Templeton, Graham, Buffett, Greenblatt, et al
Learn from the Greatest Investors
Low PEG Ratio Stock
When I think of icons in the investment world who achieved fame and made meaningful contributions to the art and science of investing, many names come to mind, including:
Sir John Templeton, Benjamin Graham, Warren Buffett, Peter Lynch, Joel Greenblatt, Jesse Livermore, Walter Schloss, Shelby Davis, John Neff and many more. All of these superstars piled up extraordinary track records during various periods during the past 100 years. Did you know that Joel Greenblatt, noted hedge fund manager, turned $1,000 into $840,000 from 1985 to 2005? During the same time period, a similar investment in the Standard & Poor’s 500 Index would have expanded to just $12,000.
Leading investors have several common traits: (1) they have methodologies that make sense, (2) they are disciplined in their investment processes, (3) they work hard and stay focused, (4) they are patient and (5) they successfully handle their psychological biases.
The leading investors use similar methodologies, but their methods are quite different from the way average investors go about investing. The best investors manage their time effectively and focus their efforts on stocks that are undervalued. They don’t waste their time on stocks that are unlikely to be bargains. They avoid market favorites (which are often overvalued) and concentrate on stocks that most people dislike (which are commonly undervalued).
To quote Sir John Templeton: “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: Where is the outlook most miserable? The obvious application of this concept in practice is to avoid following the crowd.”
Intelligent investors perform due diligence (the comprehensive appraisal of a business) by examining the financial statements (quantitative analysis); evaluating the company, its industry and management (qualitative analysis) and by attempting to determine the fair value of the company (value analysis). All your due diligence process is a waste of time, though, if you cannot overcome your psychological biases. For example, investors usually have preconceptions about a company before performing due diligence on it. The outcome of your analysis can be influenced by your preconceptions.
To quote Benjamin Graham, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
The greatest investors avoid companies that look flashy or enjoy a lot of popularity. So where do these successful investors look for potential bargains? After examining the types of stocks that the great investors tend to like, I noticed that they appear to find bargains in the same places. These places are not the ones where the average investor is looking!
Investment legends like Sir John Templeton, Benjamin Graham and Warren Buffet realized many decades before behavioral finance became a respected academic discipline that systematic psychological errors tend to create market inefficiencies. Templeton, Graham and Buffett reasoned that herding behavior (including momentum traders and short-term speculators who chase price trends) and overreaction bias (the tendency of people to overreact to bad news) are strong forces in the market that can push stocks far below their fair value.
Based on these observations, many of the world’s greatest investors look for stocks that are beaten down by the market due to bad news or negative rumors. Benjamin Graham, the father of value investing, constantly searched for companies that once fetched sky-high valuations but crashed when the companies were unable to deliver on investors’ unrealistically high expectations.
To quote Warren Buffett, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Other top investors, including Joel Greenblatt, focus on so-called special situation stocks. These are stocks that are distributed to shareholders after a merger or spin-off. One reason special situation stocks offer excellent investment potential is that investors who receive the new shares often get rid of them. The new shares are usually too small to justify a lot of research time. Others jettison their shares because they never had the intention to own these stocks in the first place. Professional investors may be forced to sell because the new stock violates their investment charters. Indiscriminate selling irrespective of price by disinterested investors can push the stock price far below its fair value—creating a bargain.
In addition to stocks suffering from negative sentiment and special-situation stocks, many leading investors favor companies with low institutional ownership or companies covered by few analysts. For example, Peter Lynch, one of the best investment managers ever, was delighted when he found a company that was not covered by a single analyst. The fact that few investors are looking at these companies often means that the stock prices are far below fair value.
Investors often don’t follow small companies, dull and unfashionable businesses, complex businesses and companies with difficult to find information. An example of an industry that many people ignore which is often targeted by top investors is the burial industry—one of Peter Lynch’s all-time favorite stock picks was burial service company Service Corporation International (SCI), which went up 10-fold between 1980 and 1990.
To quote Joel Greenblatt, “Companies that are too small for professionals to buy and that are not large enough to generate sufficient commission revenue to justify analyst coverage are more likely to be ignored or misunderstood. As a result, they are more likely to present opportunities to find bargain-priced stocks.”
