CHAPTER 18
Broker-Dealer Research Departments and Conventional Money Managers*
How Research Departments and Conventional Money Managers Think
Problems Faced by Research Departments and Conventional Money Managers
In November 1998, Toyoda Automatic Loom Works, Ltd. (since renamed to Toyota Industries) common stock, listed on the Tokyo Stock Exchange, appeared to be a good example of a common stock that was safe and cheap based on “what is” because the company was well financed and represented a way of buying into the common stock of Toyota Motor, a blue-chip automotive manufacturer at a discount of perhaps 35 to 40 percent. Toyota Industries common was trading at about 2,300 yen per share, or about $16.5 to $17 U.S. dollars. Its adjusted balance sheet, expressed in U.S. dollars, was as shown in Table 18.1.
Table 18.1 Balance Sheet for Toyota Industries Corporation (Adjusted NAV in $000s)
Research department analysts and conventional money managers probably would have had no interest in Toyota Industries common stock in November 1998 unless they had some evidence that would have led them to believe:
Moreover, in December 1995, research department analysts and conventional money managers probably would have concentrated on having an opinion as to the probability that Kmart would seek Chapter 11 relief. Analysts who thought Kmart was likely to seek Chapter 11 relief would have avoided acquiring Kmart debt even if they believed that the ultimate workout in a reorganization would be not less than 100. They would have focused on the belief that if Kmart did file for Chapter 11 relief, the market price of Kmart debt would decline, probably dramatically; for those analysts, the time to acquire Kmart debt would have been after a Chapter 11 filing, not before.
In previous chapters we discussed the characteristics and limitations of the recommended approach of value investing, the characteristics and limitations inherent in the efficient market hypothesis (EMH) and all other academic approaches, and the characteristics and limitations of fundamental analysis as promulgated in the works of Benjamin Graham and David Dodd and their predecessors. In view of the endless reports put out by Wall Street research departments and the countless presentations, both written and oral, made by conventional money managers, it is instructive to look at the analytic approach that most research departments and conventional money managers follow. This chapter serves two purposes: First, it describes the analytic techniques that are followed by research departments at most broker-dealers—the sell side—and also by most money managers responsible for the noncontrol passive investing of funds entrusted to their care—the buy side. Second, it discusses the limitations—problems—inherent in usual research department–conventional money manager approaches.
HOW RESEARCH DEPARTMENTS AND CONVENTIONAL MONEY MANAGERS THINK
Research departments and conventional money managers seem to follow a strict going concern approach. A firm is analyzed only as a going concern to be operated in the future pretty much as it has been in the past, in the same industry it has always been in, and financed as it has been financed traditionally. The market value of common stocks is deemed to be determined by future reported earnings, cash flows, or both, appropriately capitalized. A weight of almost 100 percent is given to this going concern approach, one that is forward looking because it impinges on financial statement analysis. It emphasizes a primacy of the income account unmodified by considerations of the current quality of either a corporation’s financial position or the net assets the company employs. Indeed, both high-quality assets and large net assets, or book values, tend to have negative connotations for valuation purposes for many research department/money manager analysts. A strong financial position indicates to these analysts that management has not employed assets as aggressively as they might. A high book value, too, tends to be a negative because such numbers, a priori, spell lower returns on equity (ROEs) and returns on assets (ROAs) than would otherwise be the case. Put otherwise, the strict going concern approach of research department analysts and conventional money managers seems to view financial factors that are thought of as positives in a resource conversion approach or value investing approach (i.e., strong financial positions and high asset values) as either a negative or unimportant.
Research department analysts and conventional money managers tend to believe that their objective is to estimate prices at which a security might sell at a future date in the outside passive minority investor (OPMI) market. When consideration is given to underlying corporate values, it is not these corporate values, per se that count but rather how much, if at all, the underlying corporate values ought to fit into the estimate of future prices in OPMI markets. Other considerations in the estimation of market prices include dividend policies; technical chartist market considerations, including supply and demand for securities; industry outlooks; opinions about general market levels, interest rates, and gross domestic product (GDP) growth; insider buying and selling; and Wall Street sponsorship.
