Oddball Investing

In this classique essay, that originally ran on July 22, 2004, James Boric shows us that contrary to popular opinion, there’s only one proven way to make consistent big money in the stock market. Don’t believe us?

It all started with Forrest Berwind "Bill" Tweedy in 1920…

Bill was a strange fellow. No one really knows where he came from or when he was born. And if you saw him today, you would probably laugh.

The man wore suspenders, had a bushy mustache and a good-sized potbelly. He never married or had kids. He ate lunch at the same place at the same time every day. He was an oddball, to put it bluntly. And if you happened to walk past 52 Wall Street, chances are, you would see Tweedy working at his cluttered desk – busy writing letters and looking through company reports.

Tweedy’s business was his life. And it was a successful one at that.

Bill Tweedy: Pairing Buyers with Sellers

He owned a small niche brokerage house that specialized in trading tiny illiquid securities. Day after day, Tweedy scoured the market for publicly traded companies that had between 50 and 150 shareholders on the record. He attended their annual meetings, wrote down all the shareholders’ names and sent them personalized letters. His goal was to find out who wanted to sell their shares and who wanted to buy more. From there, Tweedy paired the buyers with the sellers and brokered the deals himself.

It was a brilliant idea.

Bill Tweedy quickly became one of the only small- or micro-cap brokers in New York – the "broker of last resort," as he was called by the many shareholders who couldn’t trade their shares anywhere else. And although I don’t know how many small-cap stocks there were in 1920 relative to the number of major blue chip stocks, you can bet there were thousands more – just like there are today. That left Tweedy with a real monopoly in the market for brokering small-cap trades.

Tweedy’s business was successful throughout the 1920s and into the 1930s. Then he got his big break…

In the early 1930s, Tweedy developed a client relationship with Benjamin Graham – the father of value investing. At the time, Graham was a professor at Colombia University and had recently finished writing his now-famous books Security Analysis and The Intelligent Investor. If you aren’t familiar with Graham, I strongly suggest you read both of these books. They are two of the best primers you’ll ever find on investing. But in case you don’t have time to read the books right now, I’ll give you an abbreviated version of his main points…

Graham (who, among other things, is famous for teaching Warren Buffett the ropes of value investing) proved you could make a fortune investing in companies that were selling for a huge discount to their intrinsic value. In other words, if a company was trading far below what its assets were worth (minus all liabilities – things like debt and accounts payable), Graham was confident that, over time, the company’s true worth would be discovered…and anyone who invested while it was cheap would walk away much richer.

Think of it like this…if you went to a flea market and saw a rare three-legged 1937D Buffalo nickel selling for $900, you would buy it – knowing that the real value of the nickel was somewhere between $3,000 and $4,000. In other words, if you sold it later and ONLY got the nickel’s fair value, you would still make about 233% to 344% on your investment.

Bill Tweedy: Looking for Bargains

Not a bad deal, right?

Well, that’s exactly the philosophy that Graham used to buy shares of a company. He looked for bargains – companies selling for 60% to 70% LESS than they were worth. And it just so happened that many of the small, illiquid companies Tweedy tracked fit Graham’s "value" model simply because they received no coverage on Wall Street and were undervalued.

Thanks to their shared investment strategy, Tweedy quickly became Graham’s "go-to" broker. And Graham became Tweedy’s largest customer – so big that he moved his office right next to Graham’s office on 52 Wall Street so they could work together more efficiently.

Over the years, Tweedy’s business grew. Howard Browne (who started his career as a runner on Wall Street at the ripe old age of 16) became Tweedy’s partner in 1945. And the company slowly grew from a simple brokerage house (with about $88,000 in capital) to a full-fledged investment advisory business…that currently manages over $10 billion in assets.

Although Tweedy, Browne is a large money manager today (not the same small niche broker it was in 1920), one thing has NOT changed in its 84-year history. The company still looks to buy stocks that are trading for huge discounts to their real worth.

Here’s how it’s done…

One of the surest ways to spot an undervalued stock is to look at its price relative to the value of its assets. If a company is priced LESS than its assets are worth, you want to own the stock. It is undervalued. And you want to stay away from the companies that are selling for a huge premium to their asset value.

So how can you tell if a company is cheap relative to its assets?

Bill Tweedy: Low Price-to-Book Value

The easiest way is to scan the market for companies that have a low price-to-book value. A company’s book value is its net asset value minus its intangible assets, current liabilities, long-term debt and equity issues. Divide the market-cap by the book value and you get the price-to-book ratio.

If a company has a P/B value under 1, it is said to be undervalued. And if a company has a P/B value above 1, it is selling for a premium.

You want to own stocks that are undervalued and have room to grow. Historically, these are stocks that provide investors with the highest returns. For instance…

Tweedy, Browne looked at all the stocks trading on the major indexes from 1970 through 1981 that had a market cap of at least $1 million and traded for no more than 140% of book value. They ranked the 7,000 companies into nine groups – ranging from those that were overvalued (trading between 120% and 140% of book value) to those that were undervalued (trading between 0% and 30% of book value). What they found was incredible.

