my most read and popular posts have been a mix of different areas of interest. This post on contrarian ideas got more response via email than my next 5 most popular posts combined. 11 of the 15 ideas in that post had nothing to do with investing. If you can find a way to work your various interests into your niche in a way that is complimentary, I suggest you do it. A perfect example is Ben Horowitz opening each chapter of his book with rap lyrics.

Don’t be a shitty writer. I am no Cormac McCarthy, but I do spend time editing (I sure hope there are no typos in this post!). Maybe I am just sensitive to bad writing, but when I read a poorly written post I get annoyed. Clear writing is the key to making an impression on readers. Here are the best resources:

Bird by Bird by Anne Lamott

On Writing by Stephen King

On Writing Well by William Zinsser

One helpful tip: when you wrap up a post, search for “ly” to find all of the useless adverbs that are polluting your writing. I just did this search for this post and found 18(!) adverbs that did NOTHING to improve the sentence.

Ask for help. In the early days, I asked lots of people for help. Having other popular writers support your posts is essential if you want to build a big audience. Ask your favorite writers to read your stuff and many will say yes. Most of my readership has come from those generous enough to link to me (especially Tadas Viskanta, Josh Brown, and Barry Ritholtz—thank you guys).

Vary your content. My favorite websites tackle many different topics. Our brains get used to patterns and then take them for granted, so if you only write about the same thing over and over you’ll lose people’s interest. Jesse Livermore is best example of varied content. Sure his writing is all about economics/investing, but his last five posts have been about Bitcoin, Supply and Demand, Shiller CAPE, the history of individual country valuations and returns, and banking on the gold standard. Because I never know where he’ll go next, I am always checking his site for new posts.

Find a voice. At first I wrote trying to mimic the style of other writers. I was going for a Sam Harris-style sophisticated complexity. He is much smarter than me. He is a much better writer than me. Mimicking him was a bad idea. Writing in your own voice (which sounds obvious, but is quite hard to do) makes writing easier and more fun.

Incentivize. I stole an idea from Ryan Holiday to run an incentivized pre-order campaign for my book. The results have been awesome. I’ve been getting emails with the required receipt non-stop since I first posted the offer 6 weeks ago.  I don’t know how Amazon’s system works, but I am convinced that strong pre-orders is part of the reason the book was listed as one of the best of the month for October. Even if their editors had loved the book, I am not sure they would have given it such prominent placement if it hadn’t sold any copies. I am also going to be experimenting with incentives to join my reading list after the launch. Tit-for-tat works, so use it as often as you can.

Write. D’uh. Write a lot. Be willing to throw most of it away. If you have more words on paper, you’ll feel less attached to each passage and be more willing to cut the fat. I write every single morning at home with my coffee. I write most nights. 80% of what I write blows.

Learn from the masters. Here are a few people who are masters at what they do, follow them and steal their strategies. James Altucher, Ryan Holiday, Tim Ferris, Ramit Sethi, Noah Kagan, Chris Guillebeau, and Seth Godin.

I hope this helps! 

Building The Perfect Investor

The idea for this post came from Nas and Charles Murray. That’s got to be the only time those two have been mentioned together in a sentence, so let me explain.

Nas has a song (you can listen here, not safe for work at all and may offend) where he—how can I put this nicely— combines the best elements of women he loves into the perfect woman.

Charles Murray wrote a thought provoking book about the problems with our education system in which he outlines Howard Gardner’s seven different kinds of intelligence.

Somehow these two things coalesced in my brain and I thought it’d be fun to design the perfect investor using the these seven different kinds of intelligence, in the spirit of Nas’s “Makings of the Perfect _____.”