Research department analysts and conventional money managers tend to be tremendously influenced by short-run corporate revenue and earnings reports. As part of estimating market prices, they tend very much to be trend players, especially on the buy side, refusing to acquire securities if they believe near-term outlooks for prices are unfavorable. As part of being short-run conscious, research departments and conventional money managers tend to place much greater weight on the prospects that the development of a catalyst might result in common stock price appreciation than on the acquisition of securities solely because the price appears, on the basis of statistical considerations, to be cheap. They see a trade-off between catalysts and low prices in OPMI markets. The more likely that a catalyst will come into existence, other things being equal, the higher the price at which the common stock will sell. After all, OPMI markets, like all markets, do tend toward efficiency even though those efficiencies can be quite weak at times.1 For many research departments and conventional money managers, low price alone is not a sufficient condition for making a securities purchase. Rather, the essential condition for the purchase is the perception of a relatively near-term catalyst that will result in price appreciation, whether that catalyst is embodied in prospects for improved earnings, for earnings in excess of consensus forecasts, or for such a transaction as a merger and acquisition (M&A), a major refinancing, or a liquidation.
For research departments and conventional money managers, a common stock tends to be deemed to be cheap statistically if price-to-earnings (P/E) ratios (or price-to–cash flow ratios) seem modest relative to comparables. The earnings (or cash flow) figures used for these P/E ratio calculations are the most recent reported earnings, the earnings forecast for the period just ahead, or both, with the period just ahead being either the next quarter or the next 12 months. Rarely are other measures of being statistically cheap used; when they are, the tendency is to not give them much weight. Other measures of being statistically cheap might include price-to–net asset value (NAV) ratios, in which NAV is determined by reference to either book value or appraised value, and price-to-average annual earnings ratios for the last three or five years.
Research department analysts and conventional money managers tend to be very conscious of comparative analyses. They give great weight to a comparison between quarterly earnings as actually reported and consensus estimates of quarterly earnings and consider intra-industry comparative revenue and earnings performance to be important. Many also attach material significance to growth trends compared to P/E ratios. For example, assuming a company’s earnings per share are forecasted to grow at 30 percent compounded, a P/E ratio of 30 times is justified; 25 percent growth would justify a P/E ratio no greater than 25 times. This is called growth at a reasonable price (GARP)2 and gave rise to what analysts call the PEG ratio; that is, the ratio of the P/E ratio and the expected growth rate in earnings.3
In using analytic techniques, research departments and conventional money managers rely much more heavily on fieldwork (e.g., management interviews) than they do on intensive document reviews (e.g., in-depth analysis of audited financial statements or of court records).
Of the vast majority of research department reports in recent years, only a very few seem to provide excellent underlying analyses that are helpful for value investing. The thrusts of virtually all the reports, both the excellent and the not so excellent, are as follows:
- Estimate future earnings per share (EPS), earnings before interest, income taxes, depreciation, and amortization (EBITDA), or both. At the end of 2011, such estimates would be done by years for, say, 2012, 2013, and 2014.
- Apply to those EPS and/or EBITDA estimates an appropriate P/E ratio or EV to EBITDA ratio based on the following:
- Industry identification
- Growth trend
- Other factors, such as management appraisal, sponsorship, return on equity, or economic value added (EVA)
Almost 100 percent weight tends to be given to this approach—estimating future flows, whether cash or earnings, and applying an appropriate capitalization rate to these estimated flows to arrive at a target price for a common stock. A change in quarterly earnings estimates is deemed to be very important news and very frequently results in a change in the target price.
Research department analysts almost never recommend outright sales or selling short. Many conventional money managers sell frequently—when they believe that a security does not have short-run appreciation prospects or that an alternative commitment has better short-run appreciation possibilities.
