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“If you didn’t get the deferred-gratification gene, you’ve got to
work very hard to overcome that.”

- Charles Munger, Berkshire-Hathaway Co-Chairman, in a 2014 interview
Read more of our favorite value-investing quotes.



FEBRUARY 22, 2015



Last year our DEEP VALUE Portfolio produced a return of 30% while our RELATIVE VALUE Portfolio gained just 13%.  With the overall market providing an average return of 8% per year, that performance is not too bad.  In addition, the small-cap market, upon which the DEEP VALUE Portfolio mines for companies, was in consolidation following a substantial outperformance in 2013 and produced a return of only 5%. Nevertheless, for IntelligentValue, a result of just 30% and 13% is downright flaccid.   Over the course of the business cycle, we can typically expect average returns of triple those levels (or more).  So what went wrong, and what can we do about it? 


When we launched our DEEP VALUE and RELATIVE VALUE Portfolios in March 2009, they were designed specifically to take advantage of the extremely oversold nature of the equity markets.  Following the 2008/2009 market crash, stocks offered an incredible opportunity, and many were priced at such low levels that even 'ol Benjamin Graham would have been thrilled.

In March 2009, we bought many companies that were selling at deep discounts; some could be scooped up at less than their net current asset values.  Of the first six stocks we purchased for our large-cap RELATIVE VALUE Portfolio, five returned triple-digit gains in just six weeks.  That large-cap portfolio went on to finish 2009 with a return of 693%, and our small-cap DEEP VALUE Portfolio profited a phenomenal 1,649% in only nine months.  It was truly a value investor's paradise.


Six very busy years have flown by since those days of 'easy pickins.'  As always happen as the business cycle matures, the stock market's dynamics have changed dramatically.  While we don't consider the market overvalued, most equities are fully valued.  As sometimes occurs  in the later stages of a market advance, when we attempted to rebalance our portfolios recently, we had very few companies that met our value-based criteria.  Furthermore, the companies we uncovered as possibilities were of inferior quality.

Some value investors, when this predicament occurs, simply hang up their spurs and remain in cash until the next selloff ends. They wait for Mr. Market to go temporarily insane yet again, offering the stock of quality companies for pennies on the dollar.  However, we believe it's downright lazy to leave so much money on the table as the market continues to climb higher.  There are substantial profits to be earned as the market claws for another peak in the final stages of a business cycle (and all the way down the back side of that mountain, too).

The market environment constantly changes, and we regularly update the models to fit the present environment. The market situation in 2009, when we produced a return of 1,600% and 700% is very distinctive from the advanced market environment of 2015.  Different factors are more appropriate today than they were a year or two ago – or even six months ago.


It's not necessary to buy stocks at less than net-asset value (as we did in 2009) to make significant returns from value investing.  Primarily, the requirement is a contrarian bent.  Beyond that, there is a wide variety of successful approaches.  When the market is presenting growth, GARP (Growth at a Reasonable Price) is a successful strategy.  Others have become wealthy in special situations; uncovering hidden assets such as real estate or pension funds that are carried on the balance sheet at a fraction of actual value.  Buffett has shown that buying "wonderful companies at a discount" can make billions.  On the other hand, Seth Klarman has become a billionaire by making 'margin of safety' a top priority.

The fact that many have been successful with a variety of approaches to identifying value proves that there is no single way to do it.  What the market offers up as an opportunity is constantly changing.  We feel that being flexibility to deploy a variety of value strategies guarantees that we don't get shut out of the market.  

For this reason, as the situation warrants, we occasionally revise our quantitative stock-selection systems to take advantage of the market's current conditions.  We have been working on updating the strategies of our two value-based portfolios since the beginning of this year, and that task is now complete.  As always, we have been diligent to ensure that the revisions will provide robust performance and will maintain IntelligentValue's record of outstanding returns through our second decade of service.


We were especially intrigued to learn if we could improve the performance of our DEEP VALUE Portfolio.  Small-cap stocks (which we use as the universe for the DV Portfolio) had a terrible year in 2014 following their significant outperformance of large-cap stocks in 2013.  As we have noted several times on our IMRA Page, small-cap stocks produced a return of ~60% in 2013 while large-cap stocks gained about 30%.   That outperformance was worked off in a year-long consolidation through all of 2014. 

The chart below shows the 2013 relative outperformance and the 2014 consolidation in small-cap stocks compared to the S&P 500 large-cap index:

Small-cap stocks produced double the return of large-cap stocks in 2013, but floundered in 2014.

Small-cap stocks are now back in line with the broader market but may still have an uphill battle to outperform again in 2015.   The reason? The Russell 2000's PE is at a sky-high 59.29!  This high valuation explains the difficulty we have had in identifying viable small-cap companies that meet our quantitative selection and qualitative review.  While small-cap stocks always carry a relatively high PE, largely because of their growth potential, 59 is just too high for the group. That said, there are always opportunities to find undervalued stocks within a collection of companies, no matter how overvalued the group.


For our small-cap DEEP VALUE Portfolio, we are still working on revisions to the system that may enable the purchase of more new positions.  However, our existing deep-value stock-selection criteria has identified two new companies that appear to be viable candidates for purchase at this time. Please see the DV Portfolio page for details.  We will buy addition stocks for this portfolio when our analysis and revision of the systems is complete, and we have new recommendations from those systems.