The lower the P/B ratio was, the higher the returns you could expect – without fail.

Stocks that traded between 120% and 140% of book value rose an average of 15.7% in a single year. The stocks that only traded for 80% to 100% of book value rose 18.5%. And the truly undervalued stocks, those trading between 30% and 0% of book value, rose an average of 30% a year.

That’s pretty impressive when you consider the S&P 500 only returns you about 8.5% a year. And in dollar terms the numbers are equally impressive.

If you had invested $1,000 in all the companies trading for 30% of book value or less in 1970 (and rolled that money over each year into the next group of stocks that were trading for 30% of book value or less) it would have been worth $23,298 by 1982. That same $1,000 invested in the S&P 500 would have grown to $2,662. In other words…

By investing in undervalued stocks (those trading for 30% of book value or less), you can expect to make about nine times more money than simply investing in the S&P 500.

Who said investing was hard?

Best regards,

James Boric
for The Daily Reckoning
November 17, 2004

Today seems little different than yesterday. The leaves may be a little browner on the sycamores along the Thames. The air may be a little crisper. Or is it warmer than it was yesterday?

Day by day, we hardly notice any difference. But by degrees and hours, it the weather must be changing. Come January, it will be noticeably colder.

The seasons of the market are likewise irrepressible, but less predictable. Those warm animal spirits that drove Google over 200 times earnings must cool sometime. Just as there has been an Indian summer of enthusiasm for the techs, so there must come a New England winter of despair. We just don’t know when, exactly, it will come.

Google is like a work of contemporary art…No one knows what it is worth, but investors feel very smart and up-to-date owning it. As Jim Cramer says…it just gives you such a tingle, you know you gotta own it.

The markets have been reacting to the Bush victory. As you might expect, most investors have celebrated: They’ve bought defense stocks, sure that Bush & Co. will continue their reckless spending.

Meanwhile, gold and the dollar have sold off. Not everyone believes the Greenspan/Bush team will be able to sustain its spending spree for long. Foreigners are easing off on their purchases of U.S. debt. The smart money is taking precautions.

But now everyone seems to think the dollar will move.

"I was just in New Orleans," colleague Dan Denning reported yesterday. "Everybody’s so down on the dollar…it will probably go up."

The dollar story is not quite as simple as it looks. Economists are sure the dollar will fall. Hedge funds and smart investors are short. But the rest of the world is very, very long dollars. Dollars fill safes and mattresses all over the planet. Dollars are used in global markets and kept in central bank vaults. Americans have nothing but dollars.

Curiouser still, the U.S. Fed has not merely brought about an explosion in the number of dollars around the world; it has also lit the fuse of other currencies all over the world. The United States sells dollar debt. Foreign central banks buy it by issuing currency of their own. The result? A world flooded not only with dollars, but also with yen, kroner, euros, and pounds. The broad money supply in Australia is rising at a 9.7% annual rate. In Britain, the pounds pile up at a 9.3% rate. Canada multiplies its loonies at 9.1% per year. The Danes are expanding their money supply at a breathtaking 10.7%. Euros are increasing 6% annually. And the dollar – the U.S. broad money supply is only increasing at a fairly modest rate of 4.8%, a rate that is still far above the increase in GDP.

In a beauty contest of currencies, all the contestants have warts, bulges, and humped backs. Why should judges pass over the dollar to give any of its rivals the tiara? Then again, only the dollar has the crossed eyes of a 5% (of GDP) trade deficit…and the bow legs of a $450 billion federal deficit. Only the dollar has the buck teeth of a 1% national savings rate…along with the club foot of a consumer economy that needs 75% of the world’s savings just to stay at the same level of self-indulgence.

None of the contestants are fetching. But maybe none are less fetching than the U.S. dollar. Perhaps it can win the prize for "best personality."

What catches our eye instead, is the glint of metal…something that neither watches its weight nor sleeps with the judges.

Gold, dear reader, gold. It is what people turn to when the days grow cold…and when paper gets too ugly to look at.

More news, from our team at The Rude Awakening:


Tom Dyson, reporting from Baltimore…

"’And don’t worry about feeling unpatriotic about taking your money out of the country,’ continued Doug Casey, ‘because, in a funny sort of way, you are doing the right thing for America. When all the money is gone, you’ll be the one bringing it back to resurrect the country.’"


Bill Bonner, back in London:

*** Addison Wiggin, checking in from China…

"Those no good. No good."

It’s not so much that she said it, but the way in which she said it.

Haggling in China is an operatic affair. Hand gestures and loud outbursts are common. Storming off in disgust is encouraged. "It’s a little like cheating," said one member of our party. "We niggle for a dollar here and there, but for the merchants it’s a matter of putting food on the table."

So imagine our surprise when one merchant reacted in this way:

While haggling for a digital camera in Beijing’s famous pearl market, a cohort on the trip threw down $200 in U.S. dollars, rather than Chinese yuan. The woman sneered in disgust. "Those no good. No good here." We’d had become accustomed to U.S. dollars carrying a little extra bargaining power, but not here. She wouldn’t settle for anything in U.S. dollars, demanding remminbi, the people’s currency, instead.

