Value Vs. Glamour Stock Returns

First published at

“What happens when value and glamour stocks miss earnings expectation targets? Although, as expected, prices for glamour stocks have historically fallen, prices for value stocks have gone up — even when business fundamentals deteriorated, based on results found in this study of global equities. These results suggest the superior returns delivered by value stocks may not be a result of positive developments relative to expectations, but instead are more likely due to a gradual and corrective reversal of earlier overreaction and mispricing. This augments research by select scholars and provides fresh evidence explaining why value investing historically has been a successful long-term strategy.” — The Brandes Institute: The Role Of Expectations In Value And Glamour Stock Returns

In this part of the timeless reading series I’m looking at a study published by the Brandes Institute titled, “The Role Of Expectations In Value And Glamour Stock Returns.

The Brandes Institute is the research arm of Brandes Investment Partners and regularly produces comprehensive research reports and videos on the topic of value investing, to help investors improve their investment process.

The Role Of Expectations In Value And Glamour Stock Returns looks at the markets relationship with glamour stocks versus value stocks.. In particular, the study shows that, for the most part, investors tend to be overoptimistic when it comes to expectations for growth with glamour stocks while underestimating value stocks’ potential. For example, the chart below shows the earnings growth of ten different (#1 to #10) companies across three years. The blue line is the multiple of earnings the market is willing to pay for each company.

Value Vs. Galmour Stock

Company #10 is expected to earn $50,000 cumulatively over the next three years. Company #1 is only expected to earn $19,000 over the same period, but the market is willing to pay 2.7x for the stock. Why? The market is willing to pay a high premium for growth. Company #1’s earnings are set to jump for $4,000 to $8,000 over three years, if this growth continues, the company will earn an equivalent, if not greater level of earnings than company #10 at some point in the future.

Investors are willing to pay more for glamour stocks. However, the Brandes Institute has found that the value/glamour cycle has been surprisingly persistent and bordering on the predictable over the long-term:

“We find a manifest chronology of overreaction, revision, sentiment shift, and multiple expansion in value stocks. In glamour stocks, a similar record of overoptimism, revision, disappointment, and multiple contraction existed…the purchase of value stocks tends to exploit, rather than succumb to, behavioral biases such as overoptimism, overreaction, and anchoring. These biases tend to push prices for securities above or below their inherent worth.” — The Brandes Institute: The Role Of Expectations In Value And Glamour Stock Returns

The report notes that these biases, which push prices to extremes in the short-term, dissipate over the long-term, and security prices revert away from extreme levels.

“As prices make this reversion, we believe there are ample opportunities for profit-minded investors who can remain rational and patient.” — The Brandes Institute: The Role Of Expectations In Value And Glamour Stock Returns

Why has value investing worked?

There’s plenty of evidence that supports the conclusion that value investing outperforms over the long-term. Why this has been the case seems to have something to behavioral errors. It’s often the case that investors associate value stocks with companies that continually disappoint. As a result, there’s a perception that owning them is a direct path to poor returns. On the flipside, there are stocks that have exceeded expectations in the past, appear to offer promising results, and whose stock prices have leapt with each positive development. Such stocks bring investors comfort and confidence. Accordingly, many investors have high expectations for such stocks and, “sentiment that borders on adoration.

The study from the Brandes Institute is over 20 pages long, so I have to summarize the argument here.

Nevertheless, it’s clear from the study that investors of both value and growth disciplines are affected by emotional biases that impact the returns on value and growth stocks. For value stocks, after the initial event that caused a sell-off, after an average “cool down” period of 12 months, investors reverted to a less emotional and behaviorally biased disposition. A more balanced assessment of fair value ensued, and sentiment began to shift.

“Most notably in this study, company fundamentals needn’t immediately improve for this progression to begin. The reappraisal was a slow progression with bumps along the way, amounting to years of subsequent outperformance delivered by value stocks.”

.With growth stocks, it was found that overoptimism set expectations for growth at unattainably high levels — required to sustain already elevated stocks prices. Eventually, it then becomes increasingly difficult for a company to meet growth targets. At some point in the future, eventually, growth expectations will be missed (typically by a wide margin), and expectations will be revised downwards. Investors then become rattled, and prices fall leading to multiple contraction.

The numbers in the table below really do sum up the argument nicely.

