As I sat thinking this morning about what to write about this week I decided to sit out back,have a little coffee and decide what to talk about. As he so often does, Jacob Wolinksy saved me with a tweet. If you are not following him and reading his excellent web site ValueWalk.com you should be. It is a cornucopia all things value investing and market related. I check it daily and subscribe to his daily emails updates. This morning he tweeted a link to the very last interview Ben Graham did before he passed away. He talked with Charles Ellis, a member of the editorial board of The Financial Analysts anbout investing and Wall Street. This has always been one of my favorite Graham interviews and many of the insights are still as true and useful today as they were almost 40 years ago.

When asked what he thought of Wall Street as an institution Grham replied “A highly unfavorable--even a cynical--one. The Stock Exchanges appear to me chiefly as a John Bunyan type of Vanity Fair, or a Falstaffian joke, that frequently degenerates into a madhouse ,a tale full of sound and fury, signifying nothing”

This is even truer today that was true back in the mid 1970s. We are now right in the heart of the quarterly madness known as earnings season. Every little number is studied to within an inch of its life and ridiculous forecasts of future conditions are taken as gospel to be relied upon completely and backed up with cash. Money is bet on the quality of your guess about someone else’s guess as to sales and profits racked up by a particular corporation in a three month period of time and how your fellow traders will react to the accuracy of the original guess.

Each and every word out of Abe, Janet and Mario’s mouth is studied, considered and reconsidered as to its impact on the economy and the markets. The placement of each and every period comma and semicolon in the fed minutes is considered for its eventual effect on the stock and bond markets. We are flooded with stats and reports from governments all over the globe and traders breathlessly await them each day. It is all just noise and has very little to do with the value of a given company and the current stock price in relation to that value.

When asked about the people of Wall Street Graham replied that “They tend to take the market and themselves too seriously. They spend a large part of their time trying, valiantly and ineffectively, to do things they can't do well.” When asked what sort o thing specifically that they. “There is nothing Wall Street loves more than good prediction but there also is nothing more dangerous. The markets are a dangerous mix of math and psychology and is unpredictable in all but the smallest of time frames. Even then super computers, higher math and physics degrees and a huge appetite for risk are required. The serious young men that are the asset gathers and financial planners of today (apparently stock brokers are extinct) in their three piece suits, carefully coiffed haircuts and serious demeanors are a caricature of themselves. All of their fancy plans with pages of graphs and suggestions can be easily replicated by and fairly intelligent person in cargo shorts and a tee shirt with a calculator and a yellow pad at a fraction of the cost.

When asked how to invest Graham gave a two part answer. He told Mr. Ellis “My first, more limited, technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current-asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source. For a while, however, after the mid-1950's, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973-74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor's Stock Guide--about 10 per cent of the total. I consider it a foolproof method of systematic investment--once again, not on the basis of individual results but in terms of the expectable group outcome.”

In other words net nets should a part of your game plan as over time they work pretty well. They tend to get thin on the ground as they are now after an extended up move but like Bukowski to the bar they will be back. There are a few around today, and we own most of them but at some point there will be hundreds to choose from and we will have the cash on hand to do so.

He described his second approach as “It consists of buying groups of stocks at less than their current or intrinsic value as indicated by one or more simple criteria. The criterion I prefer is seven times the reported earnings for the past 12 months. You can use others--such as a current dividend return above seven per cent or book value more than 120 percent of price, etc. We are just finishing a performance study of these approaches over the past half-century-1925-1975. They consistently show results of 15 per cent or better per annum, or twice the record of the DJIA for this long period. I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public.”

That sound a lot like the three new portfolios we have established in the Bottom Decile report. The Graham two facto model described in an earlier interview has nee a best performer since 1926 apparently. Graham said that his testing showed 15%or so a year. Tobias Carlisle and Wesley Gray found it returned about 17.8% from 1976 to 2011 and my recent tests show about 16.5% over the past 15 years.

Our three factor margin of safety model based on Grahams work has returned about 17% over the past 15 years and if you re-balance more frequently the returns get even high. My version is based on annual re-balancing. It uses price to book value and tow balance sheet factors to insure the safety of the company.

The last model is based on Grahams original approach using book value and adds contributions form whippersnappers like Edward Altman and Joseph Piotroksi. The P and Z Model has returned right about 20% over the past 15, 10 and 5 year periods by buying stocks with high F and Z scores and trade below book value. Interestingly it has the most pronounced timing mechanism as there just are not many stock to buy under this method as we approach market peaks.

These three portfolios, along with many of our regular deep value screens are the new heart of the Bottom Decile Report . Check it out here.

Have a great week folks

Tim

Song of the week. For investors its usually best to ignore the new shiny whizzbang strategies and pick stocks the https://www.youtube.com/watch?v=3x5hNzoBc6E