PROBLEMS FACED BY RESEARCH DEPARTMENTS AND CONVENTIONAL MONEY MANAGERS
The Difficulty of Forecasting Earnings
For most companies in most industries, it is very difficult to predict future revenues and earnings and cash flow results. Future events have always resulted in large numbers of such forecasts’ being plain wrong. Traditionally, there have been industries in which such forecasts could be made with reasonable accuracy (e.g., integrated electric utilities or real estate properties benefiting from long-term leases to creditworthy tenants). For most other companies, though, predictions frequently will be in error by relatively wide margins whether those companies are automobile assemblers, aluminum producers, semiconductor equipment manufacturers, health-care providers, bank lenders, pharmaceutical firms, retailers, building product suppliers, or, as a matter of fact, just about any kind of U.S. corporation.
When research department forecasts prove to be overly optimistic, as many do, the analyst often has no anchor to windward, as would exist were the shares recommended on some other basis than merely estimates of future flows. One such other basis, rarely relied on by research departments and conventional money managers, is the acquisition of common stocks when those issues are selling at prices representing some sort of reasonable relationship to NAV. Another such basis is the restriction of common stock investments to businesses that enjoy strong financial positions so that the company will have staying power, possible comeback ability, and no likelihood of defaults on corporate debt obligations, in the event that future results are much worse than the analyst’s forecast.
Ameliorating to some extent this lack of an anchor is the fact that research department analysts and conventional money managers tend to be traders, not investors. Losses can be cut by early sales, especially if securities holdings are confined to relatively marketable issues. Trading, though, does tend to limit prospects for super–long-term profits, whether realized or unrealized, available to those following a buy-and-hold strategy.
The Competitiveness of Conventional Analysis
Attempting to forecast future flows and applying an appropriate multiplier thereto is an extremely competitive activity within the financial community. There are probably thousands of analysts, on both the sell side and the buy side, trying to do pretty much the same thing, and many are very bright and diligent.
The Likelihood That It Is Impossible to Do Top-Down Analysis Rationally
Although predicting EPS and EBITDA for companies may be difficult, predicting the P/E ratios that might be assigned to that EPS or EBITDA in a future OPMI market may well nigh be impossible. Making forecasts about future general OPMI market levels probably is much more in the realm of abnormal psychology than of fundamental finance. There is no evidence that the general market and large sectors within it are governed by any price behavior other than a random walk. Put otherwise, no one really predicts market levels accurately. Indeed, it is probable that no one really can identify those macro factors likely to influence OPMI market prices, and the weights that might be assigned to each factor.
For many analysts, too, including G&D, predicting future earnings for a company starts with top-down estimates of the outlook for the general economy, for interest rates, and for inflation. Historically, making accurate estimates about these macro factors has been hard to do.
Being unable to predict the levels or direction of general markets is ameliorated to a considerable extent, for conventional money managers with a modicum of intelligence, through diversification. Thus, if forecasts of EPS or EBITDA come through for a good percentage of the companies in a portfolio of common stocks, that portfolio ought to perform satisfactorily (certainly in comparison with other portfolios) regardless of what happens in the general market. All bets about ability to withstand market drops are off, however, for those money managers who operate with borrowed money.
With highly leveraged portfolios, money managers had better be right, or close to right, about future market prices a good deal of the time. Fortunately, in the field of institutional equity investment, most portfolios are not highly leveraged, whether they are the assets of investment companies (e.g., mutual funds), or defined benefit pension plans, or of insurance companies.
Fighting for the Heavyweight Championship with One Hand Tied behind Your Back: Predicting Future Earnings while Ignoring the Existing Balance Sheet
Analysts who focus on trends tend to think linearly: the past is prologue; therefore, past growth trends of EPS or EBITDA will continue into the future or even accelerate. The truth, however, is that the corporate world is rarely linear.
