Many value investors call themselves bottom-up investors. This
means they don't pay attention to macroeconomic conditions when
making investment decisions. They argue that they cannot predict
the macro picture, therefore they cannot rely on it.
We have asked the question,
Should Value Investors Pay Attention to the Macro
We agree with what the wise
said in his book, "The Most Important Thing: Uncommon Sense for
the Thoughtful Investor" (Columbia Business School Publishing),
where he suggests that investors should make decisions based on
where we are, instead of where we might be.
Again, we totally agree with Mr. Marks. But during an interview
of FPA Crescent Fund, we got a better understanding on how the
macro view can help bottom-up value investors. By the way, the
transcript for the interview will be published soon.
Romick has built an impressive record with his FPA Crescent Fund.
Over the past 15 years until December 2011, his fund has had a
cumulative return of 273%, compared with 149% for the S&P
500. He did this with much lower volatility, too. The worst year
he had was 2007: His fund was down 20%, while the S&P 500 was
Romick did much better than the market in 2007 because he avoided
all financials well before the burst of the financial bubble. His
macro view helped him realize that the huge profit from big banks
like Bank of America (
), Citigroup (
) and Washington Mutual would not be sustainable. Therefore,
although financials were traded at seemingly low valuations in
terms of P/E, price to free cash flow or price to book and had
more than 4% dividend yield in 2007, their earnings power would
diminish if things turned bad.
While Romick was avoiding financials from 2004 to 2007, many
value investors, including many of our Gurus, were attracted by
their low valuations and high dividend yields. Things did turn
very bad and we all know what happened afterwards.
This is actually similar to what Peter Lynch said in one of his
books. When you look at a company's earnings, you should always
ask yourself how the company makes money and whether it can
continue to make money in the same way. The macro view involved
here is not a prediction, rather an understanding of how business
works in a large scale.
The lesson learned: Don't just look at the valuation. The
understanding of how business works is way more important.
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