A sign of things to come? Given the dollar’s plight of late, one can only wonder.

*** Probably no stock has risen more than the stock in Terrorism-Is-Us, Inc. The terrorists probably couldn’t wish for a better enemy or better friend than the Bush administration. So far, its every move seems to have calculated to boost up bin Laden’s cause. Today’s front page headline in London – This One’s Faking He’s Dead – surely added to terrorism’s market share.

*** There are two big spheres of human action – private and public. In private, we look at contemporary art and wonder, not why people would buy it, but why they would accept it if it were given to them for nothing. But if a man wishes to pay $5 for a scribble to place on his wall…if he enjoys looking at it…so much the better.

But that, we believe, is such as great an exception as an honest senator. Much more often, a man buys a work of contemporary art to embellish his own opinion of himself as a hip and progressive fellow. Law, public relations, and consulting firms pay millions to place the most appallingly moronic things on their walls for the very same purpose – to advertise that they are "with it."

We visited an odd collection outside Utrecht in Holland, a few weeks ago. In one forgettable work, a series of rocks were laid out upon the floor. There was nothing special about the rocks nor about their arrangement – they were spaced out evenly, in rows. Another great work – for it was worthy of a museum – showed us pieces of what looked as though it could have been old hemp rope, or a blond Rastafarian’s dreadlocks. There was no more to it.

Contemporary art rarely has any private value. No one looks at a contemporary portrait and fondly remembers a grandfather. No one looks at a contemporary landscape and dreams of his childhood. No one looks at a contemporary painting and feels the glory of Heaven or the majesty of Earth. Instead, they look at it and say: "What a clever idea." Or, "What in the world is that supposed to mean?"

No one knows which bits of "art" are worth anything at all. A gimmick may catch on. Or it may not. If it does, the hustlers know they can make a lot of money on it; Cy Twombly’s silly scribbles just sold for $5.38 million. If it had not caught on, on the other hand, the thing would have been just thrown away. No one would get any value out of the thing on a purely private basis.

The problem art hustlers face is finding a way to describe the "art" in a way that makes it valuable. This was the task confronting the cataloguers when they put together last weeks’ sales at Christies and Sotheby’s.

Rome, a work by Thomas Demand is "a picture of an office that has been vandalized," explained the International Herald Tribune report. But the catalogue found a way to dazzle buyers. "The strange physicality of the photograph’s subject is recognized as paper construction," began the description. Some poor schmuck paid $176,000 for it.

The International Herald Tribune described Jeff Koon’s Bracelet, as "a painting which interprets the photograph of an outsized gold bracelet set against a shimmery pink backdrop." But the catalogue promoter had another view: Bracelet, it explained, is about "sexuality"…"spirituality." Some hopeful punter paid $2.24 million for it.

And of course, there were the old favorites, such as a 1961 drawing by Jasper Johns, in which, according to the International Herald Tribune account, "all the digits from zero to nine [are] on top of one another." But the catalogue’s description – "Underpinning the pattern achieved is the fact that he has denied the validity of each separate number. They are no longer ‘readable.’" – helped bring the price up to $11 million.

What marvelous tomfoolery! We stand back in awe and admiration. For every man with a million bucks in his pocket, nature has given us an elegant scam to take it away from him.

*** "Yes, I’m discouraged," Jules, 16, began last night, almost bitterly. "I studied hard for that biology test and all I got was a D. Then, I worked hard on that English paper…and I only got a B-. It’s just not worth the effort. I work hard…I stay up late every night doing this work…and I don’t get anywhere. I’m sick of it. My school sucks. My teachers suck. My courses suck. From now on, I’m just going to do the minimum to get by. It just doesn’t matter and I just don’t care anyway."

A parent has to reply. But he knows not what to say.

Your editor took a shot. He gave him a version of our simpleminded Essentialist Philosophy:

"Jules, you can’t change your school. You can’t change your teachers. You can’t change your subjects. In fact, at this stage in the school year [Jules is in his last year of high school, preparing his college applications]…you can’t change anything but yourself.

"If you allow yourself to take this attitude, you’re going to feel bad about yourself as well as about everything else. You’ll feel bad partly because you’re getting bad grades…but more importantly because you’ll know that you’re not doing the right thing.

"Look, you don’t have any control over what grades you get. I mean, all you can do is to do your best. And keep a positive attitude about what you’re doing. That’s it. That’s all. That’s the whole enchilada. But if you do that, some sort of miracle happens. You feel better about what your doing. You feel better about yourself too – because, no matter what happens, you know that you’re doing the right thing – your best. That’s all you can do, after all. And somehow, someway…doing your best really does produce the results. Sure, there are setbacks…but somehow, the effect of a sustained effort over a long period of time…and a cheerful attitude towards what you are doing and the people around you…gets where you are going."

"Hmmm…" said Jules doubtfully.

His father has his fingers crossed.