Hello Everybody,
Value investing is all about understanding the fundamentals of individual businesses and buying them at large discounts to intrinsic value. Short-term swings are completely irrelevant to this type of investment strategy. In a market where almost everything is expensive and unattractive, this is one of the most obvious irrationalities I’ve ever seen and I believe it will bring forward some of our best future investment returns. The situation reminds me of 2010 and 2011, when all of the mortgage and housing trends started to clearly point higher, but all of the talk was about a cyclical bear market and a double-dip recession.
Just about all of our largest investments in the financials are trading at 55-65% of liquidation value, which is even less than intrinsic value. Think about that. These companies are being valued at less than they would be in a liquidation scenario, yet all of the businesses are profitable and extremely well-capitalized. The logical question is: How can this be possible?
Let me explain. In a normal industry such as technology or healthcare this type of disconnect would close quickly, as activist investors, private equity and other companies would quickly make bids for the companies to take advantage of the great price. The other way to quickly close the disconnect would be to buy back stock at a discount to tangible book value, which would increase the intrinsic value per share dramatically; as market participants see this type of favorable asset allocation, the valuations would go up, creating fabulous returns. Similarly to the environment after the Great Depression, financials are in the penalty box. They are the administration’s and regulators’ whipping boy, for better or worse. Every step they take is scrutinized and regulated. This includes their ability to buy back stock and increase their dividends. Also, financials have different regulations, which prohibit activist investors, private equity and M&A from having any real impact. Most market participants are also not very patient, so they are tired of all of the litigation and the lower returns on equity, so the industry itself is out of favor. That is why the opportunity is so big!
We are buying dollar bills for 60 cents and we are buying them aggressively. We’ve had clients adding funds for this specific purpose and I’m funneling every penny I have that I don’t need for a few years into these same investments. I’m not doing this to lose money, as I think the risks of that are extremely low and that instead we will make an extremely large profit. Even better than buying a dollar for 60 cents though, we are buying businesses that are increasing their intrinsic value.
AIG trades around $50 with an intrinsic value that is conservatively around $80 per share. Intrinsic value grew 15% last year and will likely grow by 15% this year. The company is going through a regulatory process where it should eventually be able to buy back more and more stock and increase the dividend. The stock buybacks are highly accretive. The company is cutting costs and improving its efficiencies, which will bolster returns on equity. Once the company starts consistently returning 10% on equity, we should see the stock trade much closer to its intrinsic value. I believe this will occur in the next two years and when interest rates do finally rise, these financials will earn returns on equity between 12-15%, warranting a larger multiple. Book value would have to decline by about $30 billion to be worth the current price. That is a lot of Hurricane Sandy’s.
These are not difficult investments to make when you understand the facts. The hardest part for people is just being patient and letting the investments play out, but that is where the money is. T&T Capital Management is not a proxy for the S& P 500. We are drastically different. Our returns over time will be different. If you have funds that you can commit for 2-3 years, I’d strongly suggest adding to your account as I am personally. I’d want my money manager communicating to me honestly if I was in your shoes and that is what I’m doing. Buying dollars for 60 cents is as good an opportunity as we are going to get for some time, to materially improve your long-term financial condition and risk-adjusted return profile! I want you to know that we are constantly attempting to blow up our investment thesis on financials but there is no scenario where I can’t envision us being successful. The bearish arguments are all short-term oriented. If you have any questions, please don’t hesitate to contact us. I’ve never been more confident that your patience and trust will be rewarded tremendously over the next 2-3 years. Thank you very much!