Value Investing News - Interview with author Thomas P. Au - Comments

Style Box Shifts

Tom Au — Mon, 16 Jun 2008 17:44:55 -0400

I always want to be on the "value" side of the equation, although what constitutes value varies from time to time.
To determine this, I study "universes," such as Value Line, and look for stocks with below market P/Es, below market P/Bs, and above-average dividend yields, sometimes all three. In general, however, I don't like to pay more than about 20 time normalized earnings for a stock, Ben-Graham style. (This does not refer to situations where the P/E is high because earnings are miniscule, but where the P/B is low.)

One test that I use relates to whether a stock represents "value" relative to its own trading history. For instance, I once recommended Intel at 18 times forward earnings (then a market multiple), on the theory that one was unlikely to see it at such a low valuation for a long time to come. Microsoft, now a mature company, is beginning to look interesting at a mid-teens (below market) multiple. But I considered and rejected buying it just over 20 times earnings in 1989, not feeling comfortable making an assessment that it would go to 40 times earnings sooner than 14.

My internal debate has to do with absolute versus relative value. On average, the median growth stock has a P/E ratio about twice that of the average value stock (and earnings growth potential that's also about two times higher). When this ratio is greater than two, as it was earlier in the decade, buying (absolute) value was an easy call; I'm not going to pay 3 times the P/E for only twice the growth).

Now, the difference in P/E ratios is about 2 to 1, say 25 versus 13. At a time like this, relative value becomes important. Intel was "cheap" relative to its own history, but I'd never pay 18 times earnings for a utility stock. I'm now avoiding certain cyclicals that are trading 15-20 times normalized earnings; a price too "rich" for them.

At market bottoms, the ratio of growth to value P/Es is about 1.5 to 1, e.g., 12 to 8. At this point, the "value" trade is in the "expensive" growth stock. Around 1980, you could get drug companies or Phillip Morris for 12 times earnings, so why pay 8 times for a cyclical with only half as much growth? But those reversals are rare, and come around once or twice in the average career.

Style Box Shifts

StockJockey — Sat, 14 Jun 2008 19:39:50 -0400

Tom,

I had one other question. Do you ever try to anticipate shifts between growth and value, and if so, is there any ratio or metric that alerts you too a shift? Valuation?

And does time have anything to do with it, value had a good run this decade, is there enough data to say the cycles run 4-5 years, etc?

Thx

1440WallStreet.com

Reply to StockJockey

Tom Au — Fri, 13 Jun 2008 15:14:16 -0400

That's a good question, and it relates to the evolution of Value Line as much as anything else.

Value Line was founded in 1931 as a Graham and Dodd type house reflecting its times. It remained a value shop through the 1950s, with an ideology of "buy stocks below the 'Value Line,' sell stocks above it." But then it moved into the earnings momentum camp in the 1960s along with the then prevailing ethos.

While there, I studied the old archives from the 1930s because I thought the knowledge might come in handy some day. When the 1990s Internet bubble turned out to be a modern facsimile of the 1920s radio craze, I decided that we were headed to the modern 1930s, in which case the Graham and Dodd and Value Line methodologies would be most useful in something approaching their original (1930s) form, not the "evolved" post-1960s version of either G&D or VL.

Questions from StockJockey

George — Fri, 13 Jun 2008 12:40:58 -0400

Question sent in by StockJockey:

How did you reconcile your value philosophy at Value Line,which is essentially an earnings momentum approach?

Also, where do you rank Sam Eisenstadt in the history of Wall Street, is he father of quants?

Question from alexg:

Tom Au — Fri, 13 Jun 2008 10:53:26 -0400

Graham and Dodd's "Security Analysis" was written for the 1930s, an unusually depressed environment. The hypothesis of "A Modern Approach to Graham and Dodd Investing" is that we should now invest in a similar manner, because the U.S. and global economies are headed to the "modern 1930s."

Many post World War II value investors adopted the value "bent," but loosened Graham and Dodd's very strict rules to suit more accomodating times than the 1930s. To take one example, Warren Buffett is a better fair-weather investor and better investor overall than Graham and Dodd. So are the authors of many other value investing books. But I would take the "old masters" in a "stormy weather" environment like the one I foresee coming up.

My first book is a "throwback" toward 1934's "Security Analysis" and away from Ben Graham's own (later) "Intelligent Investor." In this regard, it is "more royalist than the king, more Catholic than the Pope." Perhaps the next book will be closer to the "Intelligent Investor."

Question from alexg:

George — Fri, 13 Jun 2008 10:40:37 -0400

Question from alexg: What seperates your book from the other value investing books?

That concludes the interview - Open for questions

George — Fri, 13 Jun 2008 10:36:48 -0400

Thank you for your responses to my questions, Tom. Now we will open it up for questions from other members of Value Investing News community.

I look forward to reading

George — Fri, 13 Jun 2008 10:36:17 -0400

I look forward to reading your next book. I really enjoyed Graham & Dodd Investing. Good luck with your current writing and investments.

A: Future book

Tom Au — Fri, 13 Jun 2008 10:31:58 -0400

I am working on another book. The first was a prospective; the second will be a retrospective. And the two will "book-end" what is likely to be a major crisis.

Q: Future book plans?

George — Fri, 13 Jun 2008 10:31:24 -0400

Do you have any plans to write another book in the future?

A: Margin of Safety & leverage

Tom Au — Fri, 13 Jun 2008 10:30:51 -0400

I measure margin of safety by "leverage" (lack thereof, actually). The smaller the financial leverage, the larger the margin of safety. I don't like to see most industrial companies have a debt to total capital ratio of more than about 30% (the point at which bankruptcy starts to become a real possibility). REITS, utilities, and certain other stable businesses can afford 50-50, but not much more. The other form of leverage is price to book value (asset value, dividend stream, or other measure of value). The lower the ratio, the greater the margin of safety.

Q: Most important fundamentals?

George — Fri, 13 Jun 2008 10:29:52 -0400

What are the most important fundamentals/ratios value investors should be examining?

A: Stock holdings

Tom Au — Fri, 13 Jun 2008 10:28:53 -0400

The key holdings are oil and other sourcers of energy, plus materials, and industrial companies that support these, such as oilfield services companies. I also have small "observer" positions in Taser and other weapons manufacturers, although I consider this theme premature so far ahead of 2020.

Q: Favorite stocks?

George — Fri, 13 Jun 2008 10:27:55 -0400

Can you share with us some of your current favorite value opportunities?

A: WWII Generational line-up

Tom Au — Fri, 13 Jun 2008 10:27:18 -0400

We have a World War II like generational line-up, with aging Baby Boomers as the new "Rendezvous" (FDR's post-Civil War born generation), Gen-Xers ready to morph into the "New Lost," Eisenhowers and Pattons, and a tech-savvy "Net Gen" who are ready to fight the "next war." Most important, we are on a collision course with developing countries like China that should come to a head around 2020, or shortly before.

Interview with author Thomas P. Au

George — Fri, 13 Jun 2008 09:59:12 -0400

I am pleased to announce that Thomas P. Au, cosponsor of this month's Value Investing News members contest and author of A Modern Approach to Graham & Dodd Investing, has agreed to particpate in an interview with me here at the Value Investing News Forum.

Please refrain from posting on this thread until the end of my interview with Tom. You can then either post questions in this forum thread or submit them using the site contact form.

Tom, welcome to our forum, and thank you for taking time out of your schedule to answer some of our questions.