Michelangelo dedicated four years of his life to creating the ceiling frescos in the Sistine Chapel in the Vatican. One cannot help but be both amazed and inspired by the craftsmanship of this renaissance master. Michelangelo is said to have had a sharp, critical temperament and so committed to his craft that he has been held to be one of the greatest artists of all time. Warren Buffett was once asked to describe Benjamin Graham, the father of Value Investing, and he summarized him this way: “When proper temperament joins with proper intellectual framework, then you get rational behaviour.” With both Graham and Michelangelo, two masters in their own respects, one sees that a proper temperament combined with patience and dedication leads to rational behavior and ultimately success.
Rationality allows value investors to look at market fluctuations as a friend rather than an enemy. Instead of being hyped up by market fear or greed, the value investor aim to profit from this folly rather than to participate in it. Rationality also require that value investors see shares as small pieces of a business and therefore value shares based on the underlying value of the business. These principals were established by Graham in 1934 and as principals are as relevant today as they were then.
Current global and local market fluctuations, fueled by events like the prolonged Euro zone debt crises and the slowdown in Chinese economic growth, create fear in financial markets. This in turn drives down the share prices of many great companies, which creates buying opportunities for the rational investor. Keeping Graham’s above principals in mind, value investors recognize that these conditions are currently creating good buying opportunities in certain sectors of the South African market.
Cyclical businesses like those in the commodities sector are currently very attractive and offer great value at great prices, while businesses in other sectors like industrials, pharmaceuticals and retail are generally more expensive, and thus less attractive, than commodities. Although these sectors will continue delivering value in future, it is likely to be at much slower rates than commodities will. In order to create wealth value investors will always strive to limit losses and maximize compounded annual returns over long periods. Current conditions in the commodities market sector point to such wealth creation opportunities.
Determining good buying opportunities in the commodities sector requires valuing the underlying businesses in the sector. Typically a valuation includes determining whether an investment candidate has good management in place, possesses a durable competitive advantage, has attractive economics, and whether the price per share is close to (or preferably below) the intrinsic value per share of the business.
There are a number of businesses in the commodities sector that have excellent management in place, for instance, Anglo American Plc., Assore Ltd, BHP Billiton Plc., and Kumba Iron Ore Ltd. These companies also all possess some kind of a durable competitive advantage.
There are many ways to consider the sources of competitive advantage. I typically classify a durable competitive advantage as stemming from a supply advantage, a demand advantage, or a combination of both. A supply advantage is typically created by patents, licenses, access to limited resources, specialized know-how, or economies of scale. A demand advantage is typically created by product popularity, strong brand loyalty, high switching costs, market presence, comprehensiveness of products, a market niche, etc. This classification, applied to BHP Billiton, illustrates that its diversified portfolio of low cost, high quality assets leads to a competitive advantage based both on supply advantages (relatively low cost and access to limited resources) and a demand advantage (high quality resources). Next consider the economics of each of the companies being investigated.
There are many elements to consider when reviewing a company’s economics. A detailed valuation includes reviewing a business’ annual reports, including full financials and notes, as well as calculations to determine various ratios and intrinsic valuations. In addition to this I strongly focus on the stability, growth, and sustainability of the business over time. I admit that performing detailed valuations can feel as demanding as painting the Sistine Chapel’s frescos. However, a review of readily available indicators like the price to book value ratio, the price to earnings ratio, and the earnings yield will quickly highlight favourable candidates to be investigated in more detail. In the commodities sector there are currently businesses trading with price to book value ratios close to or below 1.0, price to earnings ratios as low as 7.8, and earnings yields higher than 10%. These indicators point to great value at great prices, exactly the kinds of businesses a value investor is looking for.
In conclusion, a benefit of market fluctuations is that there are generally always great companies on offer to value investors. Currently certain companies in the commodities sector aren’t just offering great value they’re offering it at great prices, like BHP Billiton. Therefore, the investor willing to approach the market like the rational, tempered master who is willing to patiently and diligently value businesses, ignore market emotions and short term market fluctuations, and willing to remain invested in these companies for at least 5 to 10 years is likely to see above average market returns from these investments. I believe that this rational approach to investing, i.e. diligently searching for and grasping opportunities, will lead to wealth creation success, your own beautiful fresco.
