From Cole Smead At Smead Capital Management, June 7:
Dear fellow investors,
Academics argue that there are three proven factors of investing: Value, quality (Asness’s QMJ) and momentum. For our discipline, we don’t believe we can add alpha in the latter. Momentum is a weird thing, though proven. To emit a yogi-ism, you either have it or you don’t. Value and quality, in comparison, are easier to price in the security analysis of our investment discipline. While investors have looked at the last decade of failure in value, we would conjecture a new question. Just as no one thought that the brightest academic minds could have produced the failure and banking crisis of Long-Term Capital Management, what if another factor fails terribly for an elongated time? To put it simply, what will happen When Quality Fails?
We bring this question up because in so many ways this is the real problem of stock investing in 2022 and the S&P 500’s pain point over the next decade. We have heard things like price-to-earnings (P/E) ratios don’t account for the balance sheet. The balance sheet is a way to test the quality of a company in security analysis. P/E ratios are just one measure of the many yardsticks of value relative to the income statement. However, these factors can run contrary to each other and even be at odds with each other.
Quality has so captivated the minds of investors because it gives them comfort that the mania we just ended was not 1999. Back then there were no earnings, no return on capital and very little cash stacked up on balance sheets. The mania we have today is good balance sheets and good returns on capital with no problems in sight. The only issue is that there are companies before that have found themselves in this same situation as today. It was the Nifty Fifty in 1972. This was the crème de la crème of blue-chip growth businesses in America. Jeremy Siegel argued in his book, Stocks for the Long Run, that investors could have paid the highest prices ever for these securities and still almost beat the market 25 years later because ultimately the quality of the businesses was so good. They produced higher earnings growth and higher returns on capital than the rest of the S&P 500…but still lost.
To come back to reality, 25 years is a long time in human life. Most humans forget anything past three years ago. This is why dogs chase cars and people chase stocks. We will revisit one of the true darlings of the Nifty Fifty, Coca-Cola (KO), to understand as investors what happens in more understandable time frames (seven years) When Quality Fails....
....MUCH MORE
We've visited Cole's father (and the company's founder) Bill Smead, for years, most recently via NZZ's The Market.ch in January "The Lack Of Prospects For ESG (at the moment)" wherein he pitched energy stocks on a relative (to oil) valuation basis and before that we had père et fils in "Famed Climatologist Charlie Munger" (DJCO; BRK).
Along the way we also had a story about Smead Capital with this introduction:
Seattle Real Estate Not a Good Bet
The news that the city is going to shut-down CHAZ CHOP is not going to be nearly enough to save Seattle.
Amazon and Microsoft have been the engine of growth, in a way similar to
Silicon Valley where the whole world is funneling money into a small
geographical area and in the case of Amazon with coronavirus we've just
seen the high-water mark for this cycle.
Like so many societies throughout history getting wealthy means getting
flabby, with politics and programs that a poorer, hungrier society can't
afford.
Looking at a third metro area, Minneapolis' heyday was roughly 1880 -
1980 with the northern tier railroads, Great Northern and Northern
Pacific and the heavyweight ag businesses, Pillsbury, General Mills etc.
giving way to first round tech, Medtronic and St. Jude Medical, Control
Data and Cray Research and then stagnation into a violent*
little backwater, coasting on accumulated capital and slowly becoming
irrelevant on the world stage except as a chokepoint for soybeans and
corn being sent down the Mississippi or up to Duluth and eventually the
Atlantic.
Seattle was touted as heaven-on-earth with the $15.00 minimum wage for
restaurant workers but the touts never mentioned that it was only
because of Amazon that it was possible.
And now those jobs are no more and 50% of them will not come back.
For a while Seattle had more construction cranes than New York and even London but those days are gone and here's the rest of the story from Phoenix's KTAR news:
Due to Seattle’s unrest, billion-dollar investment firm moving to Phoenix....
When quality fails.
