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May 29, 2023

Highlights From Ben Graham Value Investing Conference

by Rita Silvan

If value investors had a theme song, it might just be Tina and Ike Turner’s Proud Mary: 

“You see we never ever do nothing

Nice and easy

We always do things nice and rough…”

And rough is how you’d describe the drubbing value investors have taken for the past decade. Total returns from growth strategies trounced those from value investors although, historically, value has the edge with 4.1% average outperformance since 1927. 

At this year’s Value Investing Conference, the mood was upbeat as value investors are seeing signs that with the changing regime of rising interest rates and a tighter credit market, stock valuations will no longer grow to the sky, to paraphrase Warren Buffett, and intrinsic value and margins of safety will come to the fore once again.

The agenda was filled with insightful speakers such as Anthony Scilipoti, cofounder of Veritas Investment Research and Howard Marks, co-founder of Oaktree Capital, among others who shared their thoughts on what might be around the corner and where to invest now.

Can You Dig It? Forensic Accounting Expert And Veritas’ Founder Anthony Scilipoti

Anthony Scilipoti of Veritas Investment Research kicked things off with “How to Invest like a Forensic Accountant”. As an independent firm, Veritas is not shy about their analyst reporting. “Sell is a four-letter word in the industry,” said Scilipoti. He and his team take what he calls a “forensic accounting approach” to company balance sheets and annual reports. Describing himself as a “skeptical optimist”, he takes a three-part approach to company analysis; 

  1. 1.     Evaluate the business and reporting control environment; 
  2. 2.     Identify “flammable” items; and
  3. 3.     Look for sparks, e.g. higher interest rates.

His lively talk was a roller-coaster ride through some of the biggest flame outs in Canadian business in recent times including Nortel which in 2000 represented 66% of the TSX and was, “a microcosm of growth by doing everything wrong by compounding the ills of the accounting and investment industries.” That year, Nortel reported a $6 billion difference in US vs Canada GAAP. “Nobody cares until they care,” he said. “And then they care a lot. It was like students writing their own report cards!” Eight years later, Nortel was bankrupt. Other egregious examples included Bombardier (“conglomerate accounting story and an interest allocation shuffle”), Yellow Pages (“classic accounting story”), and Valeant Pharmaceuticals (“changing accounting methods after each acquisition”). 

Investor Takeaway:

  1. 1.     Look for flammable items:
  • Change in communications.
  • Change in internal control structure and dynamics.
  • Change in non-GAAP metrics.
  • Change in accounting methods. 
  • Change in economics or competitive dynamics.
  • Unusual difference between cashflow and operating income.
  • Unusual divergence in business strategy.

 

  1. 2.     Look for sparks:
  • Change in credit environment.
  • Change in economic environment.

 

  1. 3.     Don’t over depend on what you think is your strength:

Scilipoti shared his Intrawest story. Intrawest Resort Holdings was a developer of luxury travel resorts and owned properties in Whistler and Vail. The company was highly leveraged and, as an accountant, Scilipoti was negative on the company due to its weak balance sheet. What he neglected to consider was Intrawest owned some spectacular properties. In 2006, the company was bought out with a 32% premium by Fortress Investment Group. 

3rd Great Sea Change is Now, says Howard Marks, co-founder of Oaktree Capital

The candy store is closed, and the sugar rush of cheap money is over. According to Howard Marks, co-founder of Oaktree Capital, this change in monetary policy marks a big sea change. “Buyers are not eager, and holders [of credit] are not so compliant,” he said. 

As interest rates finally settle, they are likely to do so at higher than historical levels; he expects closer to two to four per cent versus zero to two per cent and certainly much higher than during the past decade and half when loose monetary policy from central banks drove prices higher for all types of assets—from equities, real estate, art, and crypto. Investors who believed they had special skills because of strong returns misunderstood the context, Marks said. “It’s like walking through an airport on a moving walkway. Your progress is the sum of your speed and the speed of the walkway. You may think you’re a fast walker but that’s because you are not paying attention to the environment.” He believes the most dangerous situation is when “there is too much money and too many people who want to put it to work.”

“Before the GFC, there was no credit control,” he said. “There was very little difference between good and bad companies.” (Prior to the Great Financial Crisis, he had a laddered portfolio of Treasuries with an average yield of five per cent.) Marks expects the next five to ten years to be what he calls, “a less easy period” in what works [in investing] and what doesn’t. Despite pockets of correction, Marks still sees the U.S. market overvalued at 19 p/e, He says he would not be surprised if the S&P 500 dropped another 15 to 20% from here during a period of adjustment. 

The elephant in the room was machine learning and generative AI and what effect it may have on investing. Marks still sees a role for hands-on, boots-on-the-ground investors. “Can a computer sit with five business plans and figure out the next Amazon? Or meet five CEOs and predict which one will be Steve Jobs? Or figure out how a company is going to be restructured?” At the present time, AI is good at knowing about the past but is not good at qualitative or future oriented situations, he added. 

Investor Takeaway

  1. 1.     Know your environment. “Nothing kills returns like too much money.” 
  2. 2.     Know yourself. You can’t change them, but you can become more aware of your biases and learn to mitigate them. 

“My parents were born in the first decade of the 20th century and were adults during the Great Depression. This generation worried like crazy and never put all their eggs in one basket. My upbringing made me perhaps too conservative and chicken which can be good for investing in distressed debt. However, at Oaktree we’ve been accused of being too conservative.”

  1. 3.     Be wary of success because “it is cyclical and carries the seeds of failure—and vice versa!”
  2. 4.     Regarding cryptocurrency: “This time is not any different but more than 20% of the time it is different. We’ll have to wait and see.”
  3. 5.     Any tips on becoming a good investor: “I always recommend luck.” 

Value-oriented companies mentioned by conference panelists:

  • Altagas (ALA); margin of safety 37%
  • Willis Towers Watson PLC (WTN); margin-of-safety 25%
  • Constellation Software (CSU)
  • Expeditors International (EXPD) 
  • Credit Acceptance (CACC)
  • International Continental Exchange (ICE)
  • Fastenal (FAST)
  • Eurofins Scientific (ERF)
  • Sectors of interest: commodities complex; materials; oil, Treasuries
  • Geographies of interest: Europe, Japan, U.S. Canada

 

Rita Silvan, CIM is a finance journalist specializing in women and investing. She is the former editor-in-chief of ELLE Canada and Golden Girl Finance. Rita produces content for leading financial institutions and wealth advisors and has appeared on BNN Bloomberg, CBC Newsworld, and other media outlets. She can be reached at rita@ellesworth.ca.