The 6 General Principles Of Value Investing

First published at

What are the fundamental principles of value investing and how should you interpret them?

Joseph Calandro, Jr., a Managing Director of a global consulting firm, Fellow of the Gabelli Center for Global Security Analysis at Fordham University, author of Applied Value Investing, and a Contributing Editor of Strategy & Leadership, published a paper earlier this year that seeks to answer this question.

I should say now that this is only a brief summary of the paper and principles covered. It’s a highly recommended read for those interested. A link to the full paper (PDF) can be found at the bottom of this piece.

Value investing principles: Principle 1

Joseph Calandro starts by laying out the principles of contrarianism, which is also the first principle of value investing. Every value investor should be a contrarian, it’s an essential part of the school of thought. However, it’s often the case that investors fail to adopt correctly this strategy. Calandro quotes a paragraph from Liar’s Poker:

“Everyone wants to be [a contrarian], but no one is, for the sad reason that most investors are scared of looking foolish.”

Value investing principles: Principle 2

So, principle number one of value investing is to have a contrarian nature. Principle number two is the fact that value investing in itself is an opinion. Every value investor has an opinion as to whether or not a stock is undervalued at a particular level. The problem is, as Calandro writes, that everyone is confident in their own opinions when others agree with them.

Unfortunately, the value of everything is subjective:

“…the principle of value subjectivity can be operationalized; stated another way, because value is an opinion the assumptions behind a valuation should be thoroughly understood and validated.

Because value is subjective, all valuations are based on assumptions. What exactly is meant by the term assumption? A dictionary defines it as “the act of conceding or taking for granted.” The phrase “taking for granted” is a harsh one, but it is applicable to the art of valuation.” — Calandro, Joseph, Value Investing General Principles

After this statement, Calandro gives a quick run-down of the various subjective factors that usually form the basis of any value-orientated valuation technique. Even rigorous bottom-up analysis can have its downfalls and relies on key assumptions such as:

  • Will costs remain at historic levels or increase faster than inflation?
  • How will changes in the economic environment affect performance?
  • Are historic costs based on current market values?

Value investing principles: Principle 3

Principle two blends into principle three; rigorous bottom-up case specific analysis is a characteristic of all professional value investors.

And it’s here that Calandro outlines a rather staggering fact. Most of the time, even professional investors don’t bother to read the financial documents associated with their investments. In most cases, simply reading SEC filings can give investors a huge edge over the rest of the market. However, while an in-depth study of the company and its financials can significantly improve an investor’s chance of getting things right, the subsequent forecasts produced still depend on a number of assumptions, which are based on an opinion. Like all opinions, these assumptions can be formed correctly or incorrectly.

Value investing principles: Principle 4

With assumptions being subject to opinion, it’s the job of the value investor to apply a rigorous and conservative approach to the estimation of all assumptions.

“A dictionary defines conservative as “cautiously moderate or purposefully low: a conservative estimate.” Accordingly to Benjamin Graham, “It is a basic rule of prudent investment that all estimates, when they differ from past performance, must err at least slightly on the side of understatement.” Value investor Seth Klarman explains why:

‘Since all projections are subject to error, optimistic ones tend to place investors on a precarious limb. Virtually everything must go right, or losses may be sustained. Conservative forecasts can be more easily met or even exceeded. Investors are well advised to make only conservative projections and then invest only at a substantial discount from the valuation derived therefrom.’” — Calandro, Joseph, Value Investing General Principles

Another view on the matter, this time from value investor Wally Weitz, who told me earlier this year how he applies a conservative estimate to all of his valuation calculations:

“We build a model of how the income statement works. All too often this is based on estimates, which, hopefully, we are appropriately skeptical about…Then we do a discounted cash flow model using a 12% discount rate. And we get a number. That’s our — as I say we try and be appropriately skeptical about out inputs…we’ll make a high case for, if a few things go right, how good could it be. Then a low case based on if something goes wrong — hopefully we’ve already figured out what could go wrong — we try to figure out how bad things could be…”

Value investing principles: Principle 5

Principle five is based on the statistical concept of mean reversion. Specifically, market perceptions of value will fluctuate around some long-term mean. Fluctuations in pricing will frequently revert to some central tendency with a staggering level of predictability. Professional value investors seek to both identify assets (and liabilities) that are positioned to benefit from mean reversion and to identify ones that could be punished by it. For example:

“…during the depths of the financial crisis when many people were panicking, Mr. Buffett insightfully diagnosed the likelihood of mean reversion that led to a number of high profile and ultimately successful investments” — Calandro, Joseph, Value Investing General Principles

Value investing principles: Principle 6

Calandro notes that all of the above principles — one through five — are cumulative. They all build upon each other and lead to the final, and most important principle of value investing, the margin of safety. However, you cannot invest with a margin of safety unless you follow the five principles above. In order:

Principle one: Approach the market as a contrarian — if you think like everyone else you are going to value things like everyone else.

