Tim du Toit - Value investor I greatly respect

9.11.2011 | Kohti taloudellista riippumattomuutta


(Tim du Toit)

I think every investor have their own circle of people that they discuss about investing. I'm no exception. One of the people I exchange ideas with is Tim du Toit. Tim is a 44 years old ex-banker that lives in Hamburg, Germany.

You probably haven't heard of Tim before. He is a value investor and runs a newsletter called EuroShareLab. What makes his newsletter unique is that he actually "eats his own dog food". He invests his own money in the same stocks that he recommends to buy or sell but does that only after sending the newsletter out.

I think Tim's stock analyses are awesome! As you probably don't believe me without reading one yourself I've included Tim's latest issue for download for free here.

Once you get to know this guy you'll understand how exceptional he is. The best way I could think of introducing Tim to you readers is in the form of interview. It's about a time that you get to know how he approaches investing and what he have learned in the way. As the interview was done in english I've kept this blog post in english as well. I hope you find new angles to your own way of investing from it. Here we go!


Not that many finnish investor are familiar with you. Could you tell us about your background. You were born in South Africa but how did you end up in Germany for example?

As you mentioned I grew up in South Africa, mainly in Johannesburg.

After school I wanted to become an electrician. Well, I wasn’t sure of what I wanted to do and my dad said he had a friend with an electrical contracting business and was making a lot of money, so I decided to give it a try.

While studying to become an electrician I enrolled in a stock market correspondence course. I quickly realised that investing was something I was really interested in.

So after completing all the theory I needed to become an electrician I changed my studies to accounting and finance.

This led me to university where I completed a Bachelor of Commerce and Honours degree in financial management in South Africa. After that I went to the USA where I completed an MBA degree in finance and strategic management at Indiana University.

On my return to South Africa I received job offers from Absa bank (the largest bank in South Africa) and Templeton Investments. For reasons I cannot remember I took the position at the bank.

If I think of what I'm doing at the moment I cannot but wonder how my life would have turned out if I took the job at Templeton.

So I went to work in international banking doing everything from capital market activities, risk trading, trade finance, bank and country credit analysis and international tax structured finance.

In 2001 one of my previous managers at Absa became the head of a small German private bank subsidiary of the bank and asked me if I wanted to come and work in Germany.

I wasn't too happy at what I was doing at the time and thought it would be a nice experience. It also helped that I was single at the time.

So without speaking German and without ever having been to Europe before (I worked in London for three months) I sold my apartment, car and furniture and moved to Hamburg Germany with my possessions in about 10 cardboard boxes. Thinking that for one year I can stand anything and if it doesn't work out I can always move back to South Africa.

As you may have guessed I really enjoy living and working in Germany with the result that I'm still here nearly 10 years later.


You're not a newbie in investing. You've invested a long time. How did you first get interested in investing? How did it all begin?

From a young age I had an interest in business. For example I was always trading and selling things at school.

In high school I took accounting as a subject and it really fascinated me.

In 1986, shortly after finishing school, I enrolled in a stock market correspondent course I mentioned above. That really first got me interested in investing.

A year or so later I pooled my limited funds with an investment from my father and started to invest in the real world.

I went on to make nearly every investment mistake you can think of (technical analysis, broker recommendations etc.) until I realized that investing was not a recent human activity and that there must be some good research and books about what has worked. Not in the short term but over long periods of time in up and down markets.

So from about 1998 this is what I have done. Read everything I can find that can help me improve my investment returns.

And this is the reasons I give when somebody asks me why they should follow my investment advice. I made nearly every mistake an investor can make and learned from them (it was very expensive). You can thus make and pay for the same mistakes or you can take a short cut and benefit from my mistakes.

You can read more about all the mistakes I've made here: Tim’s investment journey.


Like many other successful investors you've done a lot of mistakes too. Instead of giving up you learned from them and so got better over time. I know you tried all kinds of different strategies before ending up using value investing. Can you tell us something about those and what did you learn from them?

As I mentioned I made all the classical mistakes a beginning investor could make.

I first lost a substantial part of the money my dad invested with me using technical analysis to purchase gold shares.

This taught me two important lessons. One, be very careful of companies that have no control over the price of their products and secondly, technical analysis was not the Holy Grail I thought it was.

I then lost even more money investing in ideas from ”helpful” brokers who of course wanted me to trade as much as possible.

With none of my ideas working I continued to read as much about investing as possible.

I somehow stumbled onto a short 84 page book called “Winning on the JSE” by Karl Posel an engineer and former professor of applied mathematics.

This book was my introduction to value investing. It broke investing down into a logical process with the following steps:

  • If an investor does not know what he is doing then the stock exchange is no place to be doing it.
  • Purchase only after the announcement of interim or final results.
  • Buy only where interim or final results indicate increased earnings per share and/or dividend per share.
  • Only purchase shares where the calculated value is more than the market price using sector price earnings ratios and earnings per share.
  • Realize that the price of a share can behave illogically and have the courage of your convictions to realise that logic will once again return to the market.
  • Do not purchase a company's shares if its long term loans are more than 20% of its share capital and reserves.
  • Do not purchase shares of a company where its pre-tax return on capital employed is less than 15%.
  • Do not purchase shares that have a weekly trading volume of less than 20,000.
  • Have some knowledge of the company concerned. Satisfy yourself about its history, track record and modus operandi. Read Managing Director's and Chairman's reports.
  • Sell when the price earnings ratio or net asset value exceeds the sector price earnings ratio or share price is higher than its net asset value.

The book made immediate sense to me, giving me a framework that can be applied to investing.

And for the next 20 plus years I studied the results of every possible book, research paper and investment study I could lay my hands on that showed superior long term performance – and I still do.

This of course led me to Graham, Buffett, Dreman, O'Shaughnessy, Greenblatt, Pabrai, Lynch, Piotroski etc.

You can read about my favourite investment books in the article Nine books every investor should read.

All this research led me to develop my own unique investment approach that is completely value investing based.


You've had a long career in banking. I would think that would give you more insight into business than ordinary people can have. Have that helped you in investing? What are the "lessons learned" in here?

