Unsolicited and Possibly Unwanted Advice
February 15, 2011 2:16 pm by Dean Morel
The following advice is offered with Matrix Composites & Engineering Limited (MCE) owners in mind, but it applies to all value investors who are holding on to fully valued companies.
I offer this unsolicited advice as I believe there are a number of new “value” investors who are sitting on substantial gains in MCE and my view is they should book those gains and move on.
Is there a margin of safety at the current level? I think not, the only way to get see a decent MoS is to use a very low required rate of return and optimistic forecasts. The valuation to the right is from the excellent MyClime service. To get a decent MoS I had to use a ROE of 50% and required return of 11%.- True value investors don’t forecast. Basing analysis on what analysts forecast is appropriate for growth investors not value investors. Analysts in general are over-optimistic in the long run.
- Surely you can find a better MoS else where. If not there is nothing wrong with holding cash, it gives a decent return plus the option of buying when bargains do appear.
- Who is buying at this level. MoMo (momentum) investors that’s who, there is no-one left to buy after them and they’ll head for the exists quicker than you.
- You never go broke taking a profit.
- Don’t fall in love with a position.
- If you don’t want to sell at least put in place a trailing stop.
- Mr Market is in a great mood at the moment and that means it is time to sell to him.
Put all the above together and I hope you conclude that taking your profit and looking for an investment with better margin of safety is the prudent path of value investing. I’d love to know if and why you disagree.
Disclosure: No position in MCE.
More on this topic
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Understanding Value Investing
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Value Investing: Investing for Grown Ups
(Value Investing, 4/23/12)
Aswath Damodaran: Finding the Value in Value Investing
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I am one with Acorn! Acorn Capital announced they reduced their MCE holding a couple hours after this post.
I agree Dean. I bought a small parcel to motivate me to do research, and I sold when I finally dug deep into the business model this last week.
The business’ high ROE is generated because each order is huge (imagine an undersea drill-line or pipeline stretching for a few kilometres, then imagine the number of subsea bouyancy modules required). I do not suppose the set up costs is very high with each module (rather like moulding a tooling die- after that, it is just materials in, product out, ad nauseam). Therefore, a few order (or lack of) will make or break.
There are major established and huge competitors, and the big action is in the Gulf of Mexico, and we are the furthest away, compared to the competitors from Sweden, Scotland and USA.
So, it may be that they will get a few more orders, maxed out the new Henderson facility and then the SP will go through the roof. Or they may get none, and we have a nice idle facility for tourists.
The nature of the business model renders ROE absolutely meaningless.
Thanks Peter, insightful as always. Yes the ROE could be 60% or 6% in a couple years, though of course all the newly minted valuable investors can do is extrapolate the current ROE forever.
Do you recall discussing Redhill Eduction back here http://www.fusioninvesting.com/2010/11/redhill-education-limited-rdh/
Well they may be worth a quick look after earnings downgrade sent the share price plummeting to the low 20′s http://asx.com.au/asx/research/companyInfo.do?by=asxCode&asxCode=rdh
Sick puppy indeed, may need to be put down.
High AUD, and recent changes to English requirements for skilled migration may affect Redhill for quite some time.
I have also read the announcement, and it does appear to me that management is highlighting extrinsic factors impacting earnings, and did not mention any intrinsic factors.
I think there may be better value plays around.
Dean,
have enjoyed reading your musings for some time. Laughed when I read your post as I had just finished posting on the Australian Investors Association Forum (www.investors.asn.au) with respect to Value-able pointing out that it is just another valuation model with assumptions like all other models. There is no magic bullet when it comes to investing!
Have linked to your post.
Keep up the good work.
Thanks for the kind words John.
You are so right that there is no magic bullet when it comes to investing. That is why I like writers/fund managers like Joel Greenblatt who have the humility to make sure that point comes across strongly.
Value-able is a useful valuation model despite being unoriginal. I’d prefer people read that than attend the plethora of get rich quick seminars. But as you could get three classic value investors books from Amazon for the price of Value-able, I humbly suggest there is no margin of safety in the book
A follow up- I am astounded at the attempts to use ROE in mining valuations, when it is abundantly clear that the R is not necessarily linked to the E.
David Einhorn postulates that wonderful things can happen when a company’s ROE increases from low singles to mid teens.
If we then listen to Charlie Munger’s advice and invert, then we need to answer the question: what happens when a company’s ROE decreases from high figures to low figures?
And finally, we get to James Montier’s belief in mean reversions.
A holy grail is born every year in the market. It appears that the grail is now ROE.
Great stuff Peter. Heaven forbid people investing in mining would consider using 10year rolling returns, or wonder what happens when peak margins becomes trough margins.
Though in saying that I think the structural changes occurring in the world now will persist for a long time, albeit with the occasional bump. So most investors buying quality miners won’t do too bad if they buy and hold for the very long term. The danger is buying now and selling in panic when the first bump comes along.
Supply in iron ore is coming on line fast as is coal, so those two commodities in particular must be nearing their peaks. People investing in any commodity companies should know exactly what the supply picture and then factor in demand shocks. Though it may just be easier to shoot first and ask questions later, meaning be quick to sell on any weakness. That’s not my style, but if you’re not well informed it is a strategy to be considered.
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