This is the editorial of our monthly Quant Value Investment Newsletter published on 03.092024. Sign up here to get it in your inbox the first Tuesday of every month.
More information about the newsletter can be found here: This is how we select ideas for the Quant Value investment newsletter
This month you can read about the hidden danger in your investment thinking (and life in general).
But first the portfolio updates.
Portfolio Changes
Europe – Buy Three – Hold One
Three new recommendations this month as the index is above its 200-day simple moving average.
The first is a surprisingly fast-growing GBP 2.5bn UK-based producer of renewable energy trading at Price to Earnings ratio of 3.8, Price to Free Cash Flow of 6.0, EV to EBIT of 3.3, EV to Free Cash Flow of 8.7. Trading at a Price to Book ratio of 1.1 and it pays a nice dividend of 3.6%.
The second is a €2.5bn debt free Spanish food processing company, trading at Price to Earnings ratio of 12.2, Price to Free Cash Flow of 6.8, EV to EBIT of 7.1, EV to Free Cash Flow of 5.8, Price to Book of 1.1 with a dividend yield of 4.2%.
The third is a dirt-cheap GBP 203m UK-based designer and supplier of bathroom and kitchen products trading at Price to Earnings ratio of 7.6, Price to Free Cash Flow of 6.9, EV to EBIT of 6.1, EV to Free Cash Flow of 8.9, Price to Book of 0.9 with a dividend yield of 4.5%.
Hold One
Continue to hold L.D.C. S.A. +13.3% (recommended in September 2023) as it still meets the portfolio’s selection criteria.
North America – Hold One – Sell Two
No new recommendations this month as the companies we found elsewhere in the world fit the newsletter’s investment strategy a lot better.
Hold One
Continue to hold Bel Fuse Inc. +70.4% (recommended in September 2023) as it still meets the portfolio’s selection criteria.
Sell One
Sell Taylor Morrison Home Corporation at a profit of +39.7% as it no longer meets the portfolio’s selection criteria.
Stop Loss
- Sell Somero Enterprises, at a profit of +15.6%
Asia – Buy Three – Hold One – Sell Two
Three recommendations this month as the index is above its 200-day simple moving average.
The first is a fast-growing SGD 746.7m (€515m) Singapore-based designer and manufacturer of Internet of things (IoT) devices trading at Price to Earnings ratio of 7.2, Price to Free Cash Flow of 6.0, EV to EBIT of 4.0, EV to Free Cash Flow of 3.8, Price to Book of 2.1. And it pays you a nice dividend of 8.3%.
The second is an SGD 477m (€330m) Singapore listed Australia construction and engineering services company with a strong order book trading at Price to Earnings ratio of 8.8, Price to Free Cash Flow of 5.2, EV to EBIT of 5.8, EV to Free Cash Flow of 5.0, Price to Book of 1.2 with a dividend yield of 5.6%.
The last idea is a fast growing and very profitable AUD535m (€328m) Australian rice company currently trading at Price to Earnings ratio of 8.4, Price to Free Cash Flow of 6.6, EV to EBIT of 6.6, EV to Free Cash Flow of 9.4, Price to Book of 0.9 with a dividend yield of 4.3%.
Hold One
Continue to hold SAN Holdings, Inc. +123.7% (recommended in September 2020) as it still meets the portfolio’s selection criteria.
Sell Two
- Sell The Keihin Co., Ltd. at a profit of +19.8%; and
- Sell Kitano Construction Corp. at a profit of +26.5%
Both companies no longer meet the portfolio’s selection criteria.
Crash Portfolio – Hold One – Sell One
No new Crash Portfolio ideas as most markets have recovered.
To date, the 15 Crash Portfolio ideas, recommended between August 2022 and May 2023, are up an average of 38.1%!
Hold One
Continue to hold Stella International Holdings Limited +104.4% (recommended in September 2022) as it still meets the portfolio’s selection criteria.
Sell One
Sell CNOOC Ltd. at a profit of +131.4% as the company no longer meet the portfolio’s selection criteria.
Survivorship Bias - The Hidden Danger in Investing
I recently read Nassim Taleb’s great book Fooled by Randomness again. As you know, one of the main points of the book is survivorship bias and how we are all fooled by it most of the time.
Even though it has led me to look at a lot of situations with new eyes I still think I completely underestimate how much I am tricked by it.
Survivorship Bias: A Hidden Danger in Investing
Survivorship bias is a sneaky trap that can make you think certain investments are safer or more successful than they really are. When you focus on the winners and ignore the losers, it can lead to a false sense of confidence in your decisions.
What Survivorship Bias Is and Why It Matters
Survivorship bias happens when you only look at the successes and forget the failures. This can trick you into believing that success is more common than it is.
For example, you might look at a group of successful companies or mutual funds and think that most investments turn out well. But what about all the companies and funds that didn't survive? Ignoring them gives you a distorted view of reality.
A Story from World War II: Learning from History
During World War II, the U.S. military was losing a lot of bombers. They asked a group of statisticians to figure out how to better protect the planes. The military looked at the planes that returned and saw they were hit mostly on the wings, tail, and body. They thought adding more armour to those spots would help.
However, one of the statisticians, Abraham Wald, saw a huge problem with this idea. He realized that the planes that made it back were the ones that could take damage in those areas and still fly home.
