The Oracle and “No Called Strikes”
For those of you who haven’t watched “Becoming Warren Buffett,” you should move that to the top of your to-do list after reading this article. In the documentary, he makes an analogy with baseball about investing as a “no-strike” game; you don’t have to swing anything and can wait for a pitch you like. Probably the most famous “value investor” of all time, Warren Buffett built his reputation investing in fundamentally sound companies, and in the first quarter of 2022 he smartly dumped Wells Fargo and took a “swing” at Citi (55.2 million shares at an average price of around $53.40)
I’m not advocating that you buy Citi just because “The Oracle” did. And, if you’re not ready to own Citi for ten years, like him, then don’t even think about it. For those who say they’ve been waiting over 10 years already for Citi’s stock price to appreciate and remain a “value trap”, then I’ll refer you to my original Citi article. The Citi of the past decade will look very different from the Citi of the next decade based on the current transformation and resizing efforts led by Jane Fraser, and the ideal time to add an asset to your portfolio is before a successful transformation not be priced. in.
I’m sure Berkshire Hathaway’s due diligence found that the potential risk-adjusted return offered by an investment in Citi was significantly higher than his previous investment in Wells Fargo (WFC), or any of the other major banks that have already experienced significant price appreciation. . Current market conditions are precarious, however, investing money in a stock with strong (and improving) fundamentals, an attractive dividend yield of around 4%, a cheap valuation of earnings and book value tangible, and transformative potential is a very Warren Buffett thing to do. . You have the opportunity to enter now, probably at or near the cost of Warren Buffett, with a potential return of +60% when the price returns to tangible book value.
Double Down on spin to value
Another prominent value investor is Cliff Asness, a founding director of AQR. He asks whether value stocks have underperformed growth stocks for some identifiable reason that would lend credence to the concept of a “value trap”. AQR maintains the chart below to show the ratio of “cheap” value stocks to growth stocks. As both the tech bubble and the global financial crisis show, when value stocks become excessively cheap relative to growth stocks, there is usually a corresponding rotation from growth to value.
AQR Portfolio Solutions Group has also put together a 5 minute webisode that shows the data and math (through an analysis of the components that go into a discounted cash flow valuation) that makes the case that value stocks are not cheap because of a large disparity in expected future earnings or unusually poor prospective earnings for value stocks. Instead, as of the last data point this year, as shown below, the 98th percentile gap between value and growth stocks is entirely contained within the valuation multiple. This is why the term ‘valuation trap’ should be of more concern to investors than ‘value trap’.
The cyclical nature of the market and the economy should make it clear that a return to a lower value gap will only occur following an increase in the valuation of “value stocks” or a decrease in the valuation of “growth stocks”. Either way, the prudent place to put your capital is in stocks with a strong balance sheet, cash flow to sustain a dividend and buyout stocks, and a reasonable valuation, like Citi.
If you believe in a big spin to value during the potential recession ahead, there’s still an array of value stocks to choose from. Citi continues to trade at an attractive valuation multiple against its banking peers and value stocks, broadly. The company will continue to reduce its free float by buying back shares while paying a substantial dividend.
An investment in Citi also provides a global diversification factor not present in many other valuable US stocks. The ongoing transformation of the company, through a right-sizing and the disposal of non-core activities, will improve profitability and earnings growth. And while there is always the possibility that a period of risk/recession will lead to large concentrations of cash in portfolios instead of a move into value stocks, inflationary tides will make this decision very penalizing.