You Have to Buy Low Uncertainty and Fear
Mr. Market is a manic depressive fellow. The late Benjamin Graham, the father of value investing, recommended investors either take advantage of Mr. Market’s mood swings or ignore them.
Graham championed the idea that if Mr. Market showed up on your doorstep depressed and willing to sell you a business or investment at a very undervalued price, a good investor should take advantage of him. And when Mr. Market’s mood swings back to one of being wildly optimistic, Graham suggested that an investor should inversely take advantage of him by selling back to him.
This is simple, but not easy.
One of FMT Advisory’s favorite investment models for finding attractively priced assets is just that: simple, but not easy.
On top of being manic depressive, Mr. Market is often a very confused fellow. Mr. Market often confuses the difference between fear and uncertainty, which often-times creates enormous opportunities. Therefore, one of the places to hunt for bargains resides in this equation:
Fear + low uncertainty = huge opportunities.
An Example: the Great Oil Salad Scandal of 1963
In 1963, American Express was growing at a very nice pace with their primary lines of business, which was selling travelers checks and processing credit card transactions. These core business lines had great economics at AmEx. They had high returns on tangible capital employed, and were very profitable.
In other words, American Express was a very good business. Everyone – including trust funds – owned it. Thus, Mr. Market was very jovial and optimistic about AmEx’s prospects as it entered the year 1963.
However, AmEx had started a warehousing division that made loans secured by warehouse receipts during this time. Under this division, AmEx started making loans to a company called Allied Crude Vegetable Oil Refining Corporation, which was being run by a con man, Tino De Angelis.
AmEx thought that it had $150 million in secured loans, with the collateral being the soybean oil held in the large tankers at Allied Crude. It turned out that De Angelis was running a scam; most of the tankers were filled with water, with just a little soybean oil that floated at top of the tanks.
When the tanks were checked with dip-sticks, it appeared they were full of soybean oil. When the De Angelis scam eventually unraveled (as scams always do) and Mr. Manic Depressive Market became aware of it, the market became extremely fearful of AmEx. Everyone just panicked out of the stock, including “sophisticated” trust funds. And AmEx lost almost half of its value nearly overnight. In other words, Mr. Manic Depressive Market became extremely depressed, and was willing to sell the business at any price.
Typical of Mr. Manic Market, he was confused at the time, and thought the headlines surrounding AmEx warranted all the fear, which resulted in the extreme selling of AmEx shares at deeply depressed prices.
However, there was very little uncertainty about the long-term prospects of American Express.
A young hedge fund manager, whom was just 35 years old at the time, decided to do some tire kicking. The hedge fund manager went to a myriad of restaurants and watched the waiters and waitresses cash out the guests. The hedge fund manager monitored the situation for a short while.
After about a week, the hedge fund manager tallied up the results to see if the warehousing division’s disaster changed the way people used their AmEx cards. Almost all American Express card holders, as it turned out, were still paying their restaurant bills using their trusted card, completely unfazed by the oil scandal. The young manager realized there was no impairment to American Express’ primary lines of business, which were still highly profitable enterprises that were going to continue to grow well into the future.
Therefore, at the time, the 35-year-old hedge fund manager, known as Warren Buffett, decided to invest 40% of his, and his hedge fund partners’, entire net worth into American Express’ stock, realizing the fear that gripped the markets was fully discounted in American Express’ share price. In other words, the problems at the warehousing division and the fear that surrounded it gave the young Buffett a very certain investment in a very fearful market at a very good price. Needless to say, Buffett made a lot of money on American Express thanks to Mr. Manic Market.
The moral to the story is that Mr. Manic Markets are a wonderful thing. But you have learn to ignore Mr. Market a lot of the time, while using the optimistic and pessimistic markets only to your advantage.
In FMT Advisory’s vast arsenal for investment hunting, we cherish the model of looking for markets that are wildly confused between fear and low uncertainty.
Fear + low uncertainty = high rewards.
This is just one model among handfuls that help us navigate our fortunes accordingly.
This, of course, takes an extreme amount of time, know how, and discipline. We've got it, do you?
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CEO & Chief Portfolio Strategist