The fact is that for many—if not most—companies, analysis of the amount and quality of resources that a management has to work with is as good as or an even better tool for predicting future EPS or EBITDA than is the past earnings record. It appears most research department analysts and money managers ignore this tool, especially when it indicates a strong financial position. This is true even though theoretically, no analyst interested in ROE and ROA can safely ignore equity or assets, both of which are balance sheet items. Improved returns, if applied to larger equities and assets, will give securities investors a much bigger bang. The elementary fact is that both the past earnings record and the present balance sheet are good and frequently necessary tools for predicting future flows for many companies.
It is much easier for a management to improve returns if the company has a strong financial position with which to work. A prime example of this was Nabors Industries, an oil service company with which the senior author has been associated for many years. Nabors emerged from a prepackaged Chapter 11 reorganization in mid-1988 with an all-equity capitalization. At that time, Nabors was virtually the only contract driller not burdened by large amounts of debt incurred during the pre-1983 boom time in the oil drilling industry. Given its financial strength, Nabors was able to spend the next few years acquiring contract drillers and contract drilling assets at bargain prices; other industry participants did not have the financial wherewithal to bid against Nabors for these assets. In 1987, Nabors’s cash loss from operations probably was in excess of $20 million; in 1997, Nabors’s positive cash flow from operations was well in excess of $200 million and in 2011 it was close to $1.5 billion.
The earnings record and the present balance sheet are both helpful tools for predicting future earnings, but one is not a substitute for the other. Which of the two ought to be more important in any given situation is a matter of analytic judgment. Giving blanket priority to income account considerations and thereby denigrating the importance of balance sheet items, however, seems to disadvantage many research department analysts and conventional money managers because they ignore qualitative and quantitative balance sheet data as sources for estimating future flows, whether cash or earnings.
Lack of Awareness of the Relationship between Income Account Numbers and Balance Sheet Numbers and of Analytic Conflicts between and among Related Numbers
When analysts focus only on forecasting future earnings and do not take into account balance sheet considerations, as is the case for many research departments and conventional money managers, there is no need to examine the relationship between income accounts and balance sheets. When they instead look at present balance sheets as either a helpful tool for predicting future earnings or as a margin of safety in case earnings forecasts do not work out, the relationships between the income account numbers and balance sheet numbers become important—and sometimes result in analytic conflicts.
EXAMPLE
Assume that an analyst is seeking a margin of safety for a common stock holding by having the recommended stock sell at a price that is in a reasonable relationship to NAV. It will be impossible to obtain that margin of safety if the common stock in question sells at a high P/E ratio and the company enjoys a much above average ROE. Say that XYZ common sells at 30 times earnings and that XYZ’s ROE is 20 percent. Then, a fortiori, XYZ common will trade at 6 times NAV. (XYZ earns $1 per share, making the price of XYZ common 30; an ROE of 20 percent on earnings of $1 results in an NAV of $5 per share; $5 NAV divided into 30 price equals a price to book ratio of 6 times.) Research department analysts and conventional money managers interested in companies that they perceive to be rapidly growing and also that earn high ROEs had better ignore the margin of safety that could be inherent in the price of a common stock being close to NAV if they are going to opt for growth and high ROEs.
Furthermore rapidly growing earnings in past years mean that average earnings for those past years are less than they would have been had earnings grown less rapidly. Thus, growth investors tend not to look for any margin of safety that might be inherent in a common stock selling at a price that represents a relative modest P/E ratio based on average annual earnings for a past period.
The following table presents the earnings per share of a rapidly growing company:
| Year | EPS |
| 1 | $1.00 |
| 2 | $2.00 |
| 3 | $3.00 |
| 4 | $4.00 |
| 5 | $5.00 |
| Average earnings | $3.00 |
Suppose the common stock sells at 10 times year 5 earnings of $5.00 per share, or $50. The issue also would be selling at 16.7 times five-year average earnings.