Principle two: Understand the risks and opportunities associated with value subjectivity.

Principle three: Approach valuation rigorously from the bottom up.

Principle four: Formulate conservative valuation assumptions.

Principle five: Understand how to put mean reversion to work for an investment instead of having it work against one.

Principle six: Invest with a margin of safety.


Calandro, Joseph, Value Investing General Principles (March 8, 2015). Available at SSRN: or


Credit Suisse: Family Run Firms Generally Outperform Over Time

First published at

Public family controlled firms are always a grey area for investors. In many cases, the minority shareholders have little control over management’s decisions.

However, there is evidence to suggest that a controlling family can be a good thing, after all, their fortunes are tied to the success of the company. On the other hand, there have recently been a number of high-profile family-owned corporate collapses and management control concerns have led minority investors to question whether the returns warrant the risk.

To try and answer this question Credit Suisse Group AG (ADR) (NYSE:CS) has constructed the Credit Suisse Global Family universe of more than 900 companies with a market cap over $1bn to analyze the family business model.

Family outperformance

The key takeaway from Credit Suisse’s report is that between 2006 and 2015 the 900 family businesses universe showed an excess return of 4.5% CAGR vs. the MSCI All Countries World Index (ACWI). The report also showed a correlation between business performance and the generation of the family running the business at the time. For example, buying alongside management, specifically, the first generation of management (the founders) generated the best return.

The difference in performance between the different generations of family management is highly noticeable. From the beginning of the study (2006) through to March 2015, with the first generation in charge, the company’s shares returned more than 110% on average. However, family firms with the fifth generation in charge during the period studied, only achieved a return of around 60% for investors.

Family firms: Conservative businesses model

For the most part, Credit Suisse’s data shows that family-controlled companies adopt a conservative businesses model. Family-owned companies operate a lower Return on Equity (ROE) business model in the more developed markets of US and Europe. Leverage is lower at US and European family businesses, the business cycle is smoother and more stable, growth is organic and family companies tend to invest less in R&D. Additionally, over the longer term, family companies have generated 2x the excess of the opportunity cost of utilizing assets or capital compared to benchmarks.

According to the data, family-owned companies trade on slightly higher EV/EBITDA and PB multiples compared to benchmarks. There is an element of ‘survivorship bias in these results’.

All the data points to the fact that family run businesses are better managed than their nonfamily counterparts. The research shows that family firms in the CS Global Family 900 universe have produced an ROE that has been on average 4.3% higher than benchmark (this includes companies Asia, Japan and EMEA. US family-owned companies have generated an average ROE 250bps below the benchmark) located in and cash flow returns on investment (CFROI) over 90% higher.

The 920 companies included in the CS Global Family 900 universe demonstrated a 47% outperformance compared to the MSCI ACWI over the nine years to the end of April 2015.

Since 1995, the universe of family owned companies showed annual sales growth of 10% compared to 7.3% for MSCI ACWI companies. Since 2006, this sales growth has averaged 8.5% for family companies’ vs. 6.2% for the benchmark. In all but two years, sales growth has been superior at family firms.

In trying to pin down a reason for the strong performance of family-run companies, Credit Suisse cites time horizon; a long-term corporate strategy. And this conclusion ties in with the variation in performance between the different generations of family that run the business.

Specifically, Credit Suisse found that over 40% of generation 1 and 4 owners said that the typical time horizon for the payback on a new investment was 5-10 years and over 50% of generation 2 and 3 owners expected new investments to pay back over 3-5 years. More than half of the business owners stated that their long-term management perspective was essential for the ongoing success of their business.