The main reason I went into banking is I really enjoy working in finance but never really liked accounting.

Also, especially if you work in a big bank, you can effectively change careers every two years by moving to a different department and learn something completely new while the basics remain the same.

Also banking is a fascinating business where you continually have to consider possible gains against losses and the likelihood that the losses will take place.

Because of small margins and large amounts involved bankers are very conservative. This means that not only should each loan transaction have a very small probability of losing money also should a loss take place it must be small enough to be absorbed by the profits and capital of the bank.

The main thing I learned in the banking industry is that for one you need a lot of data gathered over long periods of time to accurately say if a business is worth pursuing. And once you've invested in a business you have to monitor it all the time to be sure the size and possibility of losses have not changed.

This is basically the same road I have followed that made me successful as an investor.

I look for investment strategies that have worked over long periods of time in up and down markets. Once you follow a strategy like this you have a high probability of making money over the long term.

Compare this to an investor that invest in a hot tip or that simply buys a company because it's got a good product. The strategy has no past record of success and the likelihood of it making money, in the short or long-term, is completely random.

What never ceases to amaze me how many investors use this approach to investing. That's most likely why at social events when I tell people what I do, I hear all the stories of how they've only managed to lose money in the stock market.


Now you've decided to pursue a bit different path. You changed your career to work on your investment newsletter full time. I know from my own experience that leaving a steady job isn't that easy thing to do. Was it difficult decision to make?

I started my investment website in June 2009, working on it in the evenings and when I had a few hours free over weekends.

It was very rewarding and as it grew I realized that this is what I really would like to do on a full-time basis.

As my thinking moved more in this direction the financial crisis came along and like all banks my employer experienced a few difficulties.

About a year later the bank had to cut back substantially on its activities and retrenched a lot of people, me included.

So even though it was something that I really thought I would like to do on a full-time basis the financial crisis in a way pushed me in this direction.

I'm really glad things turned out the way they have as it is really something that I enjoy doing.

The interaction with investors and the sharing of ideas turned out to be a lot more rewarding than what I ever thought it would be.

So not only bad things were caused by the financial crisis.


Most of the newsletters that I've seen are all about "hot stocks". They're more about creating a hype around a  stock than investing. Yours is very different. Your recommendations are mostly of companies that many investors have never heard of. You also invest your own money in these AFTER you've sent your newsletter to readers. Same goes to your sell recommendations. Can you tell us what your newsletter is all about?

When I originally started the newsletter I used it mainly to make the analysis of companies I was investing in available to a few friends. More of a way to make sure I do thorough analysis and have a record of my thinking.

I first distributed the ideas by email but later started putting it on a website. Shortly thereafter people I didn't know started subscribing.

My thinking with the newsletter has always been from the point of view of a subscriber. I asked myself what would be the clearest signal I can send them to show that my advice is impartial and my incentives to do well is exactly the same as theirs.

The only way I could find to do this was if I invested in all the ideas myself.

In terms of the companies I recommend, I have an extensive screening methodology that I use combined with in-depth financial analysis. These are all based on the long-term successful investment studies I mentioned above.

Also when I first started the newsletter I looked at ideas worldwide. In the last year I have changed my focus so that the newsletter now focuses on European value investment (including the UK, Scandinavia and Switzerland).

I did this mainly because there are a lot of value investors in the USA but not so in Europe. This means the companies in Europe are a lot less followed and thus they are more undervalued than US companies.


Let's talk about how you do your analysis a little. Before you start making any deeper analysis of a company do you recognize a potential stock using a bottom-up or a top-down approach? What tools do you use?

I only look for investments by identifying undervalued companies. Thus always bottom up. Even though I do follow macro-economic developments I do not use it to find investment ideas.

I use screeners a lot. Over time I have put together a lot of criteria I screen for to identify undervalued companies.

In the past I had access to a Bloomberg terminal where I did a lot of screen programming but now I just use the screener at MFIE.

I was really looking for a Magic Formula screener for Europe when I discovered it. Since I have started using it I find that I don’t need anything else.

I also read letters by investors I admire to get ideas. But I always do my own research.

Here is an article that can help you get investment ideas from other great investors: Get investment ideas from the best fund managers delivered.


OK, so you recognize a potential stock using these tools. What happens next? What things do you look at in the companies that you analyze? What's your analyses process like?

As I mentioned, I only really start a look at the company if it is undervalued, I therefore use stock screening a lot.

Once I've identified a company that is undervalued I pull together five years of financial statements in a spread sheet where work through a 50 point checklist that allows me to quickly determine if a company is worth analysing further.

The checklist is something I have developed over the last 15 years. It mainly consists of items I have identified reading the investment newsletters and books of other great investors as well as newspapers and/or magazines.

It’s not rocket science but it forces me to think systematically and not to overlook anything. You can read more about the check list I use in the article What does your investment check-list look like?

Only after I have worked through the checklist and still find the company attractive do I start reading the financial statements and presentations on the investor relations website.

In the financial statements I look to clarify any anomalies or other points I identified when I worked through the checklist.

The main point that make an investment attractive to me is:

  • Low debt to equity, not more than 35%.
  • High return on tangible assets (classic magic formula companies in other words).
  • A low price to earnings ratio or ebit to enterprise value ratio.
  • A dividend payment (ideally over 3%).
  • Management ownership of over 10%, or for a large company more than five times management’s yearly gross salary.
  • Share buybacks are a definite plus but only if the company is undervalued.
And something I have only started looking at recently is that the company share price must have good relative strength.

This is something that I still find very difficult to implement because as a classic value investor the more a company share price has fallen the more I tend to like it.

However a lot of good research by very credible investors have shown that companies with positive momentum tend to perform a lot better than companies that don't.

Once I am comfortable that it’s a good business and there is a margin of safety I invest.


We all have make terrific and disaster investments. Can you share with us your best and worst moments? What did you learn from them?

This is an easy question to answer.

Isn’t it funny how you remember losers but quickly forget winners?

For the life of me I cannot say what my best investment was. I can however easily say what my biggest mistakes were.

