World
Global Strategy
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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20 May 2009
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.
Q 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.
Q 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).
Q 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.
Q 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).
Q 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.
Q 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

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

2 20 May 2009
 Mind Matters

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

2.3

2.1

1.9
1.7

1.5

1.3

1.1
0.9

0.7

0.5
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.

20 May 2009 3
 Mind Matters

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

4 20 May 2009
 Mind Matters

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

20 May 2009 5
 Mind Matters

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6 20 May 2009