It seems that cash returns are also another important consideration for family firms. Cash flow return on investment for the 900 companies in Credit Suisse’s study has consistently been above the discount rate for the past two decades by an annual average of 320bps compared to 190bps for companies in the MSCI ACWI universe.

family cos CFROI

Credit Suisse looked at economic profit (defined as earnings in excess of the opportunity cost of using the assets or capital) generation of family-owned companies and found that the family-owned company universe has consistently delivered greater economic profit, measured as a percentage of enterprise value, over the past 20 years.

Family firms: Some risks

Unfortunately, while there may be many reasons to invest in a family run and controlled businesses, there are also several downsides. These mainly relate to corporate governance shortcomings and the inability of minorities to control or exert a good influence over owner managers. There’s also the issue of different classes of shares, most typically nonvoting shares to external shareholders. Most of the family-owned companies in France have double voting rights now.

Family firms: The investment case

There is plenty of evidence that shows family-owned business generate excess returns and are good investment opportunities for minority investors. It pays to invest alongside the company founder, i.e., in the early years of a company’s existence — the CAGR of first generation companies has been 9.0% over the past nine years.

And if you’re looking for ideas, Credit Suisse’s HOLT screens have picked out 20 top picks based on quality and momentum factors.

family cos to buy family firms

The 5 Traits Of The World’s Most Successful Investors

First published at The Motley

Every investor sets out with the goal of trying to beat the market. A few even dare to think that they can become next Warren Buffett. Unfortunately, the harsh reality is that few manage to even come close to this goal.

Nevertheless, you can improve your chances of success. There’s no sure-fire strategy to riches, but by studying the world’s most successful investors we can pick up a few tips to help improve our chances.

1. Have a strategy

Arguably the most important trait of the world’s greatest investors is the ability to set out with, and stick to, a clear strategy.

It doesn’t matter which approach you choose, whether it be growth, value, income, deep value, distressed investing, momentum investing or day trading, whichever route you go down, it is key that you stick with the strategy.

Almost all of the world’s most successful investors, the like of Peter Lynch, Warren Buffett, John Templeton, Neil Woodford and Charlie Munger have all stuck with one strategy throughout both the good times and the bad.

2. Never stop learning

“If you stop learning, the world rushes right by you.” — Charlie Munger

Charlie Munger, Warren Buffett’s right-hand man, is arguably one of the most influential investors of all time. It’s his philosophy that investors should never stop learning, and they should always seek to improve existing skills.

Research has shown that for anyone to truly become an expert at something, it takes 10,000 hours of practice. The only way to reach this goal is to continually seek out new information.

Charlie and Warren always read for several hours each day to increase what Charlie has called their “worldly wisdom”.

3. Ask what could go wrong, not what could go right

Most investors invest with the wrong frame of mind. Indeed, when assessing an investment, most will as “what’s the upside here?” or “how much can I make?”

But in most cases, investors should constantly be asking “how much can I lose?”

This is the advice of the world’s most prominent hedge fund manager, Ray Dalio. Overseeing $170bn of client money, Ray Dalio’s fund Bridgewater has only lost money in three of the past 30 years — an unbeaten record.

Dalio attributes his success to the fact that he’s terrible at making decisions. He’s always looking for someone to shoot a hole in his theses and tell him that he is wrong. Being overconfident in this business can cost you a lot of money.

4. Know your strengths

Everyone has their own strengths, and weakness. Each investor has a company or sector that understand more than most.

It’s important that you invest inside your circle of competence. There’s no faster way to lose money than investing in something you don’t understand. If you can’t figure out what a company does or how it makes money, it’s often best to stay away, no matter how lucrative the opportunity might be.

5. Admit your mistakes 

At one point in time, every investor has made a mistake. It’s just part of the business. The best way to act on a mistake it to accept it, learn from the mistake and move on.

“There’s no way that you can live an adequate life without many mistakes.  In fact, one trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke.”  — Charlie Munger

Ben Graham Lecture Notes

I recently stumbled across collection of notes from Benjamin Graham’s lectures when he was a professor at Columbia University.

The notes were taken during lectures given in 1946, six years after the 1940 version of “Security Analysis” was published.

Actually, the name of the course was “Current Problems in Security Analysis”, and was, in Graham’s words an“attempt to bring our textbook ” Security Analysis” up to date, in the light of the experience of the last six years since the 1940 revision was published.”

