Oddball Investing

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
July 22, 2004

P.S. Of course, investing is hard; it takes an unusual combination of diligence, hard work, will power and patience to be an above-average investor. As Tweedy and Graham have shown, finding worthwhile undervalued companies takes hours and hours of analysis.

Greenspan’s assessment of the U.S. economy was ‘upbeat,’ says MSNBC. The Fed chief had looked around and said conditions were "quite favorable."

We’re glad to hear it; we just don’t believe it.

We can look around too. And what we see are people trying to upgrade their standards of living…while their real earnings fall.

We see corporations borrowing less money – meaning they are not intending to build new factories or hire new workers.

And we see the tax refunds petering out, consumer spending softening and housing starts falling.

What we see is a nation near the end of a quarter-century of credit expansion. Stocks, once cheap, are now expensive. Interest rates, once high, are now low. And consumers, once fearful and loath to spend, are now ready to gamble everything in order to buy a new house with a big-screen TV in the family room.

These conditions are quite favorable to something – but not what Alan Greenspan wants. Not to a boom, in other words…but a bust.

Over to Tom in London for the news…


Tom Dyson, from the corner of Marigold Alley and Upper Ground, Southwark…

– Publicly, Greenspan is hawkish. In his Humphrey-Hawkins testimony, Greenspan assuaged Congress with claims that economic growth in 2004 would be between 4.25% and 4.75%. Inflation would remain subdued, he predicted…core inflation would range from 1.5% to 2% in 2005. But this was the highest level of inflation that the Federal Reserve would consider acceptable, he said.

– Greenspan further emphasized his tough stance on inflation. He said, in the typically muddled language that we always struggle to comprehend, "We cannot be certain that this benign environment will persist and that there are not more deep-seated forces emerging as a consequence of prolonged monetary accommodation. Accordingly, in assessing the appropriateness of the stance of policy, the Federal Reserve will pay close attention to incoming data, especially on costs and prices."

– It’s a bluff, dear reader, and we don’t believe him. He should be worried about deflation; he just can’t say it.

– Overwhelming statistical evidence suggests that last year’s economic recovery started and peaked in the strong third quarter. This year, despite the sound of cheering coming from Wall Street, the economy is stagnating.

– Economists say the four key variables in the business cycle are consumer durables, residential building, business fixed investment, and business inventories. We turn to the latest copy of the Richebächer letter for the hard statistical analysis…

– "The growth rate of consumer spending on durables has literally collapsed from a stellar 28% in the third quarter of 2003 to negative 4.2% in the first quarter," says the Good Doctor. "The growth rate for residential building has plunged over the same period from 21.9% to 3.8% and for business investment in equipment and software from 17.6% to 9.8%."

– Greenspan counters: "Despite the softness of recent retail sales, the combination of higher current anticipated future income, strengthened balance sheets and still-low interest rates bodes well for consumer spending."

– But what’s this? M2 and M3 are collapsing too. Latest figures show that year-over-year M2 growth has dropped to 3.72%, the slowest rate of growth in the money supply since October 1995, also forewarning a slump in real GDP growth.

– It’s turning into 2003 with a twist, an ugly twist, explains Howard Simons at the Street.com. "The markets of 2003 looked like a reflation trade, even though money-supply growth was slowing and the reported price indices were quite tame," he says.

– Then, in 2004, the Fed moved to take away the punch bowl. "The yield curve would flatten, inflation would continue to rise as the lagged effect of all that stimulus, and stocks would do fine as profit growth would outweigh the effects of higher short-term interest rates," extrapolates Simons. "That misdirection lasted for just over two months."

– Now, as we move into this new period of soggy unemployment, retail sales and economic growth, the Fed will need to reapply the old accommodative policies. Viva the reflation trade! But here’s the twist…this time, there will be no Baghdad bounce…

– Simons concludes: "While bonds, commodities and foreign currencies will benefit, stocks will not. This reflation attempt, whether accompanied by rising monetary aggregates [money supply growth] or not, will have higher reported inflation, notwithstanding last week’s producer price index and consumer price index reports, slower economic growth and profit growth and the prospects for higher federal taxation with which to contend."

– Right on cue, the markets took an absolute pounding; the Nasdaq set a new low for 2004, surpassing the previous mark set on May 17. The tech index lost 43 points, or 2.2% to close at 1,874. The index had opened the day 16 points higher, but ended with a huge 59-point swing to the downside.

– The Dow also chalked up a massive loss, declining 103 points and settling at 10,046. It had been as high as 10,237 in morning trade before the reversal took place. The S&P shed 15 points or 1.3% to 1,094.

– In other corners of the markets, the dollar continued Tuesday’s rally. Gold was hammered as a result, dropping back down below $400 again. And the euro dropped 0.8% against the buck to $1.2226. Oil climbed above $41 on Wednesday, but was beaten back down to $40.66 by the end of the session.

