Has the death of value investing been greatly exaggerated?

Has the death of value investing been greatly exaggerated?
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By David Duval

These days it would seem that the concept of “value investing” has become an oxymoron given the almost daily price anomalies we see in the global marketplace. Many widely followed stocks are trading at historically high price/earnings multiples despite their poor underlying fundamentals.

Rather than invest profits back into their businesses (which might partly explain why the economic recovery in the US has been so anemic) many listed companies are using their spare cash to buy back their stock, a practice that not only rewards open market purchasers but also corporate executives with stock options and other share-related incentives.

These buybacks can often establish a bottom for a company’s share price while distorting the intrinsic value of stocks at a time when much of the trading is done by algorithm-based trading systems that have eliminated human emotion from the marketplace. In actual fact, high frequency trading – where trading times are measured in milliseconds by computers working in quasi-anonymous dark pools – has already outpaced human trading by a wide margin.

Is it any wonder that the Sage of Omaha, Warren Buffet – with few exceptions – prefers buying actual companies rather than equity positions? Nonetheless, finding value in any investment these days is a matter of patience, a strategy that has rewarded Buffett more than any other investor.

There are arguably advantages to investing for the longer term, among them being dollar cost averaging where you purchase a company’s stock incrementally over a period of time. That way you can raise or lower your equity position depending on the company’s success. It’s also a great way to reduce the volatility in an investment portfolio given the dramatic price swings we see in the marketplace today which generally correlates with the rapid pace of news (true and false) hitting the business newswires. However, this can be risky for junior exploration stocks.

On top of that, the US has a president in the White House who is not averse to threatening trade wars with his country’s trading partners (mainly Canada, Mexico and China) which can impact foreign exchange markets for their respective currencies. At no other time in history have there been so many unpredictable drivers of global stock markets than we see today and the odds are that it will probably get a lot worse.

So what to buy for value investors? Well, the world is obviously not coming to an end any time soon barring any impulsive action by North Korea’s dangerous Kim Jong-Un. Putting it succinctly, the commodities market is probably a great place to invest given the prospects for global economic growth. Nonetheless, it won’t happen overnight.

China is pumping money into its economy at a breakneck pace which has helped support major industrial commodities including copper, zinc, iron ore and metallurgical coal among others. In the meantime, oil has fallen off its lofty perch as US shale drilling escalates and major producers such an Exxon abandon Canadian oil sands for the relatively quick cash flow from shale oil in Texas.

People forget that in January 2016 oil prices settled below $30 a barrel for the first time in 12 years but have since almost doubled because of increased demand and some long awaited production discipline from OPEC producers. Positioning oneself in beat up oil stocks at the time would have been a great investment strategy and it probably still is today for people looking at a two to three-year investment window.

Despite the recent downturn in oil prices, global demand has been rising and could easily absorb shale and new oil sands production coming into the marketplace over the next few years. Just like minerals, oil is a finite resource which is depleted over time. In addition, oil production from shale wells tends to taper off quickly, meaning that replacement wells have to be drilled on a high frequency (and costly) basis.

My bets would be on major industrial commodities and not ones with relatively small global markets that are subject to oversupply (and price depreciation) when even a single new producer enters the marketplace.

While it’s hardly the first time I’ve seen this, all the hype concerning industrial minerals used in batteries concerns me as I don’t see significant consumer demand for expensive, limited range automobiles building any time soon. Call me a pragmatist but I can’t imagine anyone in Yellowknife, NWT – or any other place with cold winters for that matter – purchasing one of the highly vaunted Teslas when they are unlikely to start in winter.

There is good value in many gold stocks these days including some intermediate producers in the 100,000 to 200,000 ounce per year range that have good management, low production costs, low debt, and good quality resources that will enable them to benefit from higher prices. Unlocking the value, however, won’t happen overnight – but that’s what value investing is all about.

Re-published with permission from Resource World Magazine.

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