First, here are the different kinds of intelligence along with a brief description by Murray from his book Real Education: Four Simple Truths for Bringing America's Schools Back to Reality:

  1. Bodily-kinesthetic intelligence encompasses physical skills—gross motor skills, fine motor skills, and more generally, the ability to exert subtle and precise physical control over one’s movements.
  2. Musical intelligence is what it sounds like, encompassing highly developed senses of pitch, rhythm, tones, and the ways in which they combine.
  3. Interpersonal intelligence involves interactions with others. People with high interpersonal intelligence are good at sensing others’ emotions and motivations. They are empathetic, able to work effectively as part of a group, good at communicating with others, and effective at manipulating the responses of others.
  4. Intrapersonal intelligence involves knowing oneself and being able to use that knowledge effectively. People with high intrapersonal intelligence have a realistic grasp of their own emotions, motivations, strengths, and limits. They are able to exert self-discipline and defer gratification. They can remain analytical in times of stress. Courage and prudence are parts of intrapersonal intelligence. In excess, some of the qualities that go into intrapersonal intelligence can express themselves as neuroticism or extreme introversion, and can paralyze action through over-analysis.
  5. Spatial intelligence refers in part to the ability to visualize and mentally manipulate objects, as when an engineer holistically grasps how the parts of a mechanism interact or a chess master plays a game without looking at the board.
  6. Logical-mathematical intelligence involves numbers, logic, and abstractions. By definition, high logical-mathematical intelligence means the capacity for advanced mathematics, but it also expresses itself in the ability to mount and understand complex arguments and chains of reasoning, and the ability to make subtle distinctions. Logical-mathematical intelligence is especially important in the sciences and the law, but is useful for every occupation.
  7. Linguistic intelligence embraces everything having to do with language and the information language conveys. High linguistic intelligence includes the abilities to absorb complex written text and to express oneself precisely, eloquently, or persuasively as the situation may require. The ability to learn foreign languages easily is associated with high linguistic intelligence. Memory—the ability to store and retrieve large amounts of information at will—is part of linguistic intelligence.

So first, let’s rank these intelligences in order of importance for investors.

  1. Intrapersonal intelligence – Temperament—specifically the ability to stick to strategy when times get tough—is the defining characteristic of every great investor I’ve ever studied.  The ability to control (or ignore) one’s emotions is key in markets. As Confucius apocryphally said, "he who masters himself is the mightiest warrior."
  2. Logical-mathematical intelligence – Building complex chains of reasoning is essential for successful investing. The ability to think on the 2nd and 3rd level is a huge edge.
  3. Linguistic intelligence – Many great investors (especially activists) have a way of articulating their argument in a convincing and compelling way. Building and communicating an investment thesis is a key advantage.
  4. Interpersonal intelligence – Some might place this lower, as it is more relevant for sales roles than for investing. But along with linguistic ability, the ability to work well with people and be there for them when times are tough is a useful skill for investors, if only to keep people from redeeming at the wrong time.
  5. Spatial intelligence – There is probably something helpful about having spatial intelligence for investing, perhaps being able to visualize the big picture.
  6. Bodily-kinesthetic intelligence – I think general health is an advantage, but health is different from bodily-kinesthetic intelligence. Don’t see how this would be relevant for any investor.
  7. Musical intelligence – would love to hear an argument for this mattering, I can’t think of anything.

I think the best qualified person to build the perfect investor would be Tren Griffin or Jack Schwager, but here is my attempt.

  • Buffett’s intrapersonal intelligence. He is the master of the discipline and self-control that are the keystones of a great investment process. (Hon. mention: Seth Klarman)
  • Jim Simons’s logical-mathematical intelligence. Renaissance Technology’s track record is outrageous, built on the back of an obviously effective quantitative investment process engineered by Simons and his team. He was a code breaker and expert in pattern recognition.
  • Howard Marks' linguistic intelligence. I toyed with putting Buffett here again, but I’ve always loved Mark’s ability to write and communicate his investment philosophy and individual investment ideas.
  • Jack Bogle’s interpersonal intelligence. I’ve watched a lot of Bogle interviews and am constantly amazed at how likeable and clear he is. My guess is he could sell underwear to a nudist.
  • Peter Thiel’s spatial intelligence. This is a bit of a stretch, but I know he is very good at chess. (Hon. mention: Ray Dalio)
  • Magic Johnson’s bodily-kinesthetic intelligence. Great investor, legendary athlete. 
  • ???’s musical intelligence. Who knows?

This investing Frankenstein would be an unstoppable force.

Who would be part of your investor Frankenstein? 

