Successful value investors often work in relative obscurity,
delivering steady, market-beating returns over decades.
Jeremy Grantham is an investor that has been following a value
approach to the markets since at least 1977, when he co-founded
global investment management firm GMO. Over the years, GMO has
grown to manage more than $100 billion in assets but is still
Grantham applies a classic Graham and Dodd value approach to
the markets. Benjamin Graham and David Dodd wrote the original
textbook on value investing,
, in the 1930s. Warren Buffett would later study under
And while countless investors have read the original and
revised editions of
, only a few have mastered the concepts. The very best value
investors, a group that includes Buffett and Grantham, add a
unique perspective to their study.
In the case of Grantham, his success is at least partly due to
his ability to spot bubbles. He may know more about bubbles than
any other investor. In a recent letter to investors, Grantham
wrote, "We have studied more or less all assets for as long as we
can find data, and we have found a remarkable total of 330
'bubbles,' 36 of which we call 'major, important bubbles,' which
we define as 2-standard-deviation events."
Grantham used his knowledge of bubbles to deliver gains to his
investors when the Internet bubble was bursting in 2000 and 2001.
He also lost less than the market in 2008 as the housing bubble
In addition to studying bubbles, GMO develops forecasts for
asset classes based on its studies of long-term value. Right now,
Grantham is most bullish on stocks in emerging markets, which he
expects to provide average annual gains of 6.8%, after inflation,
over the next seven years. In the U.S., Grantham's firm sees
average annual losses of 2.1% in large-cap stocks and 3.5% in
small-cap stocks over the next seven years.
In studying Grantham and other great investors, I learned that
the biggest stock market winners have solid fundamentals and
strong technicals. I combined these factors into a model that
finds market-leading stocks with the fastest growth in cash flow.
When applying this system to Grantham's stocks, two buys jumped
Given his outlook that emerging markets will provide the
largest gains in the long term, it is not surprising to see that
two of his largest holdings are in emerging markets. It might be
surprising to see an Internet company on the list, but that shows
Grantham invests in value, in no matter what sector he finds
Yandex (Nasdaq: YNDX)
is Russia's largest search engine, with about 60% of the market.
Over the past five years, YNDX has reported average sales growth
of 46.6% and an average increase of 39.5% in earnings per share (
). Free cash flow turned positive in 2008 and has grown from
$0.15 a share to $0.74, an average growth rate of 37.6% a
In 2012, YNDX reported EPS of $0.82 and is expected to earn
$1.12 in 2013. In 2014, analysts expect EPS of $1.43. After that,
analysts expect EPS growth to average 29.5% a year in the next
five years. Using 2014 estimated earnings, the stock trades at a
P/E ratio of 24.
The PEG ratio compares the P/E ratio to the expected EPS
growth rate, and YNDX has a PEG ratio of 0.81. The PEG ratio
should be 1 for a stock that is fairly valued. This measure shows
that YNDX is undervalued.
Copa Holdings (
is also undervalued with a PEG ratio of 0.53. Copa Holdings
provides airline passenger and cargo services within Colombia and
international flights from various cities in Colombia to Panama,
Venezuela, Ecuador, Mexico, Cuba, Guatemala and Costa Rica.
Over the past five years, sales growth has averaged 17% a
year, EPS grew an average of 14.7% a year, and free cash flow
growth averaged 30.1% a year. Analysts expect earnings growth of
26.3% a year on average for the next five years. Based on 2014
EPS estimates, CPA could be worth more than $300 a share, more
than double its recent price.
CPA has been profitable every year since 2006, including the
global recession years of 2008 and 2009, when large U.S. airlines
like United Continental Holdings (
) and Delta Air Lines (
) reported large losses.
Grantham has found winning stocks in the past, and equally
important, he has avoided many of the large losses of the past.
Most investors would not hunt for value in Russia and Columbia,
but Grantham knows that successful investing requires hard work.
He now holds YNDX and CPA, stocks which my system also highlights
as potential winners.