This post is dedicated to a couple clients – you know who you are! – who requested a sort of primer on value investing. Sorry it’s so tardy, but you know, better late than never.
In an era when indexing has captivated the investing public, it seems anachronistic to be writing about actually thinking about what to invest in. After all, indexing is the ultimate ‘black hole’ for knowledge. You don’t need to know a thing, think a thing, evaluate a number, understand a financial statement, or talk to management – all you do is buy the index, which is a bunch of stocks that are the largest companies around. Are these companies in the index because they are good companies? Not always. JC Penney, a stalwart of the S&P for decades, was kicked out in 2013, in favor of a slightly larger company. It was kicked out because it ran into trouble, but it has started to recover, and now it’s actually larger than the smallest S&P companies so in a twist of irony, it might get let back in. What does all this have to do with whether JC Penney will make money for you? Absolutely nothing.
But JC Penney does offer an interesting illustration of value investing. JC Penney is Value Investing: Graduate Course, prerequisite Value Investing For Dummies. In other words, JC Penney is a tough call. It’s easy to say that banks are cheap value stocks right now, with bank bashing happening all over the place, Deutsche Bank in dire straits, and Wells Fargo in front of Congress every two minutes. This scrutiny has shoved bank prices down down down, while their earnings are really not bad thank you very much. Dividends are pretty fancy too. When stock prices fall because of a perceived problem, but fundamentals remain …. well, at least okay if not sterling, then you probably have a good value on your hands.
JC Penney is worse off than 99% of banks out there. Fundamentals are really not very good at all. In fact, Penney was given up for nearly dead, especially by the ratings agencies for its bonds which had them rated a whisker above D for DEFAULT. Penney has lost money, scads of it, for a few years now. It’s had at least a couple CEOs in just a few years. But, and here’s where thinking comes in, it has found religion, and is scrambling to improve, and it has taken tacks that are worthwhile given the retailing environment. It has begun to pay down debt, and earned an upgrade from one ratings agency at least. It is losing less money. Cash flow has been positive for some time. Its results whomped Sears, Nordstrom, Macy’s, and others in the last couple quarters. It is actually growing.
The stock, however, is in the $9 – $10 area. Ok, it’s recovered from the bottom, and it’s probably outrun the improvement that’s becoming evident – we call that ‘overextended’. No doubt one would rather pay $8 than $10. Question is, will you get a chance at $8 before it goes to $12?
Value managers try not to forecast, mostly because no one is any good at it over time. So our job is to determine if paying $10 for Penney brings us enough value to make the price worth it, today. Not two years from now, because we can’t know that. But we do know that if we pay a cheap enough price for an asset – and that’s what Penney is, an asset – it will be a lot easier to make money than if we pay a lot for an asset.
Next time, we’ll get into numbers a bit, to show what ‘cheap’ really means. Stay tuned!