There is an expression among professional investors that says, “Buy on the dips”. It comes about because investor behavior is such, that we over-estimate the impact of horrific events and under-estimate good news often. This behavior is also linked to anchoring where the most recent events weigh most heavily in our minds. Unfortunately, what has happened in Japan is a terrible tragedy. Having some business acquaintances there, the first thing I did when I heard about the earthquake last Friday is email them inquiring about they and their family’s safety. Fortunately, they are okay. However, that does not mean we cannot find reason to invest in Japan provided we keep a careful eye on events there.
Warren Buffet’s teacher Ben Graham’s focus is often about best practices and saving us from ourselves. That certainly is what his book “The Intelligent Investor” is about, being patient, disciplined and teachable and that those qualities will allow for gains in the market even above those with extensive knowledge or experience in finance, accounting and stock market anecdotes that do not practice those virtues. For instance, a portfolio manager I worked with, who at the height of the sell-off in February of 2009, before the correction took place stated the obvious, that stocks are being priced for bankruptcy, though many of them have earnings and no debt! “Certainly even those with some debt have fallen far enough to be worth something!” he said. He bought many of these stocks. Ruby Tuesdays for instance was trading between $6 to $7 a share prior to September of 2008 for a while, than between October 2008 to March 6, 2009, it fell to $0.95 cents a share. At this point, it was priced to go out of business but subsequently by April 9, it was trading for $6.61 a share again. Graham said, “99 out of 100 issues at some price are cheap enough to buy and at some other price they would be so dear that they should be sold” and he wanted to embed in the reader a tendency to measure and quantify (which is exactly what any quant would argue for). So in the ensuing example of Ruby Tuesday (ticker: RT), the advice we garner from Graham, is that one should stick with stocks selling for low multiples of their net tangible assets to purchase. But we also learn, that when the market drastically turns fearful and a sell-off occurs, it’s usually overreacting.
In the data that follows below for instance, we show the calculation of the current ratio for Ruby Tuesday during the melee of its share price falling to $0.95 per share. The data shows that total assets per share stayed pretty even from May 2008 right through to May of 2009 and that the net tangible assets (Equity per Share) were about one times the share price (right scale of price graph, trading volume is left scale). The current ratio is below Graham’s ratio of two, so it would not have passed a “Graham” screen, but when the stock traded below net assets, essentially anytime below $6 share, the stock was a buy, and when it dropped to $0.95, with a price to tangible book value of 0.20, the stock was a steal! What an opportunity! The market mis-priced average companies during the credit crisis as though they were overwhelmed with debt (like Ruby Tuesday) and it presented a great buying opportunity.
The ultimate result of this kind of investment strategy is one of conservation of principle but indeed has better outcomes over the long term than chasing glamorous stocks in the growth style, where forecasting future earnings is distant and vacuous as compared to measuring something as simple as net asset values. Thus, Graham’s odyssey is really about true value discovery, about separating what the current market price says about a stock versus its real underlying intrinsic value
Now back to Japan; when you hear of reactor meltdowns, breach of containment and over-estimates of the death toll, this means that most investors and “Mr. Market” are probably going to over-estimate the future impact of these tragic events. That’s the time to buy a Japanese Index fund or ETF. Or, if you have the stomach for it, buy some Toyota or Honda. These strategies will pay you dividends going forward. You be telling the Japanese people that you are in support of them besides. Albeit, wait a week or so for a bit (but not all) uncertainty to subside.