The largest one was a company called Lambert Howarth and the huge loss I suffered in 2007 when the company went into administration.

You can read the whole story in my article Worst investment ever - My story and how you can avoid it.

Here is the summarised version.

In July 2006 I identified Lambert Howarth on one of my screens.

It was trading at book value with a price to earnings ratio of 6,5 times, had no debt and cash equal 8% of market value.

Its market value was £34 million and the previous year had bought back shares with a value of £10.2 million.

And it was trading on a historical 14.7% dividend yield.

You must admit the company was cheap.

I invested in August 2006 and after I invested the share price kept on going down. I re-did my analysis and bought more. The share price declined further and I kept on buying until the company made up 12% of my portfolio.

Shortly after I bought the last time the company announced that it had lost the Marks & Spencer shoe account, this was 50% of their business.

Not much later the company announced it was going into administration as it lost the remainder of Marks & Spencer’s business.

Looking back at my notes and analysis my decision to invest was correct. What was wrong was me continuing to buy as the share price went down, allowing the position to make up such a large part of my portfolio.

Since then I am a lot more conservative with investments in small companies. And I consider stop loss levels a lot more, especially if an investment continues to decline after I have decreased my average price by buying more as it is falling.

I am also a lot more careful of buying more as a company’s share price falls. This also fits with the research I mentioned above concerning positive momentum or relative strength.

My other large mistake is the sofa retailer SCS Upholstery that also went into administration after credit insurers cancelled its cover.

You can read more about my experience with SCS in a comprehensive post mortem. It’s never too late to sell.

But enough bad news, now for some investments that turned out well.

In 2004 I made 115% return in one year from investment in the tobacco company Reynolds America. I bought shortly after some very negative the liabilities of tobacco companies, mainly because of the company's high dividend yield I thought was sustainable. Not only was it sustainable but the share price quickly rallied afterwards as the legal problems turned out a lot better than expected.

Also in 2004 I made a profit of 79% from the German steel company Salzgitter. In the depths of the market crash following the bursting of the Internet bubble I bought this outstanding steel company at 30% of book value with no debt and a good steel and stainless steel business. As the world economy recovered quickly thereafter the company’s share price really took off.

But as with a lot of my investments I sold this one too early.

If I had hung on, along with the huge rise in the steel price from 2004 to 2007 I could have easily earned a further 300%. But that was not to be.

As a value investor you of course sell when the company gets close to what you think is fair value. When the company was trading on a price to book value of 1.5 times I sold out.

Another company that I sold too early was the salt and potash producer K+S also in Germany. I bought the company at a low price to book value with no debt in 2003 and in September 2005 sold out with a gain of 215% or 108% per year.

Exactly the same as Salzgitter this company also went on to increase another 300% or more because of the huge boom in the price of agricultural commodities. However I was more than happy with my 215%.

From 2003 to 2006 I earned a return of 130% or 46% per year from Germany's largest perfume retailer, a company called Douglas. I also bought the company in the depths of the market decline following the Internet bubble crash when it was trading on a price to earnings ratio of less than 10 times. As the market came to its senses the company was quickly re-valued which led to this outstanding return.

From March 2003 to June 2007 I made 130% or 38% per year on an investment and ABN Amro bank. The bank was trading at them unbelievably low price to earnings ratio of under nine times. Because of its low valuation the bank became a takeover target and was eventually bought mainly by the Royal Bank of Scotland.

More recently between 2008 and 2011 I earned 110% on my investment in a German closed end investment company called Shareholder Value run by arguably one of the best small cap value investors in Germany.

And the list goes on.

The common thread with all my best investments is that I stuck to the value discipline and continued to buy undervalued companies even though I had some losses in between.

The only reason I could do this was because of all my research I was sure that value investing works.


What things have had the most influence to your investing? Any "life changing" moments? I'm a great fan of James Montier and I know that you are as well. Have James or other well known investors affected your investing?

There are quite a few people that have played a major role in how my approach to investment has developed over time.

There are too many to mention but thinking back these are the people that have made the biggest impact.

The first one I've already mentioned, the mathematician Karl Posel with his book called winning on the JSE.

David Dreman also had a big impact with his research showing that analyst forecasts are not worth the paper they are written on as well as all his long-term studies that showed value investment is a market beating investment strategy irrespective of what measurement of value you use.

Sir Jon Templeton with his advice that you cannot outperform the index if you look like the index and that you have to find your own ideas. But maybe more importantly his advice is that the only thing that matters is the after-tax real return on your investments.

James Montier as you said had a big impact. The main thing I learned from him was that a well-researched quantitative approach to investing is most likely the best investment strategy you can follow because it gets rid of all the behavioral investment problems the human brain is prone to.

Joel Greenblatt with all three of the books he wrote also had a big impact. Especially the book called The Little Book That Still Beats The Market that introduced me to the Magic Formula for selecting investments. This also confirmed what I learned from Montier that a quantitative approach to investing works well.

The research paper by Joseph Piotroski where he successfully showed that buying low price to book value companies along with a fundamental quality score can vastly improve your investment returns. If you're interested Piotroski's research you should take a look at the article Academics can enhance your returns.

And last but not least my friends at MFIE with the excellent stock screener that they developed that improved on the already outstanding investment approaches of other great investors.

As you can see my investment approach started with no structure at all, went to classical value investing and it slowly but surely moving on to more of a quantitative approach to investing.

What I find really encouraging is all these factors have contributed to the building of an investment approach where the returns keep on getting better.


Free word, Tim. Anything else you want to say to my blog readers in Finland?

Let me end on a more philosophical note.

Investing is not a difficult subject to master but it is definitely more difficult than it looks.

And like a lot of things in life, if you're not really interested it’s probably not worth your while to get involved.

If this is the case then it's much better for you to spend time to find somebody that is really interested in investing and who’s interests are hundred present aligned with yours. That means that she only makes money when you do.

Of course you have to check each year that she is still doing a good job but you must remember that even the best investors underperform from time to time. Sometimes even over a period of 3 to 4 years.

So once you've decided on somebody, made sure his or her long-term track record is good, make a long-term commitment to follow his or her advice.