15 Truths That Few Believe

What important truths do very few people agree with you on? This is the penetrating first question Peter Thiel asks readers in his great book Zero to One. The question is designed to promote deep and creative thinking, to uncover ideas that move us from “zero to one.” Moving from zero to one happens when we create a whole new category of business or thinking. The alternative, moving from “one to n,” is far more common—most of what we create is an iteration of some category that already exists.

I realize the irony here: writing a reaction piece to Thiel is just the sort of 1 to n, derivative thinking against which Thiel rails. Oh well. Reading the book, I was constantly reminded of a line from novelist David Mitchell, ‘The one dog who barks at nothing answered by a thousand dogs barking at something …’ This sums up a lot of things these days.

Thiel implores us to be the first dog, to be contrarian thinkers. For fun, I thought I’d answer his central question. Here are 15 things that I think are true even though most disagree.

1.       Brunettes > Blondes

2.       Risk controls increase risk. Risk has many definitions, but the most common that I come across is that risk equals deviations from the market/benchmark portfolio. These deviations can be in holdings (names, industries, geographical regions) or in factors (value, momentum). Many managers try to minimize tracking error (roughly the difference in returns) between their strategy and the market. Other risk controls neutralize exposure to things like the price of oil or rising interest rates. I think of risk instead as the percentage chance that a strategy will lose to a simple benchmark over one's investment time horizon. If you have a 10 year horizon (really truly, not just paying lip service), then all you should care about is "will this strategy beat a low cost index over this period, and what is the percent chance that it will win?" Anything that increases the odds of winning reduces risk, and anything that decreases the odds of winning increases risk. Most risk controls make portfolios look more like the market. That may reduce short term risk, but it often increases real risk. Strict constraints (i.e. risk controls) reduce flexibility, reduce active share, and reduce the likelihood of long term outperformance. There is a role for some constraints in portfolio construction, but they should be loose.  As Howard Marks says, to win, you have to “dare to be great.

3.       Heavily seasoned steak > basic salt/pepper

4.       College is a waste for most people. If all college graduates could run a simulation where they instead started working and gaining experience at age 18 (and avoid the cost/debt associated with college), I am convinced that most people would be better off. Having interviewed tons of people over the years, I know that college is all about getting that first job, but that it matters less and less after that. Of course there are some people for whom college is great and appropriate, but at its current cost I think it’s a waste of time and money for most.

5.       Free will doesn't exist. Read this, this, and this.

6.       Deep dives into value stocks will hurt your returns. As a quantitative money manager, I am of course very biased, but every time I dive deep into a value stock that come out of our models, I am appalled by the business and its prospects (Seagate Technology from three years ago comes to mind). If I did that for all value stocks, I’d probably never buy any of them. Some people may be able to improve on simple value screens by going very deep into the business, but in my experience you find many more reasons not to buy than reasons to buy. People disagree as to why value works. Some say it’s a compensation for taking more risk, others that investor psychology drives the opportunity in value stocks. I fall in the latter camp. Either way, it has always paid to be a contrarian value investor. Being one is much easier if you don’t know all the dirty details.

7.       Reading broadly is better than reading deeply. Don't get me wrong, expertise in a certain area can be very valuable. But I think reading lots of different, unrelated things is the key to coming up with worthwhile ideas. The last five books I’ve read are Zero to One, Ready Player One, Waking Up: A Guide to Spirituality Without Religion, As One Is: To Free the Mind from All Condition, and The Masks of God, Vol. 2: Oriental Mythology. I’ve learned as much about investing by reading psychology and mythology (a psychology derivative) as I did when studying the CFA curriculum. A well-worn library card (or, these days, kindle unlimited subscription) is more valuable than just about anything.

8.       Led Zeppelin > the Beatles

9.       EQ > IQ. I used to wish that I had just 10 or 15 more IQ points. Now I wish that I had a higher level of emotional intelligence (EQ). I've met lots of great and not so great people in my career, and the most successful ones (and the ones I've liked the most) have an uncanny ability to connect with people. I first learned the power of EQ by watching my wife navigate a crowd or meet someone for the first time.  She has a talent that I envy (and she’s doubly lucky because she’s smart, too. I hope she is reading this).  It is remarkable how much easier things are if you just know how to deal with people and make them feel comfortable and appreciated. Luckily, it’s easier to grow your EQ than your IQ.

