Buy High, Sell Low

Cover Story, by Mark Robertson, Managing Partner September 1st, 2014

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We reinforce the philosophy and process often. 1. Invest in the Best. 2. We’re Here For The Returns.

Last month’s recipe for a Smoothie Portfolio served as a reminder of how unique (and liberating) our approach to long-term investing really is. It rekindled thoughts of an extended discussion that I had with Mark Hulbert a few months ago that led to a feature in the Wall Street Journal and some air time on CBS MarketWatch. We reinforce the philosophy and process often. 1. Invest in the Best. 2. We’re Here For The Returns. It’s a mindset that literally requires us to “stand on our heads” seeking buying opportunities when return forecasts are HIGH and remaining vigilant for portfolio-centered selling opportunities when forecasts are low (and the portfolio needs it.) Stand on your head. Carry on.

If you follow along on the Manifest Investing Forum, you already know that our attention has been captured by a 1958 book written by the founder of Value Line, Arnold Bernhard. The name of the book is the spell-binding and breath taking, The Evaluation of Common Stocks. We’re certain to spend some pixels, Internet bandwidth, paper and ink on a review and reinforcement of the core principles in weeks and months ahead. A number of community participants have already ordered the book through second hand resources like Amazon, ABEbooks and Barnes & Noble … and book review will erupt on the Forum in days ahead.

If all of the deviltry of all of the crooked stock market riggers of all time were raised to the hundredth power, it would count as nothing compared to the desolation wrought by deluded crowds of investors whose imagination knows no discipline. — Arnold Bernhard.

Amen.

Powerful words. And words that resonate, resemble and reconcile with our notions of analysis and implementation of a long-term investing philosophy based on a few key metrics, trends and over seven decades of experience. Patience and discipline. Straight from the cover of the book:

“Stocks are not always worth what they sell for. Sometimes they are carried too high, sometimes too low, by mass excitement. Sooner or later, though, they move into line with value. This book explains how to project the normal value of stocks into the future.”

Lining Up Wisdom

Bernhard deserves a berth in any long-term investing Hall of Fame, but he’d probably be inducted as part of a tag team that would include his multi-decade colleague, Samuel Eisenstadt.

We’ve shared previously (and fairly often) that the Value Line method is compatible with the analysis that we do and consistent with the processes used by modern investment clubs and individual investors.

Ted Brooks probably said it best recently, “I’d stated in an earlier post that the Stock Selection Guide (SSG) based method of analysis and the Value Line company report are joined at the hip. In one sense that’s true, and in another, not so much. The SSG utilizes and organizes the Value Line sheet data in a useful manner. But, the SSG takes a little different approach to valuation.” Specifically, Value Line concentrates on their own flavor of “cash flow.”

The concept of a “cash flow” multiple is not too different from that for a Price/Earnings multiple (or ratio). The difference here is that instead of dividing the recent price of a stock by 12 months of earnings to create a P/E multiple, Value Line divides the recent price by the total of 12 months of earnings plus 12 months of depreciation (and amortization, if there is any). There is evidence that some stocks will generally trade at a price close to the “cash flow” line — THE Value Line. In those cases when a stock is trading above THE Value Line, it will often move back down toward the “cash flow” line. When it is trading below, it will often do the opposite. In some cases, a stock may trade above or below THE Value Line for considerable periods of time.

We’re Here For The Returns

It’s interesting that Bernhard starts his book (Chapter 2) with an overview of quality. We’ll be taking a much closer look at that in the future.

Bernhard and Value Line have a venerable history and their work has been heralded by the likes of Warren Buffett and Peter Lynch. In a recent comparison of research entities for stock investors, a pundit shared that Value Line conjures names like Ben Graham and Walter Schloss … and a rich heritage.

University of Chicago famed investor Fischer Black (e.g. Black-Scholes) conducted an analysis of the method and results achieved in an article for the Financial Analysts Journal, “Yes, Virginia, There is Hope.” It is noteworthy that Black was a noted efficient market hypothesis advocate. He was skeptical about the probability and frequency of superior performance for active funds based on any approach. That said, he made an exception for Value Line — basically citing the results and reaching the conclusion that if anybody can produce reliable long-term performance, it’s likely the method and disciplined approach championed by Value Line.

Mark Hulbert shared a perspective on Bernhard and Eisenstadt with the following summary, entitled “The Wisdom That Comes With Age” (May 5, 2005):

1. Be rigorously empirical and objective.

2. The importance of discipline.

Our research suggests that the low total return forecast is worthy of focus and attention. In other words, actual results have more closely resembled the Value Line low total return forecast and it’s the reason we carefully track the median low total return forecast for the universe of stocks covered in the Value Line standard edition. (We’ll share an update as another quarter closes for this indicator next month.)

Confidence in stock investing has suffered in recent years, a reality reflected by the business condition of places like Value Line. But tides are turning…

Objective methods are necessary to deal with the turbulent hopes and fears of the market place.

Discipline matters.

Go ahead. Assume the position. (Stand on your head) Buy high. Sell low.