If you are however interested in investing my best advice to you would be ignore the popular media completely. Read books and research studies by other investors that have been successful over long periods of time in up and down markets.

Learn from each of them but build your own investment strategy taking the best from what you've learned.

Each person has got a different temperament and invests in a different way. However if you follow time-tested investment strategies and build your investment strategy on what has worked you cannot do anything else but have outstanding returns over long periods of time.

Also be careful of becoming obsessed by investing. Always position your portfolio, taking only so much risk that you can sleep well at night.

Making money with your investments is a means to an end, not an end in itself. Your goal in growing your wealth should not be to have more money than all your friends but the ability to:
  • drive the car you always wanted,
  • leave the job you hate and be able to take time to look for something you really enjoy doing
  • take the holiday you and your wife have always dreamed of
  • buy the second home in a warmer climate you have always thought of
  • send your children to the university of their choice
  • simply spend more time with your wife and children.

In life the person the most money does not win or as they say in German “your last shirt does not have a pocket”.

I wish you and your readers all the best with your investments.

Thanks for the thorough interview, Tim!


I discussed with Tim and was able to convince him to offer all my blog readers 20% to 30% off of his newsletter subscription price. This offer is available only for 7 days. To sign up click here: EuroShareLab value investment newsletter. Tim's newsletter have a six months full money back guarantee in case you're not satisfied. No questions asked! To see what kind of newsletters Tim writes you can also download the latest issue for free here.

38 vastausta artikkeliin "Tim du Toit - Value investor I greatly respect"


Nimetön kirjoittaa:

Since the blog entry is in English, I'll comment in English also.

I've been aware of MFIE and the Investment Newsletter for quite a while, but always balked at the amount of euros to hand over, especially relative to the modest size of my investment portfolio. However, this offer might just push me over the edge. But why limit the offer to 7 days only? I'm sure a month would be more sensible in this case.

9.11.2011 klo 22.35.00

Jago kirjoittaa:

The important question is: how has Tim's portfolio actually fared over the course of say, past 15 years compared to an index like MSCI World or MSCI All Country World?

10.11.2011 klo 2.34.00

Jago kirjoittaa:

Another thing of note is recommendation of using 20% Stop/Loss orders or similar. To put it mildly: I think that's a completely absurd idea. Under current market volatility conditions, a 20% swing in either direction can happen relatively quickly (especially with small caps) and with very little (or none at all!) change in the underlying business.

10.11.2011 klo 2.57.00

Kohti taloudellista riippumattomuutta kirjoittaa:

I have forwarded questions to Tim and are waiting for his answers.

In the mean time here here are my point of views (which may not represent Tim's).

@Anonymous: Please note that that this newsletter is different from MFIE's. Tim writes both but they have a different recommendations and content. You have a full money back guarantee for six months. So if you subscribe now and notice that you can't get enough alpha to your portfolio from Tim's recommendations because of your limited portfolio you can simply cancel your subscription and get money back. So it's completely risk free for you.

@Jago: Please study before bashing. Tim's track record is available at his website. Stop-loss is one way of handling risk. I agree with Tim and use a stop-loss as well. If your risk tolerance is higher you of course might prefer a stop-lossless strategy. It's just a matter of taste. But not absurd IMHO.

10.11.2011 klo 9.47.00

Tim kirjoittaa:

@Anonymous – As mentioned this newsletter is different to the one I write for MFIE.

I can really sympathise with you. I also started small, so small that I had to save up part of a few months’ salary before I could make one investment.

Through compounding and continuous saving my portfolio has grown substantially, so stay with it.

My thinking with the pricing of the newsletter is that you should get at least your money back if you use only one of the 36 ideas you will get in a year. Say for example a 10% return on a position of €3000 gives you your money back and a small profit. It’s not perfect but the best way I could come up with.

I limited the offer to 7 days as it would not be fair to my existing subscribers that paid full price to have a permanent discount offer available elsewhere on the web.

I very seldom give discounts so this is really special.


@Jago – As mentioned my long term track record is available on my website and that of my newsletter here: http://profitmapper.com/investors/Profile/43

You are right that using a strict stop loss in the current rollercoaster market is not prudent. I of course also relook the fundamentals on a position that has declined, also in the case of a profit warning. I may decide to hold on but it’s important to have a method in place to relook investments and make a conscious hold or sell decision.

Just letting a losing position slide is not prudent.

Also if you look the 2 investment mistakes I mentioned a stop loss would have been very helpful. And that is really what put me onto doing a lot of stop loss research.

And if I look at all the momentum research I mentioned and the excellent returns it generates there is definitely a place for a stop loss. Not a fixed % but one tied to movement of the index.

I am testing this in a separate portfolio at the moment but unfortunately it will still take some time to say if it’s successful.

10.11.2011 klo 13.11.00

Jago kirjoittaa:

I am just baffled why would anyone use Stop/Loss to lock in their losses and make them permanent with little to no change in underlying company business, simply due to volatility of the stock price. Price volatility is not "risk".

10.11.2011 klo 13.11.00

Tim kirjoittaa:

@Jago – Maybe I did not not explain it well.

Here is a good article you can look at:
http://www.ritholtz.com/blog/2010/05/using-stops-in-volatile-markets/

10.11.2011 klo 14.13.00

Jago kirjoittaa:

Thanks for the link. I hope I didn't come out as hostile, cause that certainly wasn't my intention.

10.11.2011 klo 16.02.00

Tim kirjoittaa:

@Jago – Not at all, stop losses are controversial and a discussion and exchange of ideas is always helpful.

I was also not a fan of stop losses at first but they have their uses.

10.11.2011 klo 17.21.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Are Investors Reluctant to Realize Their Losses? is a great research. I look at it from the stop-loss perspective.

Odean analyzed trading records of ten thousand accounts of a broker company. What he found out was that investors hold to losing investments too long and sold winning stocks too soon.

I think using stop-loss would've improved these people's returns significantly. But this is behavioral finance at it's best so most people will keep going like this.

10.11.2011 klo 18.55.00

Nimetön kirjoittaa:

Thanks for the interview.