Unlike mutual funds or institutional investors, we feel no compulsion to own stocks 52 weeks of the year.  As value investors, we purchase company shares when we feel confident that our investment will be reasonably risk-free and will be profitable.  First and foremost in our minds is protection against loss.  Losses are the primary killers a portfolio's performance; therefore we place avoiding them at the top of our priorities.  To accomplish this objective with undervalued small-cap stocks, we typically want to see a margin of safety that shields us against financial calamity.  With our current systems, we are not seeing very many companies presented to us that accomplishes that aspiration. 

We will continue to work the data to identify stock-selection systems that provide undervalued companies with concrete prospects and a margin of safety.  The challenge is doing that in a fairly mature market environment and using a universe of stocks with an average PE ratio of 59.  We are working on providing two different selection systems and a 10-stock roster for the DEEP VALUE Portfolio.  When we accomplish that task, we will add stocks.  In the meantime, we feel no compulsion to purchase equities with which we are not comfortable, simply to have full portfolios.

For the mid/large-cap RELATIVE VALUE (RV) Portfolio, we were surprised and pleased by the results of our work.  We were able to design robust backtests that showed average annual returns in recent periods of about 80%.  This success was achieved by adding one or two factors to our proven ranking system and then fine-tuning the selection system.  By using our testing for robustness, we were careful to avoid curve-fitted results, and the operation came through with flying colors.  Best of all, these new factors are in logical synchronization with the conditions of a mid-to-late cycle, maturing-market environment. 

The chart below shows on view of recent year's performance of the RELATIVE VALUE Portfolio with our revisions.  As you can see, the chart is quite smooth and steady with only a minor, 10% drawdown in late 2013. 

We are quite proud of this work on this portfolio and believe it will serve us well as we progress.  Especially examine the 2014 performance.  You may recall that this portfolio, in real-time, only produced a return of 13% that year.  This revised system would have gained 80% that year with a max drawdown of only about 10%.  Remember that the RELATIVE VALUE Portfolio has an annual return of 55.4% from 2010-2014, so this is even a significant improvement over a typical year.

We considered changing this portfolio to a 10-stock arrangement, however, having enough liquidity is not a concern, and more stocks might dilute the performance and unnecessarily complicate its use.  You may buy up to $20 million per stock in this system without affecting the prices.  If you need to invest more than that, please let us know first.

We certainly do not see deeply oversold conditions in mid/large-cap companies like we saw in 2009. The stocks that are excelling now are also not defensive in nature (utilities, healthcare), as occurs just before and during a downturn. The equities that are doing well are classic, mid-cycle sectors such as consumer discretionary, technology, retail, semiconductors, aerospace/defense and technology. There is also quite a bit of sector rotation occurring, which is healthy at this point in the market's life-cycle.

Outside of value-denominated commodity companies (such as energy or metals) that got pummeled since last June, the stocks that are doing well have price momentum on their side. We were able to create some unusual momentum formulas that work significantly to enhance the returns of the RV Portfolio.  We think you will be very pleased with the robust performance we will achieve as we go forward this year.


There are several changes that you will see in the Relative Value Portfolio stocks. Unlike the previous iteration of this portfolio, which had neither positive-momentum nor negative-momentum requirements, the stocks we purchase going forward will now show positive price momentum.   Unlike the investment in Valero Energy, which we bought on November 3 and issued a reiteration to purchase on January 25, our Intelligent Price Oscillator will probably will not be showing stocks that appear to be oversold and bouncing from a support zone.  By the way, Valero is up 20% from when we bought it and when we reiterated the buy signal (both signals were at about the same price).  Instead, for new stocks, our Intelligent Price Oscillator will be in the Bullish Zone or on the way to the Bullish Zone.

In addition, the new stocks will have an average holding time of 90 days (about 4.5 months) instead of the 70 days (about 3.5 months) that they had before.  Please see the DEEP VALUE Portfolio and the RELATIVE VALUE Portfolio for details. 

We will provide an update when we identify an approach for the DV Portfolio that produces robust, undervalued, small-cap stocks that meet the IntelligentValue requirements.

Please see the DEEP VALUE Portfolio and the RELATIVE VALUE Portfolio for details.  We will provide an update when we identify an approach for the DV Portfolio that produces robust, undervalued, small-cap stocks that meet the IntelligentValue requirements.


We put in more than 150 hours in the last two weeks, working with our service provider to create new/refined stock selection systems.  Therefore, we ran out of time and were not able to write analysis pages before this update was published.  Over the coming week, we will write several new Stock Analysis Reports on the individual companies we are buying tomorrow.  You will receive an email notification when they are ready.

We hope that we have thoroughly discussed the issues in this Value Alert, and you can implement these ideas to your benefit.  Our objective is to give you the best value-oriented investment information possible, with ease of use, timely identification of the issues that affect our portfolio positions, and a full understanding of our approach.  If you have any questions or comments, please contact us with a support ticket.

Best Wishes for Another Week of Intelligent Value Investing,


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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. If you are not sure if value investing or a particular investment is right for you, we urge you to consult with a Certified Financial Advisor. Neither, nor any of its employees or affiliates are responsible for losses you may incur.