10.   (Grass fed) butter + uncured bacon are healthier than oatmeal

11.   Quantitative asset managers should be much more concentrated. The quant party line is that you should place broad bets on factors (e.g. value, quality, momentum) not individual stocks, meaning you should own enough names that your success isn't dependent on any one name. I think a large advantage exists for those willing to use quantitative screens to build concentrated portfolios. 25 or 50 holdings is better than 250 or 500 (although you'll need to agree with me on my definition of risk from above). I will have a detailed post about this soon.

12.   Introspection > hard sciences

13.   U.S. stocks are not the place to be. Sure they have done really well, are secure, and operate in a wonderful environment. But they are terribly expensive relative to international alternatives. Value--along with reversion to the mean--indicate that U.S. investors should see past their home bias and build more international portfolios.

14.   Open minded agnosticism > atheism > anthropomorphized god based religions

15.   Now that I've mentioned religion, taboo topics (money, politics, religion) > all other topics.

What would your list be?

More Stocks That Are Much Cheaper Than Usual

I had fun with a recent post highlighting some of the larger U.S. stocks which are trading at much cheaper valuation multiples than they have over the prior ten years (on average). In that post, Apple rose to the top of the heap in terms of cheapness relative to its own past. 

Below, I have extended that idea to all U.S. stocks, rather than just the larger ones. Apple is still near the top, but a dozen other names have had a more extreme change in their valuation percentile. 

I love some of the names that come through: St. Joe (a Florida-based real estate company), Take Two Interactive (a video game company that fell from $27 to $6 in 2008/09), and Alacer Gold (Gold Miner). 

I think this is a fun way to screen for out of favor stocks. I still need to test whether or not self-relative valuation is a strong predictor of future returns. What do you think?

Buyback Yield in the U.S. Market

Buybacks are the hot topic. I've written before that buybacks can be very good under certain conditions (cheap valuations, high earnings quality, not funded by new debt issuance), but they can be very bad too (especially when the stock is expensive). 

Many are saying buybacks are evil because spending on buybacks is stifling spending on R&D, capital expenditures, and other growth propellants. Point taken. But buyback spending isn't all that outrageous today.

Because I was curious, I checked to see what the current "buyback yield" (gross buybacks divided by market cap) was in the U.S. by sector and overall.

Below is a chart showing that we are still a ways off the buyback peak (frenzy) of 2007, when U.S. companies were buying back the equivalent of nearly 6% of their total market cap over a twelve month period (we are below 3% today). 

Calculation Note: This is simply a sum of all gross buybacks divided by total market cap for all U.S. stocks (with a market cap above $200MM). Same calculation is done for each sector and rolled up. Gross buyback data is from the statement of (financing) cash flows. 

Tech stocks CAN be great

Value investing has been the most consistent way to outperform the market for decades. It continues to work because it forces you to buy stocks for which the market has very low expectations (expectations which often turn out to be overly pessimistic). People are overly sensitive to losses and often shun value stocks. But what about using value in a sector that has traditionally been the most expensive out there? As we shall see, it is possible to find diamonds in the rough.


One of the interesting byproducts of value investing has been a chronic underweight to the most fun sector: information technology. Let’s say every year all you did was buy the cheapest 10% of the market based on measures of value like price-to-sales, price-to-earnings, and EBITDA-to-enterprise value. The chart below shows—through time—what sectors you would have owned in this simple value strategy. Notice the slim band for IT stocks (in highlighter yellow). It is no coincidence that the sector has been the worst performing through time: technology companies—especially new ones—are often exciting, but you have to pay a dear price for stocks with vivid and potentially game-changing futures.

Consider technology stocks by one common value metric: price-to-cash flow. Below is the historical ratio for technology stocks versus the rest of the market (all non-tech, non-financial stocks).

What had been a massive overvaluation relative to the market has been steadily shrinking since the peak of the NASDAQ bubble in 2000. This lines up with the widening of the yellow band in Figure 1.