10.11.2011 klo 18.58.00

Nimetön kirjoittaa:

Tim,

Could you elaborate on the difference between the Systematic Value Investing Newsletter (MFIE newsletter) and the Eurosharelab Value Investment Newsletter?

Based on the available samples, it seems that the Eurosharelab newsletter is the one you eat your own dogfood with, whereas the MFIE newsletter is a collection of recommendations in which you don't necessarily invest yourself, but a demonstration how MFIE can be used?

Is there also some kind of investment strategy difference between these two newsletters?

It beats me why one would first subscribe to MFIE (confident that their screeners provide added value) and then subscribe also to the newsletter (not confident that one can use those screeners).

The point of following the recommendations of a newsletter would be avoiding the painstaking research (which is perhaps not so painstaking with a screener) except due diligence, of course.

11.11.2011 klo 10.24.00

Aargh kirjoittaa:

Thanks for a very interesting interview.

A thought, value investing is based on finding underpriced companies but sometimes the screeners just pick companies that are cheap because they are high risk investments.

Hindsight is 20/20, but wasn't Tim's worst investment actually a stock that wasn't cheap. The market had it right, the company was a very risky investment because it was totally dependent on a single client. High risk/high return is exactly what an efficient market should provide. Of course, if Mark's & Spencers hadn't cancelled, it would have looked like a brilliant "value" investment.

Our host has recently invested in Automodular stock, and the story there looks similar. Cheaply priced stock and total reliance on one customer. This investment too will look either brilliant or foolish depending on what this customer does.

I'm wondering, is this a feature or a bug of the value approach? Does the market systematically overprice this kind of risk/how would returns change if you eliminated companies with this kind of very high single factor risk profiles from your portfolio?

12.11.2011 klo 13.54.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Value investing isn't riskier. Actually it is less riskier. There are several studies about the subject. I recommend reading James Montier's Value Investing: Tools and Techniques for Intelligent Investment book. It explains value investing the best way I've seen.

Market systematically overprices so called glamour stocks and undervalues "dull" uninteresting companies (=value stocks).

Like in every investing strategy you need to diversify your investments. Not every value stock is a good investment. Those are called value traps.

But like I said I recomment reading Montier's book. He explains all these subjects way better than I do. After reading you'll understand value investing's risk a lot better.

12.11.2011 klo 14.48.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Our host has recently invested in Automodular stock, and the story there looks similar. Cheaply priced stock and total reliance on one customer. This investment too will look either brilliant or foolish depending on what this customer does.

I'd argue this statement. In Tim's example the stock was going down. Automodular's stock has a high momentum intact. The company is dependent of one client at the moment. The company understands this is risky and therefore are looking for ways to diversify their business. They don't want to be dependent of just one client.

From Automodular's Q3 MD&A SEDAR file gives us more confident that it will also happen:
"Automodular has entered into a non‐binding letter of intent with a manufacturer to sub‐assemble equipment for use in the energy sector. The parties are working towards a definitive agreement which is anticipated to be signed in the fourth quarter. The contract is expected to have a one-year term and Automodular intends to secure a facility in southern Ontario and engage approximately 40 personnel to carry out the work."

12.11.2011 klo 14.54.00

Aargh kirjoittaa:

I wasn't actually arguing that value investing is risky in general. I was asking whether one method of finding value stocks (screeners) that use data like p/e, p/b combined with earnings growth and an improving balance sheets also tend to find companies that might not be great risk adjusted value. The risk might not be easily identifiable from numbers alone (i.e. dependent on one customer, it's easy to think of other risk factors that might also be invisible in the reported numbers)

I'm guessing Tim's company didn't want to be dependent on one customer either, but that's how it turned out to be. Of course Automodular wants to expand it's client base, what company doesn't? If it secures other deals the company will be a less risky investment and probably the stock price will rise to reflect that.

But Automodular was just an example. I have not studied the company, and I have no idea whether it is a good risk adjusted value. It seems obvious to me from what I've read here that it is a risky investment. High risk/high return, just as you would expect, but obviously riskier than most companies in the omx25 for example.

I was wondering how it would affect the returns if you would try to screen for that kind of risk. Whether the average return of a portfolio would go down if you left them out. So the question I was pondering was whether the market, on average, systematically misprices these types of risk and whether the excess return of value invetsing are partly explained by it.

12.11.2011 klo 17.24.00

Kohti taloudellista riippumattomuutta kirjoittaa:

I was asking whether one method of finding value stocks (screeners) that use data like p/e, p/b combined with earnings growth and an improving balance sheets also tend to find companies that might not be great risk adjusted value.

This is not the case. I refer to the backtesting results made by guys at MFIE. You can read them here. It clearly shows that a well diversified portfolio formed out of stocks that appear on the screener have better performance but still carry less risk than the market. Weather you measure it with standard deviation, beta or sharpe.


I was wondering how it would affect the returns if you would try to screen for that kind of risk. Whether the average return of a portfolio would go down if you left them out.

You are after companies that rely on just one customer here? And want to test if excluding them out of a stock screener would improve results? Unfortunately I don't know any studies made out of this hypotesis so I don't know an answer.

But in general market overvalues growth and undervalues value. There are many things that explain this phenomenon. I find the behavioral finance explains it the best. We love great stories and growth stocks create them. People have fallen in love with stories as long as stock market have existed (south sea, dot com, tulip mania etc). Value stocks are dull and hence people are reluctant to invest in them. You need to be a contrarian to invest in value stocks. Market seems to misprice both. Glamour stocks too high and value too low. But in the long term they tend to find their true value as market has efficiency (at least some, thank god!) after all.

12.11.2011 klo 17.51.00

Aargh kirjoittaa:

Thanks for your answers. I'm lazily picking your brain instead of doing my own research :)

Dependent on a single customer is just an example of the kind of risk that might not be easily discernable from the numbers alone, I guess this is one of the ways a news letter might provide added value. Perhaps I'll give Tim's letter a try.

Did your backtesting or that of others reveal whether value investing works best in a high valuation market or low valuation market? Just intuitively it would seem that in a situation like we had late this summer in Finnland where plenty of large cap stocks trade at low valuations despite having a positive earnings and growth outlook you might get less of a benefit from searching for ignored unsexy stocks.