It should be noted that the fact that the relationship also works the other way is not particularly relevant for most research department analysts and conventional money managers. The trade-off between high P/E ratios and high ROEs on the one hand and reasonable prices relative to NAV on the other hand functions in such a way that an analyst wanting to focus on common stocks selling close to NAV will not be able to invest in common stocks when the issue is selling at a high P/E ratio based on current earnings and the company enjoys an above-average ROE.
EXAMPLE
Assume Company XYZ has a NAV of $10. ROE is 20 percent, which means that earnings per share are $2. If XYZ common stock sells at 20 times earnings, the price in the OPMI market would be $40 or four times NAV.
It is quite feasible to acquire common stocks at prices closely related to present NAV and at low P/E ratios based on what a corporation’s earnings are likely to be when current difficulties, which are depressing current earnings and earnings forecast for the period just ahead, are overcome. The OPMI market, though, tends to be too efficient for there to be many opportunities to acquire securities when both prices are reasonable relative to present NAV and the P/E ratios are low relative to current earnings and immediate future earnings. Analysts and money managers focused on current earnings, forecasted earnings for the period ahead, and ROE must virtually ignore price as related to NAV. As a matter of fact, they do ignore NAV. Given the inaccuracy of most forecasts, however, they do so at their own peril.
Use of an Approach Antithetical to Those Used by Private Businesspeople and Control Buyers Not Seeking Immediate Access to Equity Markets for New Capital
The basic objective of private business people and control buyers is to create wealth (and sometimes cash flows for themselves) in the most efficient manner, which usually involves following courses of action that minimize the present value of corporate income taxes payable. Research department analysts and conventional money managers have the opposite agenda: They want corporations whose common stocks they are holding or recommending to report maximum amounts of near-term earnings from operations, earnings that tend to be currently taxable at maximum tax rates.
They also desire companies whose common stocks they are recommending to be short-term oriented. In their view, managements ought to forgo projects with possible huge long-term pay-offs if that entails sacrifices in creating near-term operating income. Given their druthers, most managements not seeking near-term access to equity markets probably would opt for the long-term view of wealth building.
Research department analysts and conventional money managers also tend to be more interested in what the numbers are, especially earnings per share, rather than what the numbers mean.
Furthermore, given the emphasis on a going concern approach to analysis, analysts and money managers tend to want the companies whose common stocks they are recommending to have a single industry focus, at least in 2012. They view those companies as operations rather than as converters of resources to other, and possibly higher value uses. If companies diversify into other industries, they no longer are seen as pure plays—they are harder to follow.
Many good managements, left to their own devices, would view the companies they control as both going concerns creating operating profits and resource conversion vehicles creating wealth by investing in different and sometimes even unrelated industries.
The current anathema of research department analysts and conventional money managers to corporate diversification does have considerable long-term merit. Too many companies have suffered because of diversification into industries not well understood by managements. Nonetheless, analysts’ apparent distaste for diversification contrasts with what many managements would like to do provided that they do not find it necessary or desirable to placate Wall Street.
Analysts and money managers also tend to use different approaches to analysis than do control buyers of corporations. Rather than focus on a strict going concern approach with an emphasis on near-term operating results, business buyers, such as leveraged buyout (LBO) specialists, tend to concentrate on three issues:
The Lack of a Balanced Focus, Resulting in Common Stock Prices that Are Much Too High or Much Too Low
By concentrating almost exclusively on earnings or cash flow forecasts and capitalization rates, analysts have no safety net when prices get way out of line. There is a strong tendency for prices in OPMI markets, both high and low, to have elements of irrationality that do not exist to anywhere near the same extent in negotiated transactions between reasonably knowledgeable buyers and sellers. In negotiated transactions, there is a tendency to consider and weight a whole gamut of factors in arriving at a transaction price, rather than just applying a capitalization rate to current earnings (or cash flow) and predictions of earnings (or cash flow) for the immediate future.
