COMMENT: Bargain hunt

By bne IntelliNews October 21, 2011

Plamen Monovski of Renaissance Asset Managers -

The English love a bargain. From the weekly car boot sales where hordes of kibitzers throng to haggle over bric-a-brac, to the millions of full-time ebay merchants, this nation of shopkeepers can never resist a good deal. The prime time BBC show "Bargain Hunt" has been drawing a multitude of viewers for more than a decade. But it is not only the English who are partial to the thrill of buying cheap. Trawling through the Sunday newspapers for coupons is a national pastime in America; Germans are notorious for driving miles to find a more affordable loaf of bread or bratwurst; Groupon addicts check their emails daily to lap up the latest discount deal.

Whilst the masses love a catchpenny when shopping, they do not seem to like them when investing. On the contrary, when prices of assets go up, they want more of them; when prices collapse, buyers evaporate. Of all assets, shares tend to behave the most like Veblen goods - goods whose demand rockets when they become more expensive. Like the buyers of Louis Vuitton bags, the latest Ferrari model or a house in Chelsea Mews, emptors of shares seem to get pleasure when they pay more. The higher the price, the greater the expectations for future growth and riches. Alas, those calculations, more often than not, fall foul of reality. The buyers of future growth, like the buyers of Ferraris, tend to find that they are sitting on a fast depreciating asset if they have paid through the nose for it.

History shows that those who buy shares much like they shop in the seasonal sales, do much better than those who prefer to purchase at a premium. The holders of value shares have on average out-performed glamour stock portfolios by a high single-digit number over long-time horizons. The difference is substantial when compounded and it holds true in most major bourses on the planet.

The greatest investors that the world has seen have all bought cheap, sometimes obsessively so. Their manifesto was forged by Benjamin Graham, whose criteria on how to buy a stock low still endure. Graham's tenets were, however, made world famous by two students who religiously attended his lectures at Columbia University - a Charlie Munger and a Warren Buffet. The investment company they created in order to implement this lesson, Berkshire Hathaway, has become the stuff of legends and made them amongst the richest people in the world (see chart).

Of course, buying when stocks are inexpensive is no free lunch. The goods may be dated or, worse, damaged. The "value companies" usually have poor management, low profitability and meagre cash flow. They have often lost their way. The risks that a powerful competitor takes their market share or a new technology disrupts their already fragile business model are high. Not so with growth firms, which tend to be run by the smartest and most capable managers; whose fortunes are ever soaring; and whose stories fill the papers and case studies in the top business schools of the world.

Stories are a powerful thing. They trigger availability in the mind. The human brain is bound by cognitive resource constraints; it needs a narrative to synthesise the reality. Growth stories are captivating; by contrast, value shares are non-stories. Nobody likes talking or writing about losers. More often than not, the lack of a story crowds out the low cost of the asset. For most investors, buying at low prices is psychologically unnatural, although logically the right thing to do. It takes a special breed to see and buy value.

Indeed, value investors are a sceptical bunch. Their default mode is "not-investing". Stingy by nature, they need to have a good reason to part with their hard-earned cash. More than anyone, they know about the risks of buying cheap. They are painfully aware of the excruciating volatility that bedevils the markets, but they embrace it because they are cognizant that this volatility is the very source of their impressive performance. Uncertainty is at the very core of investing, and the only reason why some win and many lose.

That's why they look for safety, a "moat" around a company that will make it resilient to trouble. Buffet searches for simple businesses, with consistent operating history, high returns, favourable long-term prospects and a candid management. This margin of safety is needed, as the future is generally unknown. Value buyers loathe forecasting; though perfectly able to do a spreadsheet, they are mindful of the random nature of the near term.

They are confident that, eventually, the price of a good business will reflect its worth. Whilst growth investors are very sensitive to short-term changes to already high expectations, and are quick to abandon companies that disappoint, value buyers are patient holders; they have all the time in the world. They cherish their trophies for at least five years in a world whose holding period is 10 times less that.

Over a decade, they have made hundreds of percent in Emerging Market equities, led by the ultimate value market, the cheap-as-chips Russia. Value buyers rode the bull run in gold, industrial commodities, distressed technology and manufacturing companies. Today, they look again at places that others shun, where assets are inexpensive and the margin of safety is high. Today they are looking at Africa. And they have all the time in the world.

Time is money, say the English, and they are right. Most people can be rich if they have the greatest resource of all on their side - time. When assets prices are undervalued and buyers are patient, the bargain hunt is truly on. However, value investing remains a minority sport. Long-time horizons don't come naturally to us humans. Patience is a virtue for a reason. A brain wired with dopamine needs immediate rewards to stay happy. Not too surprising then that despite the iron logic of buying assets when they are near a nadir, very few make it in the world of investing. To quote the ultimate bargain hunter, Buffet, investing is simple but not easy.

*Bargain Hunt is a British Broadcasting Corporation programme in which two pairs compete to make the most money by buying antiques at a fair and then selling them in an auction for profit.

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