Part I of my Notes from The CFA Institute’s Conference: “Security Analysis and the Search for Value”

The CFA Institute conducted a conference on value investing in New York on November 29 and 30. The program was excellent. I am posting some of my notes and some of my favorite quotes from the presentations to give you a flavor of the event. This is not a summary of the presentations given during the conference—you had to be there—and my quotes may not be verbatim in all cases. Some were written down several hours after the event, but I think they are true in spirit. The notes reflect the things I heard and saw that resonated with me. Any comments I make are included in parentheses.

The speakers included:

Fred Speece, Moderator, Speece Thorson Capital

Aswath Damodaran, NYU

James Valentine, CFA, AnalystSolutions

Andrew W. Lo, MIT

David Maris, Healthcare Analyst

Nicholas J. Colas, ConvergEx Group

Jean-Marie Eveillard, First Eagle Investment Management

David Cowan, GMO

Richard Bernstein, Richard Bernstein Advisors LLC

Michael L. Mayo, CLSA

Howard S. Marks, CFA, Oaktree Capital Management 

Although I quote some speakers more than others, it is not necessarily because the less-quoted speaker was any less interesting. After writing the notes for the first speaker, Aswath Damodaran, I realize that this will be a long post, so I am breaking it up into several parts. 

Fred Speece, Conference Moderator: Introduction

•          Occam’s Razor: Don’t make valuation more complicated than it has to be
•          Remember the importance of dividends: they made up 44% of returns since 1926
•          Know your stuff: fundamentals and valuation

Aswath Damodaran (AD) of NYU; The Dark Side of Valuation: Across Life Cycles and Businesses

The speech is on the essentials that can be found in his latest book of the same title, which I just added to the bookstore above. Professor Damodaran loves discounted cash flow models and walked us through several valuations that he performed over the years, some of which can be found on his blog (see blogroll to the right);

 Young Companies:

•  Valuing young companies in young industries is a challenge: don’t succumb to nouveau valuation methodologies like the 1990s’ “value per eyeball;” don’t be swayed by stories like “there are 2 billion new consumers” in Chindia; and when someone starts talking about paradigm shifts remember it is because he has no explanation for what is happening;
•  AD ran his model on Amazon (AMZN) in 2000 and came up with a value of $34. The stock was trading at $84 at the time. His first thought was “What am I missing?” (I think this is a perfect example of the experience most thoughtful investors have. So many investors pay ridiculous prices for companies because of the story or a paradigm shift, and not for the business’s fundamental value, that it leaves thoughtful investors scratching their heads. Successful  investors refuse to attend those parties);
• Work backwards (or as Charlie Munger would say, “Invert!!!”). AMZN could not have had margins and revenue growth that far exceeded brick and mortar retailers for too long. Eventually the cost to grow AMZN’s business would increase and AMZN’s competitors would adapt by competing directly on AMZN’s turf. The e-tailers and retailers’ margins and growth will converge. What will the values of those businesses look like when they do converge? (INVERT!!!);
• Whenever he told professionals of his lower valuations for companies like AMZN, he usually heard dismissive comments like, “You are just an academic, you don’t know the ways of Wall Street;”
• Keep it simple (the S word again);
• “If you are a pessimist at heart, don’t bother trying to value young, growth companies because they are all overvalued;”
•  “There is always a scenario that you can run in which the market price can be justified” (no matter how ridiculous). Our job is to resist basing our valuations on those;
•  ”No matter how careful you are in your projections, you will be wrong 100% of the time” (yes, very true!). You will never get all of the numbers perfectly right in every period. Then what is the point in running these models? “You just have to be more right than the market or next best analyst.” (Part of the reason I rarely do discounted future flow models is because of the inherent optimism bias in such models. When it comes to valuation of assets, I am a skeptical pessimist. I started my career as a credit analyst—possibly the most skeptical people on Wall Street— because it came naturally to me. So, if a skeptical pessimist like me knows that he should not use models that base valuations on projections because they are likely to be too optimistic, what does an irrational optimist who has no self-knowledge come up with in their discounted future flow valuations? I suspect it is something close to the market consensus);
• “Bias is the biggest enemy of good valuation;”
• “Thank God for institutional investors because they buy when everyone else buys and sell when everyone else sells, which creates opportunities for us;”

 Mature Companies in Transition

•  “Run two models: a status quo model and one where an ideal manager—you—could optimally restructure the firm;”
•  “Unless you are a depressed person, your restructured firm will always be worth more than the status quo firm;”
• How do you get more cash flow out of existing assets? “Two ways to lower the cost of capital that few think about: 1) match funding to lower default risk in the company’s bonds (and so pay less in interest); 2) make products less discretionary (e.g. branding).” Cell phones were a discretionary product when they first came out. Now they are indispensible;
• “Watch out for legacy costs” (I always look for unfunded pension and health liabilities before I invest in any company. Many companies and municipalities are going to be bankrupted by these costs. These important liabilities should be placed in the liabilities section of the balance sheet and deducted from book equity, but they are not. They are relegated to footnotes that take time to be dissected);
• “I always sell when a growth company makes a large acquisition.” Acquisitions are the worst of all possible growth strategies for improving shareholder wealth. The worst of the worst is acquisitions of public companies because the buyer must pay a significant premium over market value;
• The best managers for companies and industries in a decline are those who do not fight it. The best harvest in a decline. Eddie Lampert’s problem is he cannot harvest and sell the real estate as he had planned through the decline of Sears and Kmart;
• Truncation risk—i.e. default—cannot be accounted for by adjusting discount rates (that is obvious and truncation risk is the most dangerous for valuing deep value companies. An equity analyst needs to have strong credit skills in order to account for these risks);
• Financial services companies are opaque (So true, we gave up trying to analyze multinational banks a long time ago. A quote by Joe Rosenberg in the 12/5/11 Barron’s says it all: “…it’s impossible to figure out what banks own, even if you are on the inside.” I have been saying the same thing since 2007; there is no way that Prince and Corzine had a clue of what was happening right under their noses);
• By AD’s estimation, Citigroup could devote all of its free cash flow over the next five years in an attempt to meet the new Basel rules and that still would not be enough to pass. How on earth can they be paying a dividend?

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