To put it more simply, is it easier to beat the market when the market is overvalued in terms of historic averages of p/e, p/b and the like?

13.11.2011 klo 10.36.00

Kohti taloudellista riippumattomuutta kirjoittaa:

According to the studies value investing works in both environment (up and down). In downturn they don't generally fall as much as the market and in upswing they tend to rise more than the market. But you need to realize that there are different variations in value investing. Different ways of value investing work in a different way.

Large cap stocks aren't as good value stocks as small or micro caps. This is because a lot of analysts follow them and hence they are researched well. There is a premium in large cap value stocks but it isn't that big. You will find better investments from small cap value stocks that aren't followed as much. Luckily small cap stocks are about 90% of companies in the market so there's plenty to choose from.

In general it is easier to beat the market when you buy companies that have a low P/E, P/B, P/S, P/CF or a like. These numbers tend to be broadly low in downturn. It's harder to find cheap stocks in the upswing.

13.11.2011 klo 11.01.00

Nimetön kirjoittaa:

It would be interesting to know how do you decide when to sell while the stock or whole market in general is going up. Is it like 30, 50 or 100% gain or based on P/E or P/B ?

How do you define the "right" P/B when it`s different for every business sector, country, fundamentals changing and so on.

I bought a bit of Austevoll seafood after reading Tim`s thoughts about it. For example, at what price would you sell it?

Ive made my living from internet gambling the past 4 years with good results, been more on the stock markets for 1½ years now and I gotta say it seems to be much much more difficult compared to gambling. Gotta give respect if someone is beating the market year after year!

13.11.2011 klo 22.10.00

Nimetön kirjoittaa:

The author of the blog has a lot of knowledge in this field and therefore it is interesting to read his postings. However I want to comment a bit of his comment above:

>"This is not the case. I refer to the
>backtesting results made by guys at MFIE. You >can read them here. It clearly shows that a >well diversified portfolio formed out of >stocks that appear on the screener have better >performance but still carry less risk than the >market. Weather you measure it with standard >deviation, beta or sharpe"

First, back testing has its well known weaknesses. From mathematical point of view you can create a model that explains any recorded development history. Using the right kind of parameters you can model practically any development in history. However this kind of model is not necessarily able to tell us anything about the future. This is important difference between explanatory and predictive models.

Second there is a lot of discussion what is a right metric for risk is stock markets. Beta is quite often used to measure it but does it really do it? Quite many academics and practitioners are asking this question have their doubts.

I do not disagree with the author that there is a possibility to beat the markets. However I am more sharing the view of Malkiel that it is extremely unlikely.

14.11.2011 klo 11.38.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Please note that data mining wasn't used in the back testing. I recommend that you actually read the tests.

Although back testing is a purely academic exercise you can try to simulate reality by taking in account some basic rules with regard to the following issues;
1. Survival Bias:
Most studies don’t include companies that went bankrupt or that were taken over by others. In our test, these companies were not excluded.

2. Look ahead Bias:
When you are using data for your stock ranking that was not available at the moment of portfolio formation, your results will suffer from look-ahead bias. This bias results upwards.
We worked with accounting data from the previous fiscal year and waited 6 months to form our portfolios and actual trading.
Example:
Back-testing for 1999, we took the accounting data from the end of 1998 and formed the different portfo-lios on 13/06/1999. This ensured that all accounting data was available upon portfolio formation.
We formed our portfolios and waited 6 months before actually buying them. Then we held them until 13/06/2000 before again rebalancing the complete portfolio.
We back-tested for the period : 13/06/1999 and 13/06/2010

3. Bid-Asked bounce:
It is practically impossible to buy large positions in micro cap stocks (over 25 million). If you do so, it will influ-ence the price very negatively. The price will skyrocket. In our first paper we put a restriction of minimum 25 million on the market cap.
For this paper, we looked at this problem from a different angle.
On portfolio formation, we worked with the idea that you need a minimum liquidity for buying and selling the different stocks in the open market. The different positions need to be cleared within 5 working days.
Even by multiplying the minimum liquidity requirement by a factor 2, there was no significant decline in overall return.

4. Data mining:
You can run your computer a thousand times and pick the best results to publish. We on the other hand used the same methodology over and over again through our study with the same constituents.

5. A Reliable Database :
Before we started this project, we examined different data providers. There are very good sources available in today’s market but very few had the necessary data coverage with respect to Europeans stocks as Thomson Reuters has.
So, we selected the Thomson DataStream application and it has worked great for us.

6. Small sample Bias :
You can have a strategy that does very well over a 5-year period or longer and that may then go horribly wrong. We therefore tested the different strategies over an 11-year period. This should give the necessary time span we need to test the solidity and endurance of these strategies in detail.
All things considered, the last decade has been quite turbulent for the stock markets all over the globe. We had one bull market and two major crashes (a “luxury” for back-testers).

14.11.2011 klo 12.25.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Regarding beta from the very same paper:
The CAPM formula was developed in 1970 by William Sharpe and John Lintner and is based on the modern portfolio theory (MPT) by Markowitz.
The CAPM redefines risk in terms of a security’s beta, which captures the non-diversifiable portion of that stock’s (portfolio) risk relative to the market as a whole.
This eventually leads to a very convenient interpretation: a stock with a beta of 1,20 has a level of syste-matic risk that is 20% greater than the average for the entire market, while a stock with a beta of 0,70 is 30% less risky than the market. By definition the market always has a beta of 1.
But there is something that bothers us, if we examine the back tests in each “value” portfolio we do beat the market consistently.
In contradiction to the theory of efficient markets, this can only be explained through a higher risk or beta of the portfolio ?
In fact, each and every “value” portfolio has a beta between min.0,2707 and max. 0,5899 ?
Like Newton’s law, or even Archimedes’s law, you should be able to compute the outcome to a certain de-gree of accuracy.
With the CAPM, this is not the case, and we wonder what is wrong with it. Is it the formula, or the concept of an efficient market?
We suspect the latter.


I agree with MFIE guys.

