“There is just as much reason to exercise care and judgment in being as in becoming a stockholder.” – Ben Graham
Stocks are often mispriced for a variety of reasons. Sometimes mispricing occurs because short-term negative issues or headline risks obscure the long-term potential of a business. Other times, the stock market may unduly focus on a company’s earnings while ignoring the value of its assets. In each case, an opportunity is created to buy at a discount and wait for the market price to more accurately reflect the underlying value. We refer to the ability to wait patiently for an undervaluation to correct itself as a form of time arbitrage and it is most relevant to our Cheap Asset Play.
When we invest in a Cheap Asset we account for the fact that sometimes the investment will work out very quickly while other times it may take several years. However, we also recognize that the rate of return improves substantially as the timeline shortens. For instance, if it takes 3 years instead of 5 years for a stock to appreciate 100%, the annual return will be 26% rather than 15%. For this reason we look for opportunities to suggest corporate actions that may help the price/value gap close within a shorter time frame.
Being proactive shareholders means presenting an argument to management on different methods to unlock the underlying asset value. This includes: stock buybacks; balance sheet restructuring; mergers and acquisitions, strategic Board nominees, or taking the company private.
Where we are proactive, our goal is always to be constructive rather than antagonistic shareholders. In our view, CEOs, particularly those running smaller companies, often appreciate our perspective on how investors view their company. They seem willing to trust advice when they see we are committed, long-term shareholders who demonstrate as much interest in the performance of the business as in the performance of the stock.
In all instances the underlying investment analysis is the same and for the majority of our investments we have nothing to add on corporate policy. A proactive approach is mainly relevant to the “Cheap Assets” component of the Ewing Morris Playbook (which is currently about 20% of the Fund).