Ben Graham: Still relevant

“The subject matter of security analysis can be divided in various ways. One division might be in three parts: First, the techniques of security analysis; secondly, standards of safety and common stock valuation; and thirdly, the relationship of the analyst to the security market.”

It has been nearly 70 years since Ben Graham gave these lectures, and clearly, the financial world has changed dramatically in this time. Nevertheless, the principles behind value investing remain the same however.

Graham starts his lecture by trying to get students to forget about stock prices. The analyst’s relation with the market should be, as Graham describes it, “that of a man toward his wife. He shouldn’t pay too much attention to what the lady says, but he can’t afford to ignore it entirely.

Straight off, Ben Graham is trying to draw a line between stock prices and the underlying business.

However, Graham then goes on to discuss the market and its movements. Specifically, the predictability of the market; it won’t go up forever but it also won’t go down forever.

“When you look at the stock market as a whole, you will find from experience that after it has advanced a good deal it not only goes down — that is obvious — but it goes down to levels substantially below earlier high levels. Hence, it has always been possible to buy stocks at lower prices than the highest of previous moves, not of the current move.”

“…if you look at this chart of the Dow Jones Industrial Average, you can see there has never been a time in which the price level has broken out, in a once-for-all or permanent way, from its past area of fluctuations. That is the thing I have been trying to point out in the last few minutes.”

Then Graham gets straight into the subject of security analysis.

Ben Graham – Security analysis

Ben Graham’s first analysis is that of a new issue, Northern Engraving and Manufacturing Company, which was looking to sell around 250,000 shares at $16 per share. That meant that this company was to be valued at $4 million in the market.

“Now, what did the new stockholder get for his share of the $4-million? In the first place, he got $1,350,000 worth of tangible equity. Hence he was paying three times the amount of money invested in the business. In the second place, he got earnings which can be summarized rather quickly. For the five years 1936-40, they averaged 21 cents a share; for the five years ended 1945, they averaged 65 cents a share. In other words, the stock was being sold at about 25 times the prewar earnings.”

Even by today’s standards, a valuation of 25 times historic earnings is excessive for a manufacturing company. But that’s not the whole story.

“But naturally there must have been some factor that made such a thing possible, and we find it in the six months ending June 30, 1946, when the company earned $1.27 a share. In the usual parlance of Wall Street, it could be said that the stock was being sold at six and a half times its earnings, the point being the earnings are at the annual rate of $2.54, and $16 is six or seven times that much.”

So, Northern was being offered at six or seven times forward earnings, which Graham notes, is unbelievable. What’s more, as Graham delves into the numbers (“we don’t stress industrial analysis particularly in our course in security analysis”) he determined that Northern Engraving’s profit margin was excessively high for the six-month period being used to value the company pre-IPO. Northern Engraving’s sales margins had jumped from 3% or 4% to 15%.

Ben Graham – Ignoring company specifics

Ben Graham goes on to give further valuation case studies, although he continues to ignore company-specific factors, such as management, brand power and reputation.

One long example, given at the end of the first lecture is a comparison of three different aircraft manufacturers and an analysis of their financial position as well as valuation.

The first company was named the Taylorcraft Company, with a market capitalization of $3 million, working capital of only $103,000, with stock and surplus of $2.3 million but $1.15 million of this was what Ben Graham called an “arbitrary plant markup”.

Also, Taylorcraft had serious financial issues. The company hadn’t issues financial reports for several years, which isn’t the sign of a financially sound company.

Additionally, the company arranged to sell its shares in an amount which did not require registration with the SEC. A four-for-one split was also undertaken to reduce the stock price to $3. Graham then considers another company, Curtiss-Wright:

“Taylorcraft and Curtiss-Wright apparently were selling about the same price, but that doesn’t mean very much…the Curtiss-Wright Company has built up its working capital from a figure perhaps of $12-million to $130-million, approximately. It turns out that this company is selling in the market for considerably less than two thirds of its working capital.”

“The Curtiss-Wright Company happens to be the largest airplane producer in the field, and the Taylorcraft Company probably is one of the smallest. There are sometimes advantages in small size and disadvantages in large size; but it is hard to believe that a small company in a financially weak position can be worth a great deal more than its tangible investment, when the largest companies in the same field are selling at very large discounts from their working capital. During the period in which Taylorcraft was marking up its fixed assets by means of this appraisal figure, the large companies like United Aircraft and Curtiss-Wright marked down their plants to practically nothing, although the number of square feet which they owned was tremendous.”