14.11.2011 klo 12.26.00

Kohti taloudellista riippumattomuutta kirjoittaa:

It would be interesting to know how do you decide when to sell while the stock or whole market in general is going up. Is it like 30, 50 or 100% gain or based on P/E or P/B ?

I answer from general value investing point of view. Position is sold when intrinsic value is reached.

14.11.2011 klo 12.28.00

Nimetön kirjoittaa:

Still about the limitations of the back testing. Like your reference said it: " .. back testing is a purely academic exercise you can TRY to simulate reality ..." How succesful this try is? I have my doubts.

Now the second thing. You pointed out that it is not about data mining but first the model is created and then it is tested against the historical data. This leads us to
the following question: Does it make any difference in which order these two events (model creation and testing) takes place?

The model tested with historical data can only work in the future if and only if the data in the future shares the charasteristics of the historical data. If it does then the data mining is a perfect way to create a model. If it does not then testing does not have any value.

So some kind of relationship between historical data and future is needed or otherwise the test results do not tell anything about future. If we develop this idea still further we can see at the end of the line the idea of technical analysis in which historical price developments are telling something about the developments in the future.
Because I do not believe in TA I do not either believe much about back testing. (OK I admit that it can reveal some totally stupid strategies but not much more).

I really hope that you do understand that I really appreciate you blog. However, I am one of the random walkers and so far I have not seen enough evidence to change my mind. If there were some superior method to beat the market, then too many people would apply it that it would lose its effect.

14.11.2011 klo 16.34.00

Kohti taloudellista riippumattomuutta kirjoittaa:

I still doubt that you've actually understood what have been backtested and what it's implications are.

The backtested strategies include f.ex. Joseph Piotroski's strategy, Joel Greenblatt's Magic Formula etc. These are not just some strategies that have been formed by data mining or such. What you are saying is that a professor Joseph Piotroski's research is invalid just because it was this time tested in Europe instead of USA? I just don't understand you, sorry.

Value investing isn't technical analysis. Not even close of it. I just can't find the red thread here eather.


However, I am one of the random walkers and so far I have not seen enough evidence to change my mind. If there were some superior method to beat the market, then too many people would apply it that it would lose its effect.

This hypotesis works only if all investors work the same way as EMH suggest. Unfortunatly this isn't true. The best I can make is to ask you to read Montier's book that I've already recommended in this thread. Montier explains these things way better than I do.

What you are saying (in my ears) is that value investing can't work because otherwise everybody would be doing it. Behavioral finance explains well why many people avoid value investing although it's proven to work well (but not in ALL times!). It's against human nature to go against the crowd and buy the ugliest stocks in the market. Not everyone is capable of doing it.

Please, please read Montier's book.

14.11.2011 klo 17.24.00

Nimetön kirjoittaa:

Dear friend,

I am affraid that this conversation will not lead anywhere because both of us believe a bit too much on our own ideas (quite typical for us Finnish men :) However, I want to correct some misunderstandings in your last comment.

First, I am absolutely NOT saying that a professor Joseph Piotroski's research is invalid. That would be far too bold. I am just saying that back testing cannot be used for proving that his theory works also in the future. I expect that as an educated guy you understand the difference.

I did not either say that value investing has anything to do with technical analysis. Of course not. It would be like saying black is white. However if we use historical data to prove that something works also in the future it means that there must be some kind of connection between historical price developments and price changes in the future. (I believe that stock prices have similar kind of memory as a coin - it does not have it.)

This connection between yesterday's and tommorow's prices is the foundation of TA. So, I do NOT make any kind of link between TA and value investing. But I do point out a connection between TA and using back testing for proving the future success of any kind of theory (no matter if its based on fundamentals or something else).

The last thing is that I do not mean that value investing can't work because otherwise everybody would be doing it. I would rather say that it is extremely difficult to find any kind of investment strategy that beats the markets (after the expenses) based on the strengths of the strategy. (Yes randomness takes care that there will always be strategies that beats the markets but we cannot prove today which one does so in the future). If there were such a strategy not all but large enough group of people would start to follow it so that it would lose it strength.

This statement is also supported by behavioral finance you mentioned. If there we an investment fund that year after year after year beats the markets more money will go to that fund. Both behavioral theory and statistics suggest that those funds that make biggest profits also get more new money in them.

Yep, I have not read James Montier's book but checked some articles about behavioral investing. Maybe I should go deeper to their material. Similarily I would recomend you to go back to your copy of Malkiel's walking guide.

All the best to you and I hope that you have found the market beating strategy!

14.11.2011 klo 19.26.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Thanks for your good reply! I needed to put this in two parts because of it's length (Google blogger doesn't allow over 4096 characters long comments).

As you know I've been a very eager index investor before turning into value investing. I would probably use index investing still if I haven't ever irritated my own thoughts and expectations by reading about subjects that contradicts my own. I recommend that for other people too. You hardly learn anything new if you don't want to look in other directions.

Don't get me wrong. Index investing is the best choice for most of people out there. If that's your choice then good for you! In the long term you'll beat most of the investors because of low expenses.

Now we are talking about value investing - a strategy that have beaten market in the long term. Will it do in the future as well? I can't guarantee but as the history seems to repeat itself it's very likely.

However if we use historical data to prove that something works also in the future it means that there must be some kind of connection between historical price developments and price changes in the future.

Yes there seems to be a connection. In history there have been upswings and downturns. If history repeats itself there will be upswings (nousukausi) and downturns (laskukausi) also in the future. By value investing terms more stock are cheap in the downturn than in upswing. In the light of human history buying stocks in the downturn have always been a good investment.


But I do point out a connection between TA and using back testing for proving the future success of any kind of theory (no matter if its based on fundamentals or something else).

This would of course mean that using value metrics would go "broken". This is of course possible but so far in the history it has worked most of the time. At least I feel more comfortable knowing the fact that some strategy have worked well in the past (in the long term) than a strategy that haven't. You can of course argue if it holds in the future but I think it's more likely.


I would rather say that it is extremely difficult to find any kind of investment strategy that beats the markets (after the expenses) based on the strengths of the strategy.

