- Introduction
- Cheapest vs. Most Expensive Deciles
- Fundamental Consternation & Consideration
- Using Our Core Model to Expand the Opportunity Set
- Summary Tables
- Conclusions
- Exhibits
Introduction
In our first paper published today, Bubble Trouble? Comparing the Current Market to 1999 and 2007, we compared the current situation for our Small & Mid Cap (SMID) and Large Cap universes to the situations during the Tech Bubble and 2007. What we showed for the SMID market in this first report is that valuations are at record highs despite ROEs well below long run averages as they perpetuate a 30 year trend lower.
Having reviewed the SMID market as a whole in our prior piece, we decided to focus our attention on the degree to which value spreads may provide investors with opportunities in stock selection today. We have selected Sales/Price as the metric on which we will decile the stock universes to define “cheap” (i.e., “value”) vs. “expensive” (i.e., “growth”), but the results would be similar had we chosen EBITDA/EV or Book/Price as all three valuation metrics were fairly well correlated in our analyses.
After doing our analysis for this paper, we were both surprised and disappointed to see such narrow valuation spreads between the most and least expensive stocks. As is often the case when we get into the data, the conclusions are less concise, clean and compelling than we would have liked. In some past periods glamour stocks achieved such high valuation levels despite poor profitability metrics because of investor euphoria surrounding a specific sector (e.g., technology) while ignoring other sectors. This behavior created ripe opportunities for investors via wide value spreads. Unfortunately, as our research will show, both the cheapest and most expensive deciles of firms are similarly expensive relative to their own histories. This spread compression eliminates an “easy” valuation anomaly to exploit, unlike during the 1999 Tech Bubble when spreads were enormous.
The combination of low value dispersion at the tails combined with elevated levels of valuations in both groups implies that investors will have to work harder to find opportunities in a market whose general risk profile seems elevated to us. Our view is that investors who rely heavily on simple metrics of valuation for returns face major headwinds as the margin of safety typically afforded by such approaches may have been eroded by nearly unprecedented levels of price relative to fundamentals. Similarly, our research indicates that investors fond of pursuing the highest growth firms face a universe increasingly characterized by difficult fundamentals, making process around those disciplines more difficult to maintain.
As this paper will show, with value-spreads leaving much to be desired we believe that integrating our Core Model among the least and most expensive firms in the Small & Mid Cap space offers investors a powerful tool to exploit the fundamental fractures we see in the most expensive firms while improving the odds of better identifying inexpensive firms whose economic franchises may prove more resilient than their valuation implies.
Disclaimer
The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.
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May 18, 2014 |
| Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin
May 18, 2014
Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin