August Discount!

The last few days of July saw a general market decline, with some of our companies in the Vertex Managed Value Portfolio and Vertex Value Fund missing on quarterly earnings expectations. Mattel, Unisys, Wellcare, Genworth, Goodyear and Montpelier RE fell as much as 20% while many more declined on fears of a weak housing market in the USA and general market jitters. Let’s face it – it never feels good to be down. But, when stocks are down, that’s when the value opportunities tend to present themselves. One of the fortunate outcomes of investors’ penchant for short-term thinking and over-trading, is that when a company misses, stocks tend to be punished with extreme prejudice. This allows us to take advantage by buying a stock today 20% cheaper than at close yesterday….or not. As active fund managers, it’s our choice what course of action should be taken. The choice we made was to add to our positions and/or sell slightly out-of-the-money puts where premiums were out-sized (in the Vertex Managed Value Portfolio).

Another area we’re finding attractive is offshore drilling companies where most analysts have virtually rated the whole sector as a sell. Reasons for the sell ratings are sound – oversupply of rigs coming on stream and thus a decline in day rates will persist and possibly accelerate. History tells us a different story though. The last three sectors where analysts were overwhelmingly negative were gold and oil in 2000 – 2002, and forestry in 2009. Their reasoning was sound but stock prices were already so inexpensive, a patient investor was paid off with excessive returns as these sectors recovered. Oil, gold and forestry stocks were volatile over a few years followed by rising 5 to 10 fold over the subsequent 5 year period. The offshore drillers are already off from 30% to 50% of their recent highs and some are 80% below their 2008 highs. We’re not saying things are going to turn around tomorrow but in 5 years, these stocks have a good chance of being a lot higher. To think we’ll nail the bottom would be pure folly, however I seem to recall that to buy low & sell high, one must first buy low. Peter Lynch used to say: “it’s always darkest before dawn”.

On the overall market, we believe investor fears are unwarranted. Housing starts are still only 1 million in the USA. We believe that housing will continue to strengthen over the next few years, heading back to a long-term average of 1.5 million. Inflation is in check, and both corporate and personal debt levels are reasonable. The stock market trades at 16X earnings which is by no means expensive. Interestingly, USA GDP came in at 4% in the second quarter ahead of expectations and proving that Q1’s slowdown was indeed very much a weather related event. Home builders, lenders, and forest stocks have all become very inexpensive. Some home builders are off close to 50%!!

Our value portfolios look quite different today than a year ago and we are pretty excited about our recent additions. They won’t make any analyst’s top buy list but that’s how we like to roll. When they’re on that list, we’ll generally be sellers. We find comfort when our sanity is called into question. It usually means we’re making a very good long term purchase where rewards will be outstanding. Our challenge now is to bring in new money when a fund or the market is down, and when opportunities are greatest. With the Vertex Managed Value Portfolio (A) and Vertex Value Fund (B) down approximately 4.7% and 3.5% respectively for the month of July, we believe this is one of those compelling times.

Matt Wood
Founder and Portfolio Manager