Be Extraordinary!
Myles Rennie
Rationality allows value investors to look at market fluctuations as a friend rather than an enemy. Instead of being hyped up by market fear or greed, the value investor aim to profit from this folly rather than to participate in it. Rationality also require that value investors see shares as small pieces of a business and therefore value shares based on the underlying value of the business. These principals were established by Graham in 1934 and as principals are as relevant today as they were then.
Current global and local market fluctuations, fueled by events like the prolonged Euro zone debt crises and the slowdown in Chinese economic growth, create fear in financial markets. This in turn drives down the share prices of many great companies, which creates buying opportunities for the rational investor. Keeping Graham’s above principals in mind, value investors recognize that these conditions are currently creating good buying opportunities in certain sectors of the South African market.
Cyclical businesses like those in the commodities sector are currently very attractive and offer great value at great prices, while businesses in other sectors like industrials, pharmaceuticals and retail are generally more expensive, and thus less attractive, than commodities. Although these sectors will continue delivering value in future, it is likely to be at much slower rates than commodities will. In order to create wealth value investors will always strive to limit losses and maximize compounded annual returns over long periods. Current conditions in the commodities market sector point to such wealth creation opportunities.
Determining good buying opportunities in the commodities sector requires valuing the underlying businesses in the sector. Typically a valuation includes determining whether an investment candidate has good management in place, possesses a durable competitive advantage, has attractive economics, and whether the price per share is close to (or preferably below) the intrinsic value per share of the business.
There are a number of businesses in the commodities sector that have excellent management in place, for instance, Anglo American Plc., Assore Ltd, BHP Billiton Plc., and Kumba Iron Ore Ltd. These companies also all possess some kind of a durable competitive advantage.
There are many ways to consider the sources of competitive advantage. I typically classify a durable competitive advantage as stemming from a supply advantage, a demand advantage, or a combination of both. A supply advantage is typically created by patents, licenses, access to limited resources, specialized know-how, or economies of scale. A demand advantage is typically created by product popularity, strong brand loyalty, high switching costs, market presence, comprehensiveness of products, a market niche, etc. This classification, applied to BHP Billiton, illustrates that its diversified portfolio of low cost, high quality assets leads to a competitive advantage based both on supply advantages (relatively low cost and access to limited resources) and a demand advantage (high quality resources). Next consider the economics of each of the companies being investigated.
There are many elements to consider when reviewing a company’s economics. A detailed valuation includes reviewing a business’ annual reports, including full financials and notes, as well as calculations to determine various ratios and intrinsic valuations. In addition to this I strongly focus on the stability, growth, and sustainability of the business over time. I admit that performing detailed valuations can feel as demanding as painting the Sistine Chapel’s frescos. However, a review of readily available indicators like the price to book value ratio, the price to earnings ratio, and the earnings yield will quickly highlight favourable candidates to be investigated in more detail. In the commodities sector there are currently businesses trading with price to book value ratios close to or below 1.0, price to earnings ratios as low as 7.8, and earnings yields higher than 10%. These indicators point to great value at great prices, exactly the kinds of businesses a value investor is looking for.
In conclusion, a benefit of market fluctuations is that there are generally always great companies on offer to value investors. Currently certain companies in the commodities sector aren’t just offering great value they’re offering it at great prices, like BHP Billiton. Therefore, the investor willing to approach the market like the rational, tempered master who is willing to patiently and diligently value businesses, ignore market emotions and short term market fluctuations, and willing to remain invested in these companies for at least 5 to 10 years is likely to see above average market returns from these investments. I believe that this rational approach to investing, i.e. diligently searching for and grasping opportunities, will lead to wealth creation success, your own beautiful fresco.
Be Extraordinary!
Myles Rennie
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