Don’t Play in The Street
Weitz Market Cycles
Our investment philosophy (see below) does not change with market cycles and it is grounded in the fundamental notion that, in the short term, human behavior and stock prices will always be more volatile than actual changes in fundamental business values. During periods of extreme volatility, we are more likely to find investment opportunities in businesses that meet our investment criteria of being undervalued by the market. Generally, our investment style has an opportunity to shine in this type of “choppy” or broader market downturn thanks to our reluctance to own cyclical businesses and most importantly, our tendency to buy undervalued companies with the wherewithal to do well through all markets. Generally, our investment style may not keep pace in an extended, aggressively rising stock market. Regardless of where we are in the market cycle, based on the chart below, we should be able to provide reasonable returns over the long term.
At Weitz, when we analyze a potential investment, we think about the business behind the stock. Our strategy is to try to understand what a rational buyer would be willing to pay for 100% of a given company. Our approach is guided by our valuation discipline. The valuation may focus on asset values, earning power, the intangible value of a company’s “franchise” in its market or a combination of these variables. We then try to buy shares of the company’s stock at a significant discount (minimum 30%) to this “private market value.” We are looking for companies selling at a deep discount relative to what we believe they are worth over a long period of time. It is this discount that provides the “margin of safety” that may minimize the risk of permanent loss of capital. Ideally, the business value rises over time and the stock price follows. This allows us to focus on the long-term prospects of the company while taking advantage of short-term fluctuations in the stock price. Growth is still a prerequisite for investment. Due to our use of a five-year Discounted Cash Flow (DCF) model with a 12% equity discount rate, the company, by nature, must continue to grow to meet our investment criteria.
We generally use language such as “price-to-value ratio (P/V)” when describing the overall attractiveness of an individual equity investment or an equity portfolio. The price-to-value ratio for an individual equity investment is the current price of the security divided by its estimated intrinsic value. For a portfolio, it is simply the weighted average of all price-to-value ratios of every equity investment. As noted above, we try to buy stock of a company at a price-to-value discount of at least 30%.
Using a 5 year DCF model with a 12% equity discount rate/hurdle rate purchased at the below P/Vs would imply a five year Compound Annual Growth Rate (CAGR) of the below stated expected returns:
50% (P/V) at purchase would produce 29% five year CAGR
60% (P/V) at purchase would produce 24% five year CAGR
70% (P/V) at purchase would produce 20% five year CAGR-Weitz Target
80% (P/V) at purchase would produce 17% five year CAGR
90% (P/V) at purchase would produce 14% five year CAGR
100% (P/V) at purchase would produce 12% five year CAGR
As the information above alludes to, generally the higher P/V paid for a stock or the higher P/V of a portfolio the lower the future returns.
To illustrate, the chart below highlights a Weitz generic all-cap, long-only, equity strategy. Weitz began archiving portfolio price-to-value ratios June of 2009.
|Date||Portfolio Price-to-Value Ratio
|5 Year CAGR|
As always, all investments are subject to risk, including the possible loss of the money invested. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of securities, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income or return. Investing with a perceived “margin of safety” may limit but does not eliminate downside risk.