Curtiss-Wright had been sold off because investors were concerned about the company’s prospects after the war. However, investors were failing to take into account the company’s hefty land ownership, which had been written down to zero.

Of course, there was no guarantee that Curtiss-Wright’s prospects would improve, but the discount to working capital and fact that investors were missing the property opportunity gave a margin of safety.

A rough summary

This is just a rough summary of the first lecture in the series of ten Ben Graham archived lectures. If you’re interest in going through all ten articles, you can find them here.

Low Rates Are Not Good For Equity Returns

With the US economy showing signs of life, the Federal Reserve is widely expected to raise interest rates during 2015 for the first time since the financial crisis.

And the market seems to be terrified by the prospect of higher rates. The Fed’s easy money policies have propelled the market higher for much of the past six years, and investors are concerned that if the market loses this support, a correction will follow soon after.

However, there’s plenty of evidence that suggest the opposite will happen.

Interest rate hikes – Three studies

The first set of data comes from Ben Carlson, a portfolio manager for the endowment fund at the Van Andel Institute, a medical research center in Grand Rapids, Mich. This data was first published in The Wall Street Journal.

Carlson looked at the 14 periods during which the Fed was boosting short-term interest rates since the S&P 500 index’s inception during 1957. It was found that the average return during each period was 9.6%, including dividends.

Another study, this time from Northern Trust, a Chicago-based firm, once again published in the The Wall Street Journal, measured stock performance from six months before to six months after the Fed’s first announcement of a rate hike. 80% of the time, the market moved higher following an announcement.

And finally, a short study from J.P. Morgan Asset Management. JPM’s study showed that during the past two-and-a-half decades, when the Fed increased interest rates by 0.25% stocks fell slightly soon after but rebounded within a one to three months.

The most interesting and comprehensive data set on the topic comes from Credit Suisse Group AG (ADR) (NYSE:CS).

Interest rate hikes – Broad study

Credit Suisse’s Credit Suisse Global Investment Returns Yearbook 2013, an annual publication and highly recommended read, looked at the data from a study conducted by Elroy Dimson, a respected Professor and expert in market history and theory.

Elroy Dimson and his colleagues looked at the data for 20 different countries over a period of 113 years to see if there was any relation between higher interest rates and higher real equity returns. Within the period studied, there were 108 overlapping 5-year periods, giving a total of 2,160 observations — so the conclusions drawn from this data can be considered to be highly informative.

The 108 overlapping five-year periods were ranked from lowest to highest real interest rates and allocated into eight bands; the lowest 5% and highest 5% of real interest rates with six bands of 15% in between. As the chart below shows, the difference in returns across the data set is significant.

Market Performance after rate hikes Interest Rate

The real interest boundary plot show the boundary between bands. The bars are the average real returns on bonds and equities, included reinvested income over the subsequent five years within each band. A the investment yearbook notes:

“…the first pair of bars shows that, during years in which a country experienced a real interest rate below ?11%, the average annualized real return over the next five years was ?1.2% for equities and ?6.8% for bonds…As one would expect, there is a clear relationship between the current real interest rate and subsequent real returns for both equities and bonds. Regression analysis of real interest rates on real equity and bond returns confirms this, yielding highly significant coefficients.”

The highest band, when real interest rates averaged 9.6%, equity returns over the subsequent five-year period hit an annualized 11.3%. This is significantly above the mean annualized real return of the US equity market during the period 1900 to 2014. Over this period equities produced an average annualized real return of 6.5%; bonds produced a return of 2.0% and bills produced 0.9%.

Interest rate hikes – Reduced risk premium

By definition, the expected equity return is the expected risk-free rate plus the required equity risk premium, where the latter is the key unknown. Credit Suisse’s data shows that up until a decade ago, it was widely believed that the equity premium relative to bills was over 6.2%. It’s now believed that the equity risk premium is significantly lower. In the US at least during the period 1900 to 2014, according to the data above, the equity risk premium versus bills was 0.6% lower at 5.6%.

However, as Credit Suisse points out, as the US has been the world’s economic powerhouse over the past century, equity returns are bound to be higher than average. Excluding the US, the annualized historical equity risk premium versus bills stands at a lowly 3.5%. Including the US the global premium over bills stands at 4.1%.

