World

Global Strategy

20 May 2009

Mind Matters Vanishing value � has the market rallied too far, too fast?

James Montier (44) 20 7762 5872

james.montier@sgcib.com

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BEGINNING ON PAGE 6

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Perhaps I am odd, but I have come to the conclusion that I prefer falling markets to rising

ones. Not for any sadistic or even masochistic reason, but rather I like finding stocks that I can

buy. Unfortunately the swift rebound in the markets is leading to rapidly vanishing deep value

opportunities. In early March 179 stocks passed my deep value screen, whereas today only 63

names appear. The good news is that I think one can still build a diversified high quality

basket from the names on the list. Names like BP, Merck, Novartis still appear. However, if

this erosion of value continues, I’ll soon be worrying about a value drought.

Two months feels like a lifetime in these markets. But I am astounded by the speed of the

value bounce. In early March my deep value screens were showing an unusual degree both

in length and depth. High quality names like Microsoft and Sony were appearing on my lists.

However, deep value has enjoyed a remarkable couple of months. The list of stocks I put

together is up 48% since early March (against a global market return of 33% - all measured

in dollar terms).

Whilst I should presumably be celebrating such a performance I am actually more

concerned that the number of deep value stocks is disappearing at a rate of knots. In

March, 179 stocks passed the Graham deep value screen. Today around 63 pass. In Japan,

57 stocks passed in March; today there are 11. In Asia, there were 67, but only 17 today.

Similarly our net-net screen was throwing up nearly 600 stocks globally in early March �

the highest number of such stocks I have ever seen. Today I can find 369 (although 62% of

those are Japanese small caps � reaffirming my belief that this is amongst the cheapest

asset classes in the world).

Whilst not yet entirely absent, the erosion of value at such a swift pace alarms me a little.

At this rate, Ben Graham�s wise words �When such [bargain] opportunities have virtually

disappeared, past experience indicates that investors should have taken themselves out of

the stock market and plunged up to their necks in US Treasury bills� will become all too

relevant in a short time.

At this rate all we will have left is relative value. I dislike relative value as I�ve never been

comfortable simply buying a stock because it was cheap relative to another stock. As Seth

Klarman notes �Absolute-performance-oriented investors� will buy only when investments

meet absolute standards of value.�

Mind Matters

20 May 2009

2

Vanishing value

Perhaps I am odd, but I prefer falling markets to rising ones. Not because I am a sadist, or for

that matter a masochist, or even because I am bearish by nature � rather because falling

markets generally throw up far more opportunities for me to invest in.

For instance, if you can cast your mind back two and a bit months (it seems like a lifetime in

these markets) I put out a note (Mind Matters, 4 March 2009) which provided a list of deep

value opportunities. These were stocks that passed four criteria (an earnings yield at least

double the AAA bond yield, a dividend yield at least two-thirds the AAA bond yield, total debt

less than two-thirds tangible book, and a Graham and Dodd PE of less than 16x).

One of the features of that list was the unusually high quality of the names it generated.

Stocks such as Microsoft, BP, Novartis and Sony all appeared. The other feature was the

length of the list, with 179 names appearing. The selection has performed remarkably well.

Since publication, the deep value stocks identified have risen some 48% in dollar terms (the

MSCI All World has risen 32% over the same period).

Performance of the deep value baskets since 4/3/2009 (rounded, %) *

Deep value stocks MSCI index

UK 34 30

Europe 37 32

Asia 55 39

Japan 37 22

US 33 24

Global 48 33

Source: SG Global Strategy * Please note that past performance is not necessarily any guide to future returns. Figures shown do not include any transaction or execution costs. Full details of the portfolio and its history are available upon request.

However, this leaves me in a quandary. The number of opportunities has shrunk rapidly in

some places. For instance, in Japan only 11 stocks now pass our four criteria. This compares

with 57 Japanese stocks that passed in March, and is lower than the 19 Japanese stocks that

passed in July 2008! Similarly, in Asia only 17 stocks pass the screen compared with 67 in

March. Worldwide, the number of deep value opportunities stands at a little over one-

third of the number I found in March.

Number of stocks passing our deep value screen

Now 4 March

US 6 10

UK 18 20

Europe 12 25

Japan 11 57

Asia 16 67

Global 63 179

Source: SG Global Strategy

The good news is that, I think, one can still build a relatively high quality diversified portfolio

from the 63 names that appear on our deep value screen. For instance, BP, Novartis, Merck

and Cannon still appear (a full list can be found on page 5). However, I suspect that one will

need to be careful if the deep value opportunities continue to disappear at this rate. The

relative paucity of bottom-up opportunities can itself be a signal. As Ben Graham opined

Mind Matters

20 May 2009 3

True bargain issues have repeatedly become scarce in bull markets� Perhaps

one could even have determined whether the market level was getting too high

or too low by counting the number of issues selling below working capital value.

When such opportunities have virtually disappeared, past experience indicates

that investors should have taken themselves out of the stock market and

plunged up to their necks in US Treasury bills.

Regular readers will know that I am also a fan of Graham�s net-nets. Of course, in today�s

market place the vast majority of net-nets will tend to be small caps. In my note from 4 March

I wrote �Currently I am finding the highest number of net-nets I have ever come across.� In

fact, I found almost 600 net-nets in March. Thanks to a 50% gain in that basket, today I can

find 369. Over 62% of these are Japanese, reaffirming my view that Japanese small caps

remain among the cheapest assets in the world.