I agree. I have studied tons of different strategies and most of them fail when you count in all the expenses (bid-ask spread, transaction fees, taxes etc). But I have found that there exists several strategies that seem to beat the market after several years. Even when they are well known.

14.11.2011 klo 21.02.00

Kohti taloudellista riippumattomuutta kirjoittaa:

If there were such a strategy not all but large enough group of people would start to follow it so that it would lose it strength.

True. There also exists reasons why such a anomaly exists. I'll tell an example using a career risk. Before dot com bubble value investing beat the market by wide margin. Many new value investing funds were established because of this. Then came the "new era" of growth stocks. That just kept going higher and higher. These value investing funds that kept their style intact lagged market return significantly. In finance industry your performance is measured usually by every quarter. After many bad quarters these value investing fund managers got fired because of their poor performance and funds were terminated. Financial houses couldn't afford keep lagging performance this long and by this wide margin. Of course everyone knows what happened after dot com bubble burst. Value investing started working again with a wide wide margin compared to the market.

So you need to understand that there are several kind of investors that affect different anomalies. They have their constraints. In this example career risk showed why (at least partly) value investing started working again. Of course the main reason behind was that stocks' fundamentals were appreciated again.


If there we an investment fund that year after year after year beats the markets more money will go to that fund. Both behavioral theory and statistics suggest that those funds that make biggest profits also get more new money in them.

Yes but there aren't such funds. Or strategies. They all have their weak points. Some strategies might work with wider margin a smaller amount of time and fail miserably most of the time. Even though this might be a good strategy in the long term would you go for it? Probably not.

My point is that even if in the long term some strategy works well the short term pain may be so big that people aren't capable of handling it. Our time on the planet is limited after all.

I hope you all the best with your investing strategy as well!

14.11.2011 klo 21.02.00

Nimetön kirjoittaa:

Appreciate your comments. It is refressing to have this kind of discussion in which both parties respects each other and also other side's opinions even though they do not agree with all details.

Hyviä sijoituskelejä!

14.11.2011 klo 22.13.00

Cat kirjoittaa:

Thank you, Tim and Pasi, for insightful and detailed interview!

I especially liked this: "Learn from each of them but build your own investment strategy taking the best from what you've learned."

15.11.2011 klo 9.42.00

Jago kirjoittaa:

@Kohti taloudellista riippumattomuutta

I've actually progressed in a very similar fashion. I started out as a devout indexer, but eventually I came to the conclusion that (even realizing the high probability of underperforming an appropriate benchmark) value investing and picking stocks suits my personality somewhat better. It also makes for a very fun hobby :)

15.11.2011 klo 15.42.00

Kohti taloudellista riippumattomuutta kirjoittaa:

@Jago: It's intriguing path. Who knows where it will lead in the end :)

15.11.2011 klo 19.20.00

Tim kirjoittaa:

@ Anonyymi
This comment may be a bit late but it’s the answer to the question:

What is the difference between the Systematic Value Investing Newsletter (MFIE newsletter) and the Eurosharelab Value Investment Newsletter (Eurosharelab.com)?

You are right. In the Eurosharelab newsletter I eat my own cooking, hopefully more steak than dog food.

For the MFIE newsletter I only use the screeners and do a bit of analysis to make sure the company is not wrongly included in the screener. The newsletter is right for you if you do not want to do all the analysis from companies you get from the screeners.

It thus has a mechanical investment approach.


For the Eurosharelab newsletter ideas can come from everywhere. Screeners, reading, other outstanding investors I follow or discussions I have with fund manager friends.

I do a full analysis of the company as you can see in the example above.

The Eurosharelab newsletter thus is a European value investment newsletter with deep fundamental research.

The companies in the Eurosharelab newsletter is usually larger than the ones mentioned in the MFIE letter as I have quite a few fund and hedge funds as subscribers.

They are both about value investment but with different approaches.

I hope this answers your question. In not just ask.

18.11.2011 klo 17.57.00

Nimetön kirjoittaa:

Thank you Pasi for your fascinating blog. If I had to name 2 people who have had the biggest influence in my goals in life - I would say an investment advisor I met at age of 18, an economics major with passion for finance, and you. And special thanks for also introducing us to Tim! I find Tim's work extremely inspiring. Now studying economics and finance myself (while scraping up some capital) I wake up happy every day knowing I'm on path I truly love. :) Keep up the good work you both.

19.11.2011 klo 12.00.00

Kohti taloudellista riippumattomuutta kirjoittaa:

Thank you very much! I really appreciate your kind words :)

It sounds that you are studying a subject that you really care about and are inspired of. I wish all students could have the same passion. It will take you far. All the best people in their field of expertise are passionate. I can sense the same in you.

19.11.2011 klo 12.24.00

Nimetön kirjoittaa:

Heh, remains to be seen - but let's hope so. In other news..

I'm looking for a book or two to read during xmas holidays - and open for suggestions from anyone! At the moment I have my eyes on The Little Book of Value Investing by Christopher H. Browne from Tim's list. But if there's something better existing, let me know.

Should have something to do with value investing and/or stock picking in general. Usefull but not too theoretical. Something light for holidays. :)

Second topic I'm quite curious about is behavioural finance. If there's a good, yet relatively light and well written book existing, tell me.

Hint: A great deal of books can be partially read in Google Books. I find it nice to have a look at the content before purchasing. Can be quite a moneysaver!

28.11.2011 klo 17.03.00

Kohti taloudellista riippumattomuutta kirjoittaa:

For easy x-mas reading that don't go too deep in theories I would suggest "The Little Book" series:
The Little Book of Value Investing
The Little Book of Sideway Markets
The Little Book of Behavioral Investing

All "Little Books" can be read in a day or two.

If you want to read a "thriller" then I'd recommend Rogue Trader by Nick Leeson or Erottaja by Karo Hämäläinen (this book is in finnish only).

Pabrai's The Dhandho Investor - The Low-Risk Value Method to High Returns was also easy to read and didn't contain too much theories or math.

There you. That's my "easy reading" list :)

Merry X-Mas!

28.11.2011 klo 17.14.00

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