One great feature of value investing is that it doesn’t hold grudges. Who cares if tech has been expensive and a weak performer for decades? If those stocks are now trading at much cheaper multiples, we should consider them for the portfolio. I’ve written about Apple’s transformation from growth darling to hated value stock back to value darling. Apple’s journey typifies the sector as a whole.

Buying the best technology stocks

While more and more technology stocks look cheap, you can also use value to select the best investments within the technology sector. In fact, over the long term, the cheapest technology stocks have done quite well even as the most expensive tech stocks have lost money.

Here is the universe of technology stocks broken into quintiles (and best & worst 25 stock portfolios), and their historical returns and standard deviation of returns. These results are based on a rolling, annual rebalance like my other tests. Cheap technology stocks have delivered an annual return of nearly 14.5%, and have done so with much lower volatility than the rest of the sector.

We know that value works across sectors, but these results highlight the importance of valuations within sectors as well. If you want to buy tech stocks, forego the new exciting ones and focus instead on the cheap, seasoned alternatives.

Value and More

Value only works if you stick with it and adapt to changing opportunities. There are other factors—like momentum, quality, and shareholder orientation—that have provided an edge just as value has through time. I combine several of those key ideas into a cohesive whole in my upcoming book, Millennial Money: How Young Investors Can Build a Fortune. For information on the extra content available to those who pre-order the book, you can read more here

The Devil's Dictionary

Jason Zweig has a fantastic new website that include's a "Devil's Financial Dictionary," you have to check it out. 

Zweig's dictionary was (I think) inspired by one of the most fun little volumes every written, Ambrose Bierce's "Devil's Dictionary." Here are a few of my favorite definitions from the original:

CONSERVATIVE, n. A statesman who is enamored of existing evils, as distinguished from the Liberal, who wishes to replace them with others.

CRITIC, n. A person who boasts himself hard to please because nobody tries to please him.

DESTINY, n. A tyrant's authority for crime and fool's excuse for failure.

EDUCATION, n. That which discloses to the wise and disguises from the foolish their lack of understanding.

EXISTENCE, n. A transient, horrible, fantastic dream, Wherein is nothing yet all things do seem: From which we're wakened by a friendly nudge Of our bedfellow Death, and cry: "O fudge!"

FAITH, n. Belief without evidence in what is told by one who speaks without knowledge, of things without parallel.

FUTURE, n. That period of time in which our affairs prosper, our friends are true and our happiness is assured.

HABIT, n. A shackle for the free.

HAPPINESS, n. An agreeable sensation arising from contemplating the misery of another.

LAWYER, n. One skilled in circumvention of the law.

LECTURER, n. One with his hand in your pocket, his tongue in your ear and his faith in your patience.

LIFE, n. A spiritual pickle preserving the body from decay. We live in daily apprehension of its loss; yet when lost it is not missed. The question, "Is life worth living?" has been much discussed; particularly by those who think it is not, many of whom have written at great length in support of their view and by careful observance of the laws of health enjoyed for long terms of years the honors of successful controversy.

OCEAN, n. A body of water occupying about two-thirds of a world made for man—who has no gills.

PAST, n. That part of Eternity with some small fraction of which we have a slight and regrettable acquaintance. A moving line called the Present parts it from an imaginary period known as the Future. These two grand divisions of Eternity, of which the one is continually effacing the other, are entirely unlike. The one is dark with sorrow and disappointment, the other bright with prosperity and joy. The Past is the region of sobs, the Future is the realm of song. In the one crouches Memory, clad in sackcloth and ashes, mumbling penitential prayer; in the sunshine of the other Hope flies with a free wing, beckoning to temples of success and bowers of ease. Yet the Past is the Future of yesterday, the Future is the Past of to-morrow. They are one—the knowledge and the dream.

PHILOSOPHY, n. A route of many roads leading from nowhere to nothing.

POLITICIAN, n. An eel in the fundamental mud upon which the superstructure of organized society is reared. When we wriggles he mistakes the agitation of his tail for the trembling of the edifice. As compared with the statesman, he suffers the disadvantage of being alive.