Still, not all markets are created equal.

Market Equity risk premium vs. bills Equity risk premium vs. bonds
Australia 6.6% 5.6%
South Africa 6.4% 5.5%
Norway 3.1% 2.3%
France 3.0% 6.0%
Switzerland 2.2% 3.7%

Annualized equity risk premium 1900 to 2014.

Interest rate hikes: No need to fear a hike

All in all, the evidence suggests that investors have no need to fear an interest rate hike. The data suggests that while the market may suffer in the days and weeks following a hike, one to six months out, performance will start to improve and the market will push higher at a high single/double-digit clip.

Although, I should note that as always, past performance is not necessarily a guide to future performance.

Blind Valuation Test

Blind valuation one

Blind Valuaion  1

Blind valuation two

Blind Valuation 2

Blind valuation three

Blind Valuaion 3

The big reveal

I can now reveal the names of the three companies.

1. Gencor Industries, Inc. (DE) (NASDAQ:GENC)

A manufacturer of heavy machinery used in the production of highway construction materials, synthetic fuels, and environmental control equipment.

  • Current share price $9.64
  • Market capitalization: $91.80 million

2. Carriage Services, Inc. (NYSE:CSV)

Provider of death care services and merchandise in the United States. The Company operates in two segments: funeral home operations and cemetery operations.

  • Current share price $24.75
  • Market capitalization: $458.09 million

3. McRae Industries (OTCMKTS:MCRAA)

A manufacturer of boot products targeted to the western/lifestyle and work boot markets. The Company’s principal lines of business are manufacturing and selling military combat boots and importing and selling western and work boots.

  • Current share price $29.40
  • Market capitalization: $72.20 million

Clearly, these are all very different businesses, and, as a result, each one should be valued differently.


The responses were varied for the whole group, but, on the whole, a net-nets approach was the most favored method for valuing company number one. Responses ranged from $9.30 to $11.

Using Ben Graham’s formula for finding the net current asset value per share (Current Assets- Total Liabilities/Shares Outstanding), using only the figures supplied, Gencor’s NCAV per share stands at $9.295.

Rapid growth

Carriage Services is growing rapidly in a defensive, low-growth industry and is generating significant amounts of free cash flow. Over the past five years, the company’s revenue has expanded at a CAGR of 4.9%, net profit at 17.6% and free cash flow at 13.3%. Book value has grown at a CAGR of 10.7% over the period. Carriage is growing and becoming more efficient as it gets bigger. ROE has doubled over the past five years, and ROA has increased by 150%.

The one thing I didn’t note about Carriage is the fact that the company is a consolidator. The group has become extremely proficient at consolidating assets during the past few years. Therefore, there’s no reason why the company can’t continue to grow at the rate it has been since 2009.

Using a DCF analysis, based on Carriage’s current sustainable current free cash flow of $12.9 million, if the company’s cash flow continues to expand at 13% per annum for the next four years, before settling into a long-term growth rate of 10% and using a discount rate of 13%, which is higher than average but lower than the rate of 15% I’d usually use, we arrive at an implied valuation of $29.04. At this price Carriage would be trading at a historic P/E of 32.9, around the same as its closest listed peer, Service Corp International, which currently trades at a historic P/E of 32.8.

Answers for Carriage were extremely varied. They ranged from $9.42 to $25.18.


And lastly, blind valuation three, McRae Industries. Target prices for this stock ranged from $25.70 to $54.67 based on several different valuation metrics. The low-end valuation, $25.70 was based on McRae’s net asset value. Jeff Sciscilo submitted the higher price target using the following analysis:

1) BV in 2014 was $62.45M, we take a normalized ROE of 11.8% to get our normalized Net Income of $7.357M or $3.02 per share. We then multiply that by a mid-cycle normalized market multiple of 16x to get our price target of $48. In the current market and the growth of the company demand a premium of let’s say 20x normalized EPS, or $60. Assuming a required rate of return we get to $54.54/sh ($60/1.10) to get the price you would want to pay TODAY.

2) Due to a high period of current growth, extrapolating current revenue and net income growth rates is difficult. If we apply an H-model to normalized FCF using a short term growth rate of 20% (average of NI and Rev Growth rates) over the next 10 years and a terminal growth rate of 6% with a required rate of 10% you come to $54.67.