Japanese small cap price to book ratio

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Source: SG Global Strategy

While they have not yet vanished entirely, deep value opportunities are certainly thinner on the

ground. It may appear tempting to pursue an alternative approach by either easing the

parameters or even looking for relative value in order to increase the size of the potential

universe. I can understand why one might be tempted to remove the dividend constraint in the

current market environment. As an experiment I ran the screen without the dividend

constraint, but it only added 20 names to the list.

I always shy away from relative valuation. I have never been comfortable with the idea of

buying a stock simply because it was cheap relative to another stock. As is often the case,

Seth Klarman puts it best, arguing that focusing upon relative valuation is largely caused by

relative benchmarking as it is in essence a way of reducing your tracking error.

Money managers motivated to outperform an index or a peer group may lose

sight of whether their investments are attractive or even sensible in an absolute

sense... Absolute-performance-oriented investors, by contrast, will buy only

when investments meet absolute standards of value. They will choose to be fully

invested only when available opportunities are both sufficient in number and

compelling in attractiveness, preferring to remain less than fully invested when

both conditions are not met.

Mind Matters

20 May 2009

4

Stocks passing the deep value screen (rounded)

Company EY DY MKt cap ($) G&D PE Country

OMV AG 18 4 10,280 10 Austria

Kesko Oyj 9 5 2,630 14 Finland

Rautaruukki Oyj 20 9 2,813 9 Finland

Total S.A. 12 6 122,649 11 France

Vallourec S.A. 21 7 6,227 12 France

Deutsche Lufthansa AG 14 8 5,746 11 Germany

MAN AG 18 4 9,237 13 Germany

Cosco Pacific Ltd. 12 5 2,317 10 Hong Kong

HongKong Electric Holdings Ltd. 9 5 11,661 14 Hong Kong

Kingboard Chemical Holdings Ltd. 11 4 2,108 9 Hong Kong

Orient Overseas (International) Ltd. 14 4 1,970 6 Hong Kong

Television Broadcasts Ltd. 8 6 1,656 15 Hong Kong

Wharf (Holdings) Ltd. 9 3 9,398 12 Hong Kong

Yue Yuen Industrial (Holdings) Ltd. 14 6 3,340 11 Hong Kong

Ambuja Cements Ltd. 12 3 2,343 16 India

Aneka Tambang 9 13 1,550 15 Indonesia

ENI S.p.A. 14 8 92,897 9 Italy

Koninklijke Boskalis Westminster 16 7 2,117 14 Netherlands

Royal Dutch Shell Class A 16 6 150,053 8 Netherlands

StatoilHydro ASA 10 3 64,619 13 Norway

SembCorp Industries Ltd. 10 4 3,475 16 Singapore

Singapore Airlines Ltd. 15 9 9,399 11 Singapore

Singapore Press Holdings Ltd. 9 9 3,164 12 Singapore

Skanska AB 9 6 4,356 12 Sweden

Novartis AG 9 5 90,279 14 Switzerland

ASUSTeK Computer Inc. 8 5 5,933 10 Taiwan

Compal Electronics Inc. 11 8 3,403 11 Taiwan

Inventec Corp. 11 7 1,532 12 Taiwan

U-Ming Marine Transport Corp. 19 13 1,681 14 Taiwan

AGA Rangemaster Group PLC 16 5 94 5 United Kingdom

Anglo Pacific Group PLC 22 6 205 12 United Kingdom

Bloomsbury Publishing PLC 9 4 136 11 United Kingdom

BP PLC 12 7 143,304 13 United Kingdom

Braemar Shipping Services PLC 19 8 97 13 United Kingdom

Castings PLC 20 7 94 8 United Kingdom

Charter International PLC 16 4 1,427 15 United Kingdom

Computacenter PLC 14 5 426 8 United Kingdom

Diploma PLC 9 6 223 14 United Kingdom

Greggs PLC 9 4 610 16 United Kingdom

Headlam Group PLC 13 8 329 14 United Kingdom

Hornby PLC 16 9 57 10 United Kingdom

Kier Group PLC 12 4 597 12 United Kingdom

Millennium & Copthorne Hotels PLC 9 3 1,037 10 United Kingdom

Renishaw PLC 12 6 463 13 United Kingdom

Royal Dutch Shell PLC (CL B) 15 6 149,541 10 United Kingdom

T. Clarke PLC 19 11 71 7 United Kingdom

Ted Baker PLC 8 5 227 15 United Kingdom

Carnival Corp. 12 6 20,982 12 United States

Chevron Corp. 18 4 132,068 13 United States

Genuine Parts Co. 9 5 5,113 14 United States

Marathon Oil Corp. 17 3 20,264 10 United States

Merck & Co. Inc. 14 6 53,708 10 United States

Mind Matters

20 May 2009 5

Stocks passing the deep value screen (rounded) (cont’d)

Company EY DY MKt cap ($) G&D PE Country

Nucor Corp. 15 3 12,225 15 United States

Canon Inc. 7 3 46,308 15 Japan

Daiichi Sankyo Co. Ltd. 8 5 12,227 16 Japan

Fuji Media Holdings Inc. 6 3 2,840 14 Japan

Ito En Ltd. 7 3 1,179 13 Japan

Itochu Techno-Solutions Corp. 9 3 1,713 14 Japan

Konami Corp. 8 3 2,461 15 Japan

Mitsubishi Rayon Co. Ltd. 10 2 1,592 14 Japan

NHK Spring Co. Ltd. 18 2 1,231 16 Japan

Nok Corp. 15 2 1,869 12 Japan

Ono Pharmaceutical Co. Ltd. 7 4 5,324 16 Japan

Otsuka Corp. 11 3 1,352 16 Japan

Source: SG Global Strategy

Mind Matters

20 May 2009

6

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