Given access to capital markets, though, an overpriced stock can be an important asset for a corporation run by a management with skills in M&As. See example that follows.
Analyses That Focus on Base Case Forecasts Rather than Alternative Scenarios
An investor putting $100 million or more of his or her own funds into an equity situation in which the funds will be tied up on a permanent or semipermanent basis usually does not rely as heavily on base case forecasts as do research department analysts and conventional money managers. This is understandable because the latter groups enjoy marketability and can, at least theoretically, undo investments rapidly. One consequence of this, though, is that there is far less need and desire for research department analysts and conventional money managers to conduct in-depth investigations: Given high portfolio turnover, it becomes terribly unproductive to do in-depth investigations. Furthermore, it becomes impossible for even the largest organization to conduct in-depth investigations when the number of securities in a portfolio runs to hundreds of issues.
EXAMPLE
The market price of a common stock can be enhanced by using the security in mergers, especially when analysts concentrate solely on P/E ratios, as in this sample scenario:
The post-merger income account is shown in Table 18.2.
Table 18.2 The New Income Account
| Variable | Value (000) |
| Net income | $13,000.00 |
| Number of shares outstanding | 10,800 |
| Earnings per share | $1.20 |
| Price-to-earnings ratio at price of 60 | 50.0x |
If the normative P/E ratio is 60, post-merger XYZ common should sell not at 60 but at 72.
By contrast, large investors holding equities on a permanent or semipermanent basis tend to investigate relatively thoroughly on two bases: the base case and the reasonable worst case. Most also put the optimistic case into the investigations mix.
External Pressures That Can Compromise Analyses
Research departments of broker-dealers that also have an investment banking presence can face pressures to recommend the common stocks of investment banking department client companies, especially those whose public issues were underwritten by the firm. Sometimes, even if only in a small minority of instances, these recommendations are based more on the good of the firm rather than the good of the client. Money managers frequently are under pressure from their firm’s marketing department to undertake portfolio window dressing. Probably the most common scenario is that good marketing may require that the portfolio consist largely of the most popular issues, instead of emphasizing issues that, although less popular, are more attractive fundamental values.
The Difficulty of Concentrating on Operating Ratios Based on Financial Accounting Statistics
Given their emphasis on viewing companies strictly as going concerns, research department analysts and conventional money managers tend to place great worth on the analysis of operating margins—gross profit margins and operating income margins. This type of analysis has limited usefulness in many industries because the data are derived from short-form (i.e., no detail by specific items) financial statements, rather than long-form corporate cost, or managerial, accounting data. For most companies, if analysts do not have access to cost-accounting data, it becomes extremely difficult to understand the nitty-gritty of operations. Profit-margin analysis based on financial accounting can be a helpful tool, but it is a limited one. Also, comparative numbers can be tricky.
EXAMPLE
Company ABC and company XYZ each have operating income of $1 million from conducting the exact same activities. ABC claims to have sales revenue of $50 million, and XYZ, for the same activities, books consulting revenues of $10 million. On the basis of these numbers, ABC’s operating profit margin is 2 percent and XYZ’s is 10 percent. Furthermore, ABC might treat, say, rent expense as a cost of goods sold, whereas XYZ might treat rent expense as an administrative or general expense, which would be a component of operating expense.
Heavy Reliance on Fieldwork to the Exclusion of Reading Documents
Reading the documents is no substitute for fieldwork—interviewing managements, competitors, customers, government regulators, and others who can contribute information to an analysis. The reverse is also true: Doing field work is not a substitute for carefully reading relevant documents—Securities and Exchange Commission (SEC) filings, stockholder mailings, court records, competitors’ documents, and industry publications. Indeed, fieldwork and document reading go hand in hand. Those who read and understand document contents tend to be much more skillful at fieldwork than are analysts who ask questions before they have a good documentary background for asking those questions. Documents tend to be given short shrift, though, by many research department analysts and conventional money managers. In part, this is understandable: Much of what is in documents appears to have little relevance to predicting what near-term OPMI market prices will be, and reading documents is very time intensive, hardly worthwhile for those trading in and out of large numbers of securities in a portfolio. Finally, interpreting documents, especially financial statements, takes a fair amount of training; which many analysts seem to lack.
