TAKEAWAY NUMBER ONE: Invest at the point of maximum pessimism.
In pretty much any other aspect in life, you should go where the outlook is the best; get
a college degree at a university which is generally held in high regards, aim for a
job in an industry that seems promising, marry a person which your friends and family approval
of, et cetera.
But in investing, you should do just the opposite.
In fact, if you don't happen to be best friends with Warren Buffett or the son of Charlie
Munger, you can probably use the opinions of your friends and family as a strong indicator
of what you shouldn't be investing in.
Sir John Templeton identified himself as a bargain hunter; a value investor that always
attempted to buy assets that are priced below what he believed was the actual value of that
same asset.
He says that "To buy when others are despondently selling and to sell when others are avidly
"buying requires the greatest of fortitude and pays the greatest ultimate reward".
This typically means investing at the point of maximum pessimism In a company, an industry
or a country where the general opinion is that "Shit is about to hit the fan".
For instance, Sir John Templeton made a fortune by; acquiring companies at the eve of World
War two, investing in Japan in the 1960s when the general opinion was that stocks from that
country shouldn't be touched with a ten-foot pole and buying Airlines shortly after the
9/11 terrorist attack.
The basic premises for investing during the point of maximum pessimism is that if the
outlook changes, the reward will be truly remarkable.
Therefore, strong companies facing known issues that you have good reasons to believe are
just temporary makeup for good bargain hunting grounds.
A successful bargain hunter must focus on probable future events rather than actual
current ones.
To be able to keep up the mental fortitude to buy when others are despondently selling
and sell when others are avidly buying, one must separate himself from the crowd.
Templeton didn't just think about this figuratively, he literally moved to the Bahamas to avoid
the herd mentality that he experienced in New York.
Now, you don't have to go this far neither figuratively nor literally because in the
coming few takeaways, we will examine a few other techniques that you can apply to separate
yourself from the casual investor.
TAKEAWAY NUMBER 2: So... what is a bargain exactly?
Typically, when people buy a stock, they buy into a story.
"Airbnb will revolutionize the way that people travel".
"Tesla is making zero-emission cool" and "Beyond Meat will bring the livestock industry to
its knees".
While some of these stories may turn out to be true, it doesn't necessarily mean that
you should invest in these companies.
In fact, you should probably be extra careful when there's a compelling story attached to
the company.
Why?
Because almost without exception, the rest of the investing community will have noticed
these compelling stories too, which causes these stocks to trade at very high multiples.
To Sir John Templeton, most of them would probably not qualify as bargains.
But what did he actually consider a bargain?
A bargain to Sir John Templeton was an asset that was priced at an 80% discount or more.
In other words, if he thought that the stock was worth $100, he'd like to buy it at $20.
This only happened on rare occasions of course, but it proved to be tremendously profitable
nonetheless.
Another guiding light for Sir John Templeton was a low P/E multiple.
Depending on the time horizon of your investment, Templeton had two general suggestions; you
either, (1) Find stocks that are priced so that using their earnings in five years, they
traded a P/E of five, or (2) Find stocks that are prized so that using their earnings in
ten years, they trade at a P/E of two.
To illustrate, I will take Tesla as an example, just because it is a hot potato.
It is currently trading at $163 Billion.
So, if we use the first criterion, it must have earnings of $32.6 Billion in five years.
By comparison, Toyota which is the world's largest car manufacturer had earnings of $23.1
billion last year.
Or, if we use the second criterion, Tesla must earn $81.5 billion in ten years.
Currently in terms of profits , that would make Tesla the second largest company in the
entire world.
Let's just say that I think some healthy skepticism is necessary here.
TAKEAWAY NUMBER 3: Investing abroad is no longer foreign.
Sir John Templeton was referred to as "The dean of global investing".
He liked to invest in foreign markets which to him meant that he invested outside of the
US.
He had tons of success in countries like Japan, South Korea and China, especially while these
were still regarded as emerging markets.
Remember takeaway number one?
Since your mission is to exploit pessimism, you mustn't only do this at a company or industry
level, but also at a country level.
If you look in the US, you will find some bargains.
If you look in Sweden, you will find some bargains.
If you look in India, you will find some bargains, but if you look in the U.S., Sweden and India,
you will find more bargains.
