Could you spot a bargain on the stock market?
Would you know if the intrinsic value of its underlying business were greater than its current price?
How would you assess the opportunity? What valuation methods would you use?
IESE MBA students have been put through their paces as bargain-hunters this semester. “Value Investing,” part of the MBA New York module, saw them work through the fundamentals of the value approach to investment and cover all stages of the investment process – from the search for potential stocks to the execution of the trade.
First articulated by Graham and Dodd in the 1930s, value investing is a research-driven approach predicated on in-depth analysis of a stock and examining all available financial data about the company. Exponents include legendary investors Mario Gabelli and Richard Pzena, both of whom came to the IESE campus in New York to share invaluable insight and experience with students.
Look for the “Skewed Returns”
First to visit campus was Richard Pzena, chairman and CEO of Pzena Investment Management which has more than $26 million under management.
Hunting down the bargains on the stock market can be a risky business. Pzena himself, whose contrarian investment approach has seen him build concentrated portfolios of underperforming companies trading at low prices, is the first to attest that the stakes can be perilously high.
“Value investors get killed once every decade. It happened during the Internet bubble and again last year. Everything hinges on the market recognizing the intrinsic value of beaten down assets, and that takes time.” Furthermore, half or more of your investments might not turn out as expected.
The secret to success, says Pzena, is to hunt out the “skewed returns.”
“You look for investments with downside protection coming either from the firm’s customer base or the assets it owns. So while you could lose, say, 20 percent of your investment value in the downside, you can maybe double the value on the upside if things go well.”
The underlying idea is that bad performers do not perform badly forever. Indeed, empirical studies show that over periods of around five years, profitability reverts to the industry mean on average.
There are real bargains to be found, Pzena believes, in the three-fold scenario of “undervalued companies with current earnings below the historic norm, management that has a viable strategy for earnings recovery and a tangible downside protection.”
The Success Equation: Private Market Value and a “Catalyst”
Oftentimes described as “the value investors’ value investor,” Mario Gabelli, founder, chairman and CEO of GAMCO Investors Inc, was another distinguished guest at the New York campus.
GAMCO currently has around $40 billion under management with an annual compounded return of 15.3 percent net of fees. The success of the franchise, says Gabelli, is built on an investing “equation” that offsets the “private market value” – in other words, what a well-informed analyst would pay for assets with similar characteristics – against market price.
“We invest primarily in the equity securities of cash generating, franchise companies, selling in the public market at a significant discount to our appraisal of their private market value.”
Gabelli’s analysts then look for a pending “catalyst” – events or scenarios that will bring the value of the stock to the surface. These, says Gabelli, could take many forms.
“Examples of catalysts might be regulatory changes or industry consolidation; repurchase of shares, management or capital succession or shareholder activism.”
Access to “Living Legends”
IESE’s Marc Badia, assistant professor of accounting and control, is the academic director of the first year of the IESE MBA. The Value Investing course, he says, exposes students to the “priceless professional experience of world-leading fund managers.”
“The course is eminently practical with students exploring publicly available data sources, assessing the quality of information, implementing valuation models and analyzing every dimension of an investment decision. And before they present their own stock recommendations at the end of the five days, they have access to some of value investing’s living legends. Not only did they have a chance to explore their learnings with Mario Gabelli and Richard Pzena, they also got to share the classroom with Whitney Tilson of Kase Capital and Colin Moran of Abdiel.”
Badia is also quick to stress that the course not only targets students looking to build a career in asset management.
“The course is equally for students interested in managing their own portfolio of stocks – no matter the size – with a value approach.”
Part of the Financial Accounting course within the MBA program, “Value Investing” builds key general competencies in decision making, critical thinking, judgement and communication.