Graham & Doddsville, an investment newsletter from the
students of Columbia Business School, has proven in the past to
be a must-read for value investors - and the most recent issue
didn't disappoint. The fall 2012 issue had a fantastic interview
, the managing partner of Gotham Capital, in which he talked
about his start in investing, how he's changed as an investor
over time, and the responsibility he feels successful financial
professionals have to give back to society. In that interview,
Mr. Greenblatt gave an interesting answer in response to a
question about selectivity when adding positions to his portfolio
(bold added for emphasis):
"One of the things I said in
"You Can Be a Stock Market Genius"
is if you don't lose money, most of the alternatives are good.
Even if you don't know what the upside is - if you just
know there's upside - you can create scenarios where you have an
. Positions with limited down-side are the types of positions
that I have loaded up on in the past. Not the positions with the
biggest payoff. I could buy a lot knowing that I wouldn't lose
much and that there were good possibilities that it was worth a
lot more over time. At the very least, I knew that my downside
was well-protected and so I could create an asymmetric
risk/reward by saying if I don't lose much, there are not many
alternatives other than to make money."
This quote is particularly relevant today, for the simple reason
that the majority of investors appear concerned with one thing -
yield and capital preservation. To date, this has resulted in
huge inflows to fixed income ETF's, as well as run-up's in both
telecommunications and utilities, which offer sizable dividend
yields and are assumed to be the safest place to hide in the
scary world of equity investing.
Using the 10-year as our example, treasuries appear to pass the
first bar - the U.S. government will repay that bond someday, so
you'll get your principal back in 2022 in addition to your sub-2%
annual yield. However, real risk isn't measured in terms of
nominal capital preservation: It's measured in terms of
purchasing power - and on that front, Treasuries look very risky
indeed. Let's look at a simple example recently presented by
: This simply looks at the return on a 10-year purchased at 1.5%
(like it was a few weeks ago), and the rates it could potentially
move to a few years down the road (assuming it follows the
historical precedence of tracking nominal GDP, which is simply
the summation of real growth and inflation, this doesn't require
much- even 2% real global GDP growth and 2% inflation gets us to
a 4% yield):
Average Annual Return
Remember, this is the what many people assume is the "safe"
asset; in reality, Treasuries look a lot more like return-free
risk - and most retail investors, who think that they have
avoided risk by ditching the equity markets and instead loaned
some money to Uncle Sam, are setting themselves up to potentially
get slaughtered, as they've done time and time again.
Compare that to a company like Procter & Gamble (
), which has paid a dividend for 120 years, has increased it
every year for over half a century (at a rate approaching 10% per
annum), and currently yields 3.30%. The company is on solid
financial footing, trades at a reasonable multiple to earnings
and free cash flow, has pricing power to mitigate the effects of
inflation, and is priced for limited growth in the future despite
a huge - and decades-long - market opportunity coming from
billions of individuals who, much like their development market
counterparts, want products that make their lives easier and
recently put it, "You've got a lot of people and they all want to
look good; it's just a basic human emotion, and the Chinese are
just like everybody else."
This isn't a big secret - and in 2000, Procter & Gamble rode
the market tide that lifted all boats, partly due to talks of the
huge surge in demand that would come from the developing world.
At that time, the stock peaked just shy of $60 - or about 50x the
split-adjusted earnings for fiscal year 2000 of $1.235 per share.
The performance of P&G common stock since that time shows
what happens when years of unattainable growth are priced in by
the market - eventually, that stock is due to take a beating.
Yet, compare the current 10-year Treasury investor of 2012 to the
guy who bought P&G at the peak - on a 10-year basis (with the
benefit of hindsight), we can see that the long-term equity
investor (due to slight capital gains plus the growing dividend)
still managed to outpace the bond buyer who's holding long term
treasuries sporting a sub-2% yield.
Yet even with the benefit of hindsight, long term investors still
grab Treasuries in the name of "safety" - despite the fact that
P&G, which would've outperformed today's bonds even from the
50x starting point, trades at a normalized multiple of well under
half that level.
When I look at the financials for P&G (along with companies
on a similar trajectory like PepsiCo, Johnson & Johnson,
etc), I think their current valuations (and even more so a few
months ago) exemplify exactly what Mr. Greenblatt is talking
about; it's a situation where there's plenty of upside potential,
with almost no real risk of permanent impairment of capital. The
same thing is true with Berkshire Hathaway (
)(BRK.B), yet even more so - in this case, the plenty of upside
potential and limited downside risk was solidified by an open
buyback at a price just a couple percentage points below the
market price - and with tens of billions in capital to support
that floor. I think time will show that investors in situations
like BRK.B and PG will trounce long-term Treasuries over a period
of five or more years; considering that most people have a time
horizon extending years (if not decades) into the future, I think
the decision for the intelligent investor is crystal clear.About
GuruFocus: GuruFocus.com tracks the stocks picks and portfolio
holdings of the world's best investors. This value investing site
offers stock screeners and valuation tools. And publishes daily
articles tracking the latest moves of the world's best investors.
GuruFocus also provides promising stock ideas in 3 monthly
newsletters sent to