As with many ordeals in life, surviving a worldwide market tsunami is easier if you're still in your 20s. Sitting in a meeting room in the University of Toronto's Rotman School of Management, Edmun Tsang, Douglas Chung, Tisnai Thaitham and Bonnie Chan are all smiles - remarkably happy for a group of second-year MBA students who have lost $170,000 of a $1-million portfolio over eight months in a class stock-picking contest.
They weren't playing with Monopoly money, either. There's a real $1-million endowment at stake.
Yet even with that loss, the team, called Snowball, has come from behind just two days before the finish to win the contest by a slim $257 margin over second-place Yellowstone.
"I don't feel it should be that significant, but it made us feel good," says Mr. Tsang, 27, with a grin.
Too much fist pumping might be inappropriate, indeed, because the contest is part of a course in old-school, Ben-Graham-style value investing taught by Prof. Eric Kirzner, one of Canada's leading authorities. The value approach is all about buying into sound companies for the long term, not going for quick trading gains over hours, days or even months. As part of the course, the class of 25 also flew to Omaha last November for a morning meeting and lunch with Warren Buffett, Mr. Graham's most renowned disciple.
As things turned out, 2008-2009 was probably the best academic year ever to take the course. Almost any sound investing discipline can make money in a bull market. A bear market, especially a full-blown panic like the crash of 2008, reveals both the strengths and limitations of the value style in particular.
Prof. Kirzner was impressed by the way all of his students stayed focused during the short-term upheavals.
"In terms of quality of analysis, they were terrific," he said. Even though Yellowstone finished No. 2 in the contest, Prof. Kirzner awarded them his own $1,000 annual prize for the student or group he felt was particularly outstanding. "Winning that was the icing on the cake," says Yellowstone's Naomi The.
One big reason Snowball edged out Yellowstone in the money standings was that the team bought a large position in Goldman Sachs, then exercised classic value discipline and bought more during a market rout. Snowball bought Goldman for $115 (U.S.) a share in October - well below its pre-crash highs of $180 - then watched it plunge below $60 in December. After some jitters, they bought more at $69.
"Once you pick a stock, you have to stay with it if you believe in your method," said team member Tisnai Thaitham, 28. By the end of the contest, Goldman's share price had surged back to $120, and it amounted to 25 per cent of the value of Snowball's portfolio of 10 stocks.
Of course, Snowball lost money over all, as did the other five teams in the contest. But the Snowball and Yellowstone portfolios had declined by a relatively modest 17 per cent by April 15, the final day of the contest, compared with roughly a 27-per-cent drop for the Standard & Poor's 500 Index starting last Oct. 1.
The impact on the class's $1-million endowment was also limited. The money was provided four years ago by John Watson, co-founder of Toronto-based Sprucegrove Investment Management. Students don't manage that endowment directly, but at the end of the school year, a committee led by Mr. Watson and Prof. Kirzner adds and deletes stocks based solely on the students' picks and analyses. As of early June, there were seven stocks in the portfolio - in holdings ranging from $25,000 to $75,000 - with the rest in cash. The real portfolio is the basis of the equal holdings in eight companies that Prof. Kirzner allocates to the teams at the beginning of the following school year.
Managing close-to-real money wasn't quite the same as the real thing to some of the more experienced students in the class, however. Yellowstone's John Purcell, a big, gregarious 29-year-old from Massachusetts who worked the phones for Fidelity Investments as a retail broker between undergrad and grad school, said that professional money managers are under constant pressure from jumpy individual clients and often even-more-panic-prone institutions.
"Things would have been a lot different with someone barking in our ear all the time," he says. "In the real world, you need client service."
First, for all its talk of the "intrinsic value" of individual stocks, and the need for a "margin of safety" in any prudent investment, value investing provides no guarantee that you will avoid losses during a market downturn, or that you will lose less than market indexes.
Strict value investors are supposed to ignore prospects for the market as a whole, and concentrate on individual companies - their earnings history, dividends, debt coverage, likely future revenue and profit, and so on. If the intrinsic value of the stock, calculated on the basis of those fundamentals, is comfortably less than the market price, it's a buy signal. But the numbers aren't everything - there's always judgment involved.
Last October, when each team presented a company to the class that it would like to buy, stock markets had already plunged substantially. A lot of companies looked cheap according to such classic value criteria as the 10 tests devised by Ben Graham, co-author of the value investing bible, Security Analysis, first published in 1932, and author of The Intelligent Investor. The tests include such things as a relatively low price-earnings multiple and a high dividend yield.
"In some years, it's hard to find companies that meet three or four," Prof. Kirzner said. "This year, there's so many that meet seven or eight."
Yellowstone was keen on Aracruz Celulose, a Brazilian pulp and paper company that appeared to be lean and efficient. It was then trading at just over $20 a share on the New York Stock Exchange, down from more than $80 in early 2008. The group figured that there was about $80 of value in the stock.
Aracruz was also headed for a merger with Grupo Votorantim, a Brazilian conglomerate. But Graham's 10 tests didn't include probing into such modern-day hornets' nests as losses from trading in currency futures. Within weeks, Aracruz had to borrow $2-billion (U.S.) from banks to cover currency losses. The company also had two families with substantial shareholdings, who had apparently been eager to cash out before those troubles were reported. The merger was soon put on hold, and the shares plunged to less than $10 (U.S.). "We got screwed by the families down there," Mr. Purcell says.
To many of the students, the intuitive judgment and gut feelings that are part of classic value investing made them feel more confident than the complex mathematical and computerized techniques they studied in other courses.
"In Applied Portfolio Management, I had to get the right beta, make the efficient frontier and so on," said Group 3's Mr. Tehrani. "I think it's all bunk. It's like a course in logic. It doesn't appeal to me intuitively."
That sentiment was particularly strong among students who'd had operational and management experience in companies before they arrived at Rotman.
Yellowstone's Naomi The, 27, worked at Birks for four years, mostly in corporate finance. Mike Dragotsis, 29, was a financial analyst at Pizza Pizza for three years, where much of his work involved forecasting. Value Group 3's J.P. Rasminsky joined his family's Ontario-based mattress manufacturing business in 1999, after completing his undergrad, and was involved in the gut-wrenching decision to close it last year, because it was no longer competitive.
So many broad factors now come into play in running a company that those students in particular believe that traditional value investing is now more relevant than ever.
Yet even Prof. Kirzner stops well short of saying that value investing is a panacea. "Fundamentally, it's a method of picking stocks," he says. If you look at the determinants of investors' overall returns, however, "it's still all about asset allocation [between stocks, bonds and cash] particularly for retail investors."
That was certainly true in late 2008, when stocks plummeted, and U.S. Treasuries soared. Even within the realm of stock selection, Prof. Kirzner argues, the value approach seems to have limitations.
"I believe the great ones have a great talent at buying," he says. "I haven't really met any great sellers."
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HIGHLIGHT OF THE STUDENT YEAR
Just how popular is 78-year-old Warren Buffett with the university crowd? For pretty well every MBA student in Prof. Erik Kirzner's value investing class at UofT's Rotman School of Management, the highlight of the year is a two-day trip to Omaha. That's because it includes a meeting with the Sage, and lunch with him at Piccolo Pete's Restaurant ("a south Omaha tradition since 1933").
Last Nov. 21, Prof. Kirzner's two-dozen value investing students were among a group of close to 150 from six universities who rode the elevator to the 11th floor of the headquarters of Mr. Buffett's Berkshire Hathaway holding company.
Given the pandemonium in the markets last fall, some were hoping that Mr. Buffett would offer some specific advice on how to handle it. As is often the case, Mr. Buffett was more interested in discussing techniques of valuing individual companies. Still, Prof. Kirzner recalls Mr. Buffett saying that he thought the market plunge was presenting "a buying opportunity," and that newly elected Barack Obama was a "good choice" as U.S. president.
Of course, Mr. Buffett often says that trying to buy at the bottom of the market and sell at the top is foolish. And his own short-term market timing has often been far from perfect. In September, 1987, Berkshire became the largest shareholder in Salomon Brothers, the troubled Wall Street investment bank, just before the stock market crash in October of that year. It took Mr. Buffett a decade to sort out problems at Salomon.
Last September, Mr. Buffett came to the rescue of Goldman Sachs by investing $5-billion (U.S.), which helped the bank sell new shares to other investors at $123 apiece. The stock sank below $60 in December, but Mr. Buffett has already had a last laugh of sorts - Goldman soared up through $120 again this past April and is selling today around $140.
The Sage's aura endures, no matter what happened in markets yesterday, or even over the past decade. As one of Prof. Kirzner's students said after the Omaha visit: "What does he care if he paid 70 times earnings for Coke?"