A principal problem for analysts who choose not to rely on documents they have intensely scrutinized, especially audited financial statements, is that many analysts involved in passive investing have been defrauded or otherwise victimized, by promoters selling stories with no hard-nosed backup. This was true for public holders of U.S. corporate bonds before the Trust Indenture Act of 1939, true in the 1960s when small companies went public, true in the 1970s and 1980s when tax-sheltered limited partnerships were all the rage, true in the 1990s for analysts recommending common stocks of companies in emerging markets with virtually nonexistent document disclosure requirements, and true in the 2000s when institutions bought AAA rated residential mortgage-backed securities.
Heavy Reliance on Perceptions of What Others Think
All rational analysts involved with passive noncontrol investing are probably influenced to some extent by what they perceive are the opinions of insiders or smart money. For example, if insiders and 10 percent shareholders are selling common stock, that is a factor to put into the mix of information. That information becomes far more meaningful, though, when it becomes a supplemental part of the buy-and-hold analyst’s independent judgment about what the firm might be worth or what future dynamics for that firm might be. Depending on the individual situation, insider selling might mean on the one hand that a security is overpriced or, on the other hand, that the company is now a more attractive takeover candidate, in part because insider-owned blocks of stock can be purchased or otherwise tied up. The analyst is unlikely to be able to make good judgments on this issue without having independent opinions about corporate values and dynamics.
A rationale for relying solely on perceived opinions of insiders and smart money is that the analyst’s sole goal is to predict the prices at which a security will sell in the immediate future. If you are going to try to predict near-term prices, you had better focus on what you believe influential others think: buy and sell recommendations of major research departments, consensus forecasts of quarterly earnings, and insider trading. This in fact seems to be what a lot of research department analysts and conventional money managers do, especially those with no interest or little training in fundamental analysis. Relying heavily on the perceived opinions of others, to the exclusion of independent fundamental analysis, seems a tough way to make a living, though.
The focus of broker-dealer research departments and money managers may be helpful in predicting near-term market prices. However, this same focus tends to mislead in imparting deep understanding of a business and the securities it issues. Such deep understanding is essential for OPMIs interested in long-term investments; for control investors; for most distressed security investors; and for credit analysis. It seems to us that these misperceptions arise out of an overemphasis on four factors:
SUMMARY
In summary, there are huge problems involved in obtaining satisfactory long-term performance by following what appear to be the basic precepts of research department analysts and conventional money managers. Both value investing and the teachings of Benjamin Graham and David Dodd also have problems. Nonetheless, it appears much easier and basically much more productive to adhere to value investing standards rather than research department and conventional money manager approaches. Still, it is obvious that some—though probably a substantial minority of—portfolios run by conventional money managers perform quite satisfactorily on average and over the long term. This can be attributed to the fact that many money managers are very smart. Even so, what even the best conventional money managers do seems to be the hard way to achieve satisfactory results compared with the results of analysts who lean more toward value investing.
* This chapter contains original material and material contained in Chapter 4 of Value Investing by Martin J. Whitman (© 1999 by Martin J. Whitman). This material is reproduced with permission of John Wiley & Sons, Inc.
1 See Chapter 14.
2 The concept appears to have been popularized by Peter Lynch in his 1989 One Up on Wall Street (New York: Fireside, 1989).
3 This ratio was developed by Mario Farina in his book A Beginner’s Guide to Successful Investing in the Stock Market (Palisades Park, NJ: Investors’ Press, 1969).