– And here’s the rub…even with the strong deflationary pull revving up again, from our lofty perch above London’s dirty River Thames, we can’t see any deflation for miles. That’s because Greenspan, Bernanke et al will do everything they can to haul that M2 and M3 growth rate back up. It’s 2003 with a twist…


Bill Bonner, back in Baltimore…

*** "Tobacco was once a major industry in Maryland," said an old friend the other day. "Now it is just a rip-off…"

Everywhere we go, we try to gauge the temper of the times. Sometimes we are amused. Sometimes, we are saddened. Often, we reminisce.

"I tell you, Bill" our friend continued, "it just isn’t like it used to be. We’ve all got those fancy kitchens with the islands in the center and that fake marble on the top. We’ve all got air-conditioning and wall to wall surround sound. But it seems like something got lost along the way. But maybe it’s just me…I’m beginning to feel like a cranky old fuddy-duddy."

It’s hard to draw a bead on life when you’re moving through it so fast. Your point of reference shifts everyday. You drive around and remember old landmarks. You recall how things used to be. You think they were better. But you tend to forget the ugly parts.

Rural Maryland used to be pretty – at least, as we remember it. Where we grew up, there were horse farms and tobacco farms. On the Eastern Shore, there were truck farms. As a child, we heard about ‘truck farms’ and wondered. If they could grow trucks over on the other side of the Chesapeake, why couldn’t we plant a few Fords or Chevvies on our place?

Growing trucks must be easier than farming tobacco, we were willing to bet. Tobacco was the world’s most disagreeable crop. It has resisted mechanization for 3 centuries. In the 1950s…as now…harvesting was done by hand. Our first job was working in the tobacco fields. We would get out at dawn and begin cutting down the plants. One by one, row by row, hour after hour.

The tobacco plants had to lie out in the sun for a while in order to relax. Then, we would work our way down each row…picking up each plant and spearing it onto a stick. This went on through the heat of the day, sweat running down our arms, and soaking our shirts…tobacco gum got all over our hands and clothes.

By the late afternoon, if we timed it right, we’d be ready to drive the tractor between the rows and throw the sticks – each with 5 or 6 plants on it – onto the trailer. Then, they’d be taken to the barn and hung up to dry.

It was miserable, exhausting and dirty work. But it was a living and a life for hundreds of thousands of people. Maybe it still is.

Once, an uncle was dying of cancer. We had all gathered at his house to say goodbye. Naturally, the conversation turned to what everybody did and what everybody knew: tobacco.

Suddenly, the dying man interrupted.

"They won’t be planting any tobacco where I’m going."

Being around a dying man can be awkward. You don’t know quite what to say. For a child it is almost frightening. You’re afraid to get too close for fear the dying man will take you with him.

An uneasy silence fell over the group of cousins. No one wanted to contradict our elderly uncle…but they didn’t want to acknowledge that he was a goner either.

But an aunt, her face red and creased from years of hard farm life, feared neither death nor dying. In fact, she feared no man either…and seemed almost on an equal footing with God himself.

"How the hell do you know what they’ll be doing?"

In a few minutes, all of us were speculating about planting tobacco in heaven and about the Great Reunion we would all enjoy some day as we gathered in those celestial fields to begin chopping down the plants.

Somehow, it all seems so rich…those memories, that is. That time. That life.

But it is all gone.

We look out our car window and see houses where tobacco fields used to be. And where tobacco barns used to sit. Now they are little shopping malls, filled with commuters, picking up supplies on their way home from the office.

"Get this…you won’t believe it," continued our friend. "They’re now offering tax credits for preserving tobacco barns. You get paid to keep them up. The state decided they were kind of picturesque."

What was once function is now pure form. What was once real life…is now a fraud. Is it better, dear reader?

"I tell you, this tobacco stuff has gotten really crazy. The state legislature wants to stop people from growing tobacco. You know, everybody’s against smoking. So, they pay tobacco farmers not to grow the stuff. They want farmers to switch to growing Chardonnay grapes or something. Can you imagine any of our relatives doing such a thing? It’s absolutely wacky.

"You know, when we were growing up…nobody had a dime. You worked like a dog in the tobacco fields and if you were lucky, you could make a living at it. But then they came up with these crazy ‘land preservation’ deals. You could sell the development rights to your farm. It was great, because you were just agreeing not to do anything you weren’t already doing…you were agreeing not to cut up your farm and sell it as lots. Heck, who wanted to do that anyway…unless you were dying or something.

"So, you could sell the development rights for a couple thousand dollars an acre – I think it’s up to $5,000 or more per acre now – I don’t know, I haven’t kept up with it. But if you’ve got a 200-acre farm, you’ve got a cool million bucks…for doing nothing different.

"And then they come along and pay you not to grow tobacco at all. They pay you based upon what you were getting from it. So, if you had earned $50,000 a year growing tobacco last year, they’d pay you – I don’t know – maybe $40,000 a year not to grow it. And then, to top it all off, they give you a tax credit to fix up your tobacco barn so you’ll have a place to put the tobacco they’re paying you not to grow. It’s crazy."

The Daily Reckoning