On market valuation
I just finished a quick read of this post about Warren Buffett’s early investments. The gist of the post seems to be that Buffett, early in his investing career, didn’t just buy cigar butts as everyone seems to think, rather his largest investments tended to be quality companies acquired at reasonable prices. I don’t really know whether I agree with this thesis as there doesn’t seem to be enough information in the post to back it up; he cites a couple of early investments while focusing primarily on Buffett’s investment in Western Insurance. What really struck me about the post was not the thesis but that Buffett was able to purchase his position in Western Insurance at 1.3x earnings. Yep, that’s right Buffett purchased his investment at less than 2x normalized earnings. OK. So my takeaway from the post was not about what Buffett did or didn’t do early in his career but THAT HE WAS ABLE TO PURCHASE SHARES IN A PROFITABLE COMPANY FOR LESS THAN 2X NORMALIZED EARNINGS! Doesn’t that kind of stock valuation seem rather incongruous with valuations in today’s market? It does to me! In fact, by comparison it makes today’s equity markets look like we are in super bubble territory. We don’t have to argue about whether the normalized Shiller PE is or is not above the long term average to determine whether today’s markets are at or above long term levels. Can you name any shares on the NYSE or NASDAQ that are trading at a PE or FCF multiple of 5, let alone 1.3? If you can, please send those names along to me (and only me as I don’t want the rest of the universe competing with me to when I purchase a gazillion dollars worth!!)
So you may be asking why, then, am I still holding any equities in my portfolio. Shouldn’t I be 100% in cash or, even better, 100% short? The problem there is the age-old issue of timing. While I think the market is in super bubble territory, there is no reason it can’t reach super, super bubble territory or even super, super, super bubble territory before a crash. I think I finally learned my lesson last year when I took a small position in S&P 500 puts…. and lost it all as the market steadily climbed higher. There really is no reason for an investor to speculate on the direction of the market. However, that doesn’t prohibit an investor from holding cash if nothing really mouthwatering seems to be available. So today I’m about 1/3 in cash and 2/3 in equities that I think are still either significantly undervalued or have somewhat of a negative correlation to the market. Let’s review. My biggest two positions are AIG (about 1/4 of the portfolio after the recent reduction) and BAC warrants, both companies significantly undervalued by Mr. Market in my view. Then there is Steel Partners (SPLP), a holding company trading at a discount to NAV, where many of the listed companies it holds positions in are, themselves, trading at a discount to intrinsic value; so two levels of discounts. On the non-correlated side I have investments in some commodities that have fared poorly recently, gold (Novagold), agricultural commodities, iron ore and gold (Altius Minerals) and forestry products (Resolute Forest Products and Fortress Paper). I also have a position in MFC Industrial, a company with exposure to metals and oil and gas (which, however, I will be selling shortly), a video game developer that is a net/net (Gravity Ltd.), a small position in RadioShack (made even smaller by the decline in share price over the past 2 years), and finally a short-term spinoff trade (Oil States International). I plan on liquidating the MFC Industrial and the Oil States International positions in the coming weeks to increase my cash hoard even further. The rest of the less correlated positions (NG, ATUSF, RFP, FTPLF, GRVY and RSH) I view more as options than pure equity plays; each has considerable upside but can waste to nothing if conditions remain as they are today.
I know that a portfolio structured like mine will do nothing if the market levitates higher. That’s just the price I’ll have to pay to sleep peacefully at night.