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Wilbur Ross and 40% returns

May 13, 2014

Ever since watching this video of Wilbur Ross speaking at the Ivey School of Business I’ve been thinking about what makes a good value investment, and I’ve come to the conclusion that:

  1.  any true, i.e. deep, value investment has to entail the possibility of a 3x or greater return (note that I’ve jus pulled ‘3X’ out of a hat; what I really mean is that one has to think in multiples of the current market price not 2 digit percentage returns),
  2. in order for multiple return potential to exist, either the company, the industry or, hopefully, both have to be in some sort of stressed situation,
  3. the key to identifying ‘stressed situations’ is to go only where no foot is currently treading.

You can see this kind of thinking reflected, but without the rationalization, in Walter Schloss’ simple but tried and true approach to investing where his first level filter is the list of new weekly lows. Now, this approach doesn’t exactly identify stressed situations on an industry basis except indirectly, as market prices tend to reflect the level of ‘stress’, but in some sense it’s doing the same thing in an oblique, company-specific way.

Why have I been thinking about this? Well, obviously because I’m looking for the next great investment, but also because I’m trying to explain to myself why I haven’t been able to find those great investments over the past year. The short answer is NOTHING SEEMS TO FEEL LIKE A STRESSED SITUATION in this market. I think one of the reasons is that the lake of liquidity that has pumped up the market from its 2009 lows is supporting just about everything. We haven’t really been in a stock picker’s market since before 2008; simply everything, the turds as well as the cruise ships, have been floating ever higher on the increasing tide. There will necessarily come a day when the tide stops coming in, and on the ebb we may see some value opportunities as we did in 2008/2009. I’ve been wary of this market for the past couple of years on this count and my performance has really suffered; Despite my largest position being in AIG which has floated upward admirably with the tide, I have lagged the market. Part of my underperformance can be attributed to my significant cash position, but part is because my deep value investments have not really kept up. Oh, and then there is the small issue of Fortress Paper, an ill-conceived because ill-timed investment. My definition of ‘deep value’ on that one was simply wrong. However, had I waited until now when it has really become a deep value play I might have been OK. I was just dazzled by the seeming opportunity and FORGOT ONE OF THE CARDINAL RULES OF INVESTING; DON’T INVEST IN SITUATIONS THAT DEPEND ON COMMODITY PRICES. They are simply not predictable and there is almost no ‘margin of safety in such company shares.

So where does this line of reasoning lead, in terms of searching out new investments? Like Wilbur Ross I need to look only at sectors, or individual companies, where the stock market value has collapsed, when everyone is running away, dumping the shares, saying there’s no chance for this company, no future, get out now while you can still get a few cents back on the dollars you invested! Unfortunately there are few of them around at the moment. Perhaps the mining sector….. and thus the investment in Altius Minerals. Perhaps Russia with all this Ukrainian thing going on. (By the way, we have the Monroe Doctrine which let us invade a bunch of Central American and Caribbean counties over the  years… did we expect that Russia wouldn’t follow the same kind of logic?   but I’m getting off track)… so thus the starter position in Gazprom. But even in these two instances the valuations are not really stress valuations. So I’m turning to another of Greenblatt’s favorite areas, spinoffs. There are a number of recent and upcoming spinoffs that look somewhat promising. Now if some large pension funds would just begin to load up on AIG stock and bump the price another 10% or so, I’ll be able to begin selling down my position and free up some cash.

  1. take a look at OZM. Forward P/E < 9x, worth 12x. 7.5% yield next year

  2. Rob permalink

    Do you think FTP is a good value investment now?

    • Though I have a position I don’t think Fortress Paper is a ‘value investment’ anymore. When they still owned the Dresden mill I thought of this as the hidden value in the company and thus providing a margin of safety. However, when Dresden was sold and the funds from the sale used toward completing the strategic plan put in place a few years prior (when DP prices were well over $1,000 a ton) this was tantamount to wagering the future of the company on a turnaround in DP pricing; the margin of safety simplyy disappeared. Right now I think the shares are somewhat undervalued for the potential upside, but you should remember this is potentially a 100% loss situation vs a 3-5x upside, and the odds of a turnaround are getting slimmer and slimmer as time passes.

  3. Jack permalink

    You mentioned Russia as a place to invest. I agree! I have gotten some ideas from your blog, so I thought I’d share one. You might try the RSJX etf. I know that fundamental investors might snub an ETF, but it has its advantages in this case. For one, it is hard to get around the fraud catastrophe risk prevalent at most Russian companies. If you diversify, the fraud risk is reduced. I had thought of investing in OJSC Pharmstandard (mentioned by Francis Chou in one of his most recent annual reports), but decided that the individual corporate governance catastrophe risk was just too much for me to stand and that the ETF is comparatively just as cheap. Second, it trades at half of book and 4x cash flow. Third, the RSJX has the advantage of having much less energy exposure compared to other Russian ETF’s. Fourth, the multiples that RSJX sells at are much lower than equivalent ETF’s for perhaps equally despised countries, like Argentina, Turkey, and Greece.

    • Jack permalink

      Sorry, the ticker is RSXJ not RSJX.

    • Thanks for the comment. Interesting idea. My interest in Gazprom was piqued by the situation in Russia (and the Ukraine), but I particularly like the valuation of the company (Gazprom) as well as the general market. At the moment we’re up 20% from my purchase price and I may shortly decide on (OH HEAVENS) a short term trade to catch the quick gain as my confidence in the Russian market is quite low. Sorry, you a moment of weakness.

  4. Jake permalink

    Check our Exco Resources (XCO). They are a 90% nat gas, 10% oil shale E&P. Wilbur Ross owns almost a quarter of the shares. Howard Marks owns another 20% or so. You probably came across the name when studying SD.

  5. Matt permalink

    The 3X idea isn’t necessary for me as I primarily stick to debt and preferreds. My approach is that I am looking for something that has no downside but upside of 15% IRR or better. Pretty limited investment set in general, but especially so today with only a couple very illiquid securities I am trying to buy.

  6. Seb permalink

    the Russian idea is good in my opinion. Bought Sistema and Sberbank and am already up 20 per cent on both stocks. Still lots of upside…

    @ Jack: I would also not recommend to invest in Pharmstandard! Corporate governance is not up to western standards. Read the news from about a year ago and you will be happy about your decision on the ETF which is a good way to diversify, i think.

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