PRAY, v. To ask that the laws of the universe be annulled in behalf of a single petitioner confessedly unworthy.

PRESIDENCY, n. The greased pig in the field game of American politics.

RATIONAL, adj. Devoid of all delusions save those of observation, experience and reflection.

REALITY, n. The dream of a mad philosopher. That which would remain in the cupel if one should assay a phantom. The nucleus of a vacuum.

RELIGION, n. A daughter of Hope and Fear, explaining to Ignorance the nature of the Unknowable.

WEATHER, n. The climate of the hour. A permanent topic of conversation among persons whom it does not interest, but who have inherited the tendency to chatter about it from naked arboreal ancestors whom it keenly concerned.


Searching for Deep Value Stocks

Deep value investing is a powerful way to beat the market, but deep value stocks are an endangered species in the U.S.

I was recently talking with Tobias Carlisle, author of Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, about what constitutes a deep value stock. To find these stocks, Tobias prefers to use the “takeover” multiple. One version of the takeover multiple is the ratio of EBITDA (earnings before interest, taxes, depreciation and amortization) to enterprise value (market value of equity plus book value of debt minus cash).

This is a great multiple for stock selection. Like the price-to-earnings ratio, it helps you find unloved companies, but it also penalizes stocks for having too much debt (more debt = worse ratio, ceteris paribus). If all you did was buy the 10% of stocks with the cheapest EBITDA/EV ratios on an annual basis, you’d have outperformed the market by more than 5% annually over the past five decades.

I asked Tobias what he considers a very cheap multiple EV/EBITDA multiple, and we agreed that somewhere below 5x indicates a cheap stock, while a multiple of less than 3x indicates very deep value. So here is the problem: today, we face what is perhaps the most difficult environment for deep value investing in history.  Just 3.2% of non-financial, U.S. companies with a market cap of at least $200MM trade at an EV/EBITDA multiple below 5x.  That is just off June’s all-time low of 2.9%.

There are just 65 stocks today with deep value multiples. Most are small. While a few big energy stocks make the cut (COP, HES, MRO), the median market cap of these 65 stocks is just $1B. If we limit ourselves to EV/EBITDA multiples below 3x, then I see just 7 stocks available. The largest has a market cap less than $2B.

So what is a deep value investor to do? Two options are to go smaller (into the micro-cap market) and go international. I’ll explore these options in a future post. Going smaller isn’t feasible for big institutional asset managers, but is possible for the little guy. Going international is great, but hard to execute as a small individual investor.

As I’ve written before, this bull market has left us with a very homogenous market where valuations are clustered around the mean. The sad fact is that in 2014, it’s hard out there for a deep value investor.

For much more on the topic, go read Tobias’s book. You’ll notice that the book is expensive, but trust me—it is worth every penny. 



These Stocks Are Much Cheaper than Usual

Apple's stock is far cheaper today than it has been over the last decade. The transformation of Apple's valuation looks so remarkable, it made me wonder if other large U.S. companies have undergone a similar transfromation.  I found some very interesting companies pop up...

To identify stocks whose relative valuation (compared to all other stocks) has changed the most, I first calculated each large companies average valuation percentile (where 100 is most expensive) over the past 10 years. To measure cheapness, I use measures like price-to-earnings, price-to-sales, EBITDA/EV, free cash flow/EV, and total yield.  As a reminder, here is how Apple's valuation has changed. 

As it turns out, there are other companies that appear far cheaper today than they have been over the past decade, but Apple still leads the charge. Notice that some of the names, especially Whole Foods, aren't especially cheap today...but they are still much cheaper than in years past. 

Here are three other examples: Corning, Coach, and NetApp. 

Most valuation measures are used to compare companies across a market or industry at one point in time. But it is also interesting to compare valuations for individual companies against themselves through time.

The reason that value works is that it is a proxy for expectations. Cheap valuations = lower expectations for the future--but these bleak forecasts often turn out to be too grim. This alternative way of looking at value can help investors identify stocks that are both cheap today, but also have had falling expectations over time.  To paraphrase Templeton, the key isn't to find stocks for whom the outlook is good, but to find stocks for whom the outlook it is miserable.