A signal that may lead to interesting stock ideas is new ownership by an activist investor. Activist investors complete thorough due diligence because they buy a large number of shares in a company to influence management to make favorable changes. Activist investors often create value through the changes they recommend. Companies targeted by activist investors with respectable track records—such as Carl Icahn, Bill Ackman and Daniel Loeb—can be excellent starting points for further scrutiny.
Although following the advice of brokers, tipsters, family and friends is seldom the road to riches, certain types of clues gleaned from this advice can be very rewarding. Insider buying is a great example. The substantial and coincident buying of shares by well-informed insiders (especially the CEO and CFO) can be a strong signal that something good is about to happen at the company. According to one of the U.K.’s greatest investors, Anthony Bolton, insider buying is even more significant after a sharp rise in the company’s share price, as this signals even more upside is possible.
Additional information is available in the book, “Excess Returns: A Comparative Study of the Methods of the World’s Greatest Investors” (Harriman House, 2014) by Frederik Vanhaverbeke of Belgium. Mr. Vanhaverbeke’s book and his article in the November 2014 issue of the American Association of Individual Investors Journal was my source for this Cabot Wealth Advisory.
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One of the stocks that I’ve recently discovered using a system currently used by Warren Buffett combined with my low PEG Ratio methodology is Synaptics.
Synaptics (SYNA: Current Price 78.91) develops and sells custom-designed human interface solutions for consumer electronics companies, such as Acer, Apple, Asus, Dell, Gateway, HP, HTC, Lenovo, LG, Logitech, Nokia, Samsung, Sony and Toshiba. Products include touchpads and touchscreens for notebook PCs, computer monitors, mobile phones, digital music players and remote controls. The company was founded in 1986 and is headquartered in San Jose, California.
In November 2013, Synaptics acquired Validity Sensors, a fingerprint sensor provider also based in San Jose. In June 2014, Synaptics purchased Renesas SP Drivers, a Japanese company specializing in the manufacture of microchips that control LCDs (liquid crystal displays). Both purchases will broaden Synaptics’ product lineup, and both companies are producing better than expected results.
Synaptics’ touchscreen and fingerprint technologies hold great promise. The company’s industry-leading touchscreen technology provides thinner, clearer displays. The technology helps Synaptics’ customers reduce time, cost and space during the manufacturing process.
Synaptics’ fingerprint technology is in the beginning stages of adoption, but already Apple and Samsung are including the technology in their leading iPhone and Galaxy models. Fingerprint technology is used to unlock smartphones and other electronic devices, and also allows device owners to make retail purchases using iPhone Apple Pay and Galaxy S5 PayPal.
Sales will likely rise 27% and EPS will advance 17% during the 12 months ending 12/31/15 compared to prior 12-month increases of 10% and 19% respectively. Sales and earnings could rise more rapidly if Synaptics’ touchscreen and fingerprint technologies are adopted faster than forecast. The recent proposal to lower tariffs on a multitude of technology products exported to China could provide an additional boost to Synaptics’ 2015 sales and earnings.
SYNA shares are very reasonably priced at 16.5 times current EPS. The PEG ratio is low at 0.97. The company does not pay a dividend, but its balance sheet is very strong with plenty of cash to fund management’s ambitious plans. Buy at the current price. Sell when Synaptics’ stock price reaches my Minimum Sell Price. Minimum Sell prices are provided for every stock I follow in every issue of Cabot Benjamin Graham Value Investor.
Until next time, be kind and friendly to everyone you meet.
J. Royden Ward
Chief Analyst, Cabot Benjamin Graham Value Investor
Editor’s Note: You can find additional stocks selling at bargain prices in Cabot Benjamin Graham Value Investor. You can also find details of the Warren Buffett and PEG ratio methodologies to discover undervalued companies with exceptional potential. Find out why our subscribers are showering us with compliments.
In every issue, you’ll find Roy’s legendary Maximum Buy and Minimum Sell Prices for over 275 stocks. Just buy below the Max Buy Price and sell at the Min Sell Price—it’s that easy.