The planes that didn’t return were probably hit in different, more critical spots—like the engines or cockpit. Wald suggested adding armour to those less damaged areas instead. His insight saved many lives and shows how important it is to consider what you’re not seeing.
Survivorship Bias in Your Investments
This kind of mistake happens in investing all the time.
When you look at an investment strategy or a fund, you are only seeing the survivors, the ones that performed well enough to stick around. Also, think of all the Bitcoin and Tesla millionaires you read about all the time. The investors and strategies that failed are not mentioned and the unsuccessful funds were closed.
This can make you think that an investment strategy or fund is a safer bet than it really is. If you knew about the funds that failed, you might think twice.
The Tech Boom: A Modern Example of Survivorship Bias
The dot com boom of the late 1990s is another example. Companies like Amazon and Apple became giants, but for every success there were hundreds of tech startups that failed.
If you only look at the winners, you might believe that investing in technology companies is a good idea. But that’s survivorship bias at work. Many investors lost a lot of money on companies that no longer exist, and their stories are never told or quickly forgotten.
How to Avoid Survivorship Bias
Now that you know what survivorship bias is and how it can mislead you, here are some simple steps to avoid it:
- Look at the Whole Picture: Don’t just focus on the winners. Try to find out about the investments that didn’t make it. Understanding why some failed can help you avoid similar mistakes.
- Use the Right Tools: Consider using stock screeners and other tools that give you a full range of data, including companies that didn’t survive. This will help you see the bigger picture.
- Diversify Your Portfolio: Don’t put all your eggs in one basket. Spread your investments across different sectors and types of assets. This reduces the risk of being too dependent on any one success story.
- Be Cautious of High Returns: If something looks too good to be true, it might be. High returns can be tempting, but they might also be the result of luck or survivorship bias. Look carefully at the risks as well as the rewards.
- Learn from Failures: Success stories are easy to find, but failures often hold the best lessons. Look for stories of investments that didn’t work out to better understand the risks.
Final Thoughts: Keep Your Eyes Open
Survivorship bias is a danger in investing (and in life generally) that can lead you to make wrong decisions on incomplete information. Being aware of it and taking steps to avoid it helps you make better decisions.
Remember, the investments (or choices) you don’t see —those that failed— are just as important as the ones that succeeded.
By looking at the full picture, you are better equipped to invest and protect your hard-earned money.
Reading Recommendations
Japan’s Great Investment Story
Daniel Rasmussen, Lionel Smoler Schatz, and Yuto Kida discuss the transformative changes happening in corporate Japan in their article, Activism at Scale in Japan: The TSE's Reforms are Driving Big Changes in Capital Allocation. While Japan's recent economic news has focused on the yen's volatility, there is a compelling story of corporate reform that investors shouldn't miss.
As a long-term newsletter reader this is a trend, we have been investing in for a few years already.
Main Points:
- TSE Directive: The Tokyo Stock Exchange has required companies with price-to-book ratios below 1x to create plans to achieve a 1x ratio, aiming to break Japan's reputation as a “value trap.”
- Widespread Response: Over half of the companies on the TSE's Prime and Standard sections have issued plans, with many focusing on increasing dividends and buybacks.
- Positive Market Reaction: Companies that have announced specific, actionable plans have seen their stock prices rise significantly since the reforms.
- Examples of Action: Companies like T.RAD Corporation and TOLI Corporation are increasing dividends, buying back shares, and selling cross-shareholdings.
- Future Potential: If these reforms continue, Japan's stock market could sustain its upward momentum, potentially leading to substantial gains for investors.
Summary:
"Japan's corporate landscape is undergoing significant change. With the Tokyo Stock Exchange pushing companies to improve their price-to-book ratios, we're seeing widespread action in the form of increased dividends, share buybacks, and strategic sales of cross-shareholdings.
These changes are driving a rally in Japanese stocks, with companies actively responding to investor concerns. This shift, driven by clear plans and accountability, is setting the stage for continued market growth. For investors, now is the time to pay attention to Japan's evolving corporate governance and capital allocation strategies."
Why the Current Bubble is Not 2000
Ty Cobb, Tom Hancock, and Anthony Hene from GMO's Focused Equity Team wrote an insightful article titled Concentrate! Is it like 2000 again?
This article delves into the current enthusiasm for AI stocks and compares it with the 2000 tech bubble, warning investors about potential pitfalls. While acknowledging these parallels, the authors advise caution, reminding investors that historical patterns do not always predict the future.
Main Points:
- The current market shows a narrow focus, with a few stocks driving the S&P 500, like the 2000 tech bubble.
- Historical patterns (like the narrow market) can be warning signs but don't guarantee similar outcomes.
- Today's top stocks have better fundamentals and lower P/E ratios than those during the 2000 bubble.
- The top companies now are more diversified and include high-quality tech and pharmaceutical companies.
- While some indicators are reminiscent of 2000, the market's fundamentals are stronger, reducing the risk of a similar crash.
Summary:
"While it's tempting to draw direct comparisons between the AI-driven market of today and the tech bubble of 2000, the underlying fundamentals are different. The quality and financial strength of current leading companies provide a buffer that wasn't present back then.
Investors should remain vigilant but not overly pessimistic. History can rhyme, but it doesn't always repeat."
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