Duh!
Not only will it lead to you finding more opportunities, it will also increase the diversification
of your portfolio.
Even in today's global economy, holding stocks from different markets and with different
currencies will decrease the volatility of your portfolio.
This may help you with a before-mentioned mental fortitude that is required when going
against the herd.
A common objection against investing abroad is that there's lack of information.
It is true that not all markets are as transparent as... for instance the American one but lack
of information isn't always a bad thing.
It could also create opportunities.
You just need to investigate the details and reach better conclusions than the rest of
the investing community.
Beware of situations in which you're at an informational disadvantage of.
For instance, if there are no annual reports available in a language that you understand,
you should obviously stay away.
Ignoring details can lead to bad investments in foreign stocks just as well as it can lead
to bad investments in your domestic market.
Whether the mistake was caused by misjudging a corrupt government or a corrupt top management,
your wallet won't really care.
TAKE AWAY NUMBER 4: The bottom-up and top-down approaches.
It's no secret that investing abroad may be different than investing in your domestic
market though.
You will have to take differences in accounting, culture, consumer behavior and politics among
other things into account.
It is a worthwhile endeavor, but a time-consuming one.
Therefore, we'd like to focus on just a few of these markets and the question then becomes,
which ones?
There are two approaches that you can take, a bottom-up or a top-down one.
The bottom-up approach basically consists of screening a lot of companies.
For this, you can use services such as Capital IQ, Bloomberg or Screener.co.
The bottom-up approach starts on a company level.
On the other hand, a top-down approach would look at something like the growth of GDP of
different countries and see where the potential for growth in the future seems to be the greatest.
The top-down approach starts on a country level.
Sir John Templeton preferred the bottom-up approach and he thought that getting a country
right begins with getting individual companies right, not the other way around.
Here's a quick and dirty attempt of mine to make such a global bottom-up analysis.
I screened a total of 54,000 publicly traded companies using Screener.Co and the following
criteria (which doesn't come from the book by the way).
This narrowed down the 54,000 companies to only 226.
Take a guess, where do you think that most of these companies could be found?
The US?
Nope.
Sweden?
Nah...
India?
Close but no, not that either.
Most of these uh, let's call them qualitatively undervalued companies could be found in Vietnam,
China and Russia.
The top ten list looks like this.
As mentioned before, you must be very careful not to put yourself at an informational disadvantage
here though.
What do you think about investing in Vietnam, China and Russia?
I'd love to hear your thoughts in the comment section.
TAKE AWAY NUMBER 5: Master 100 yardsticks of value.
Sir John Templeton always said that there are more than 100 yardsticks of value that
an analyst can use to find bargains.
The primary advantages of knowing more than one way to find value is that you can find
it during in many different conditions, and that you can confirm your bargains from many
different angles.
Here are six yardsticks for you... soon you'll only have 94 to go.
A low P/E: As mentioned earlier, Templeton didn't want to pay too much for the earnings
of a company.
A low price/book: The book value is the value of the assets of a company after deducting
all liabilities.
Benjamin Graham famously was an advocator of buying stocks that traded below their book
values.
Lots of acquisitions in an industry: Companies usually know their competitors really well.
Therefore, when there are a lot of acquisitions going on in an industry, it's a sign that
insiders think the industry is undervalued.
If companies are willing to bid up their competitors, let's say 50 to 100% or more before acquiring
them, it's a strong signal that there are bargains in that market.
Companies are buying their own shares: Similar to the last point, if a company is acquiring
its own shares, it should mean that the insiders think the company is undervalued.
Lots of money on the sidelines: This is an indicator of a market that is undervalued
in general.
When the largest institutional players are sitting with tons of cash on the sidelines,
it's a bullish sign.
Eventually, this money has to go somewhere and this will drive stock prices upwards.
Absence of IPOs: The insiders want to get as much money as possible for the companies
when they go public.
If there are no IPOs in the market, it means that most insiders think the stock market
prices are too low and vice-versa.
Follow the insiders.
They typically know their businesses better than you do.
To take one step further towards mastering 100 yardsticks of value, you should check
out the book that I will cover next week, "The little Book of Valuation".
It covers how to value a company, pick a stock and profit.
Cheers guys, see you soon!