Bill Hortz's picture

[Numerous articles have been tolling the bells for value investing over the past few years, but the truth is that while value has not been the best relative performer, increased market volatility and disruptive industry events have been feeding value portfolios for future gains. These portfolios can be seen as smart diversifiers against today’s manic clinging to all things seen as “growth” and astutely positioning for future drivers of earnings and key areas of shifting investor attention.

To further explore these deep value perspectives and investment opportunities, we reached out to an experienced value investor veteran, Harris Kempner, Jr, President of Kempner Capital Management and Portfolio Manager of Kempner Multi-Cap Deep Value Fund (FIKDX). Adding the certainty of continuing and growing industry disruption fueled by innovation and new business models to the unchanging basic nature of stock markets that are prone to external shocks and investor cycles of fear and greed, a reassessment of deep value investing may be very timely. ]

Hortz: While you have said in other interviews that you do not waste time figuring out the overall dynamics of the market, you seem to be a follower of market disruptions. Can you tell us how following disruptions helps your deep value investment approach?

Kempner: I guess the best way to put this is that disruptions sometimes cause significant panic selling in individual stocks or groups of stocks. One part of our approach is to look for these panics in the market and try to discern whether their effects will be temporary or longer term.  Since we expect to hold individual stocks for 3-5 years, we can afford to be patient when this happens to find the best deep value companies that we can determine at these bottomed out prices.

We tend to see the world a little differently than other people do as we focus on looking at stocks that are washed out, unpopular, cheap for the wrong reasons. It is a distinctive skill set and practiced investment approach we have focused on for over 30 years. We are always happy when market or industry disruptions can bring great companies to our attention.

Hortz: Can you give us an example of a corporate disruptor or disruptions that you been following?

Kempner:  Announcements from corporate leaders like Google, Apple, Facebook or any major company stating they are moving into a new space or industry can trigger panic selling through that industry. We were very happy when Amazon (AMZN) started mentioning their diversifying intentions into new areas, like supermarkets and health care. They are a great example of a company disruptor causing knee-jerk stock price overreactions in those industries. That’s when we start doing our analysis and do our shopping for best deep value and low down side risk companies in those industries. That led us to great companies to invest in at favorable price entry points at the time including Kroger (KR), Cardinal Health (CAH), McKesson (MCK) and Walgreens (WBA) - all thanks to Amazon.

As another type of disruption example, I also have been keeping my eye on the Iranian-U.S. conflict and what it might do to the price of oil and oil stocks. Energy stocks here are a good example of our view of things. I do not believe the almost religious affirmation that oil is going to be used less and less, and that there is a peak oil demand in the short term, 5 years or so. That view seems to be motivating a lot of investors around oil stocks. On the contrary, I think there are plenty of statistics out there that seem to indicate that there is increasing oil demand over the next 5 years. That is my analysis, and with the patience factor we employ, we feel that those stocks that have been completely out of favor will eventually be recognized as to having better growth prospects than they are recognized at this point. All the while, they are paying us well to hold them and be patient with strong dividends. When we have market disruptions, of the likes of Iran-US tensions, we have the great opportunity of finding what are truly deep value opportunities within these already depressed stocks.

Hortz: In your analysis of pummeled stocks, what is the specific criteria for determining if they are bargains or deservedly cheap?

Kempner: In the first place, what we look for is investment quality from their credit point of view, having a strong record of management stewardship and consistently paying dividends that provide some downside protection. Then it’s determining a lower risk entry point. We never buy a stock unless it is trading within 20% of its 52 week low. For instance, if a stock’s 52 week low is 50, we will not pay more than 60 for the stock. And then we will buy in increments and average down the position if the opportunity presents, but never more than 3.5% of total portfolio by market value for any individual stock. Those are some of the technical things we always apply. The key, though, is that companies need to be understood in terms of their longer term future. Each different stock, and the industry it’s in, needs to be understood in terms of the path it is carving for itself, and there’s no single criteria for that. That is a unique analysis and journey we go through with every company.

As an example of a depressed industry group, a year ago or so, we looked at semi-conductors. While this not an area that you would consider as typical value stocks, when there are major corporate disruptive activities or market overreactions, some company stocks can get cheap enough to become value or deep value stocks. Our analysis of the depressed sector uncovered Applied Materials (AMAT), Skyworks (SWKS) and KLA-Tencore (KLAC) as very cheap at the time. So you see…opportunities do open up and can come from anywhere.

Hortz: How do you evaluate corporate managements with so many industries going through accelerating change dynamics?

Kempner:  The only way we feel you can figure out management is through their eventual financial performance and their ability to anticipate trends in their industry.  We look at their performance, the way that they actually manage their company on an ongoing basis. There may be certain big things that can stick out that we may want to avoid, such as, unwise leverage or spending more than they are making to expand their holdings, decisions favoring growth at any cost, or if management tries to command the company to buy back too much of its stock.  These become negatives for shareholders since cash could be used to defray debt or increase a company’s competitive position. We look for warning signs like that and would avoid those managements because that is not the kind of leadership we want in a long term holding.

Hortz: What then is your selling strategy and how does your deep value perspective handle growing risk in a portfolio holding?

Kempner: At some point you need to have some sort of sell discipline so that you don’t lock in too long into a company ownership position. What we look for is down-side risk starting to appear. For example, how are P/E multiples and cash flow multiples looking relative what it traditionally looked like. Has it gone from a 7 P/E to a 12 P/E when it generally averages 10 or 11? We are basically looking at all the stocks we own all the time to see if there are any sell candidates and what we tend to do is the mirror image of what we do on buys by selling portions or in increments. Very rarely do we sell all of position at one shot unless we see something very crucial happening on the horizon.

As an example, we are roughly at half of the positions we were with semiconductor stocks from when we started building positions 18 months ago. They got cheap and we bought a few high quality companies over time as we mentioned earlier, then they got more expensive and we started selling them. We have been more persistent sellers because they reached our estimation prices where they were adding down-side risk to the portfolio. That’s how we roll.

This is a process. On a daily basis we make buy, hold or sell decisions on our stocks. We are not only looking for things to buy but also testing what we do own to make sure the fundamental story is still there and valuations are not starting to add risk to the portfolio.

Hortz: Are there any other key investment criteria or goals that impacts your investment management process and that you feel most differentiates you?

Kempner:  Since we do not care for index comparisons as we discussed, our overriding investment goal for our clients is generating a total return greater than the rate of inflation over a three to five year period. People’s money should be worth more in real terms at the end of such a period than it was in the beginning. This perspective informs our actions and is an alternative goal from industry norms and thinking. I feel this sets us apart from literally 99.9% of other money managers that focus on industry category benchmarks or competitor performance.  We think our investment focus or mindset makes it possible for us to be patient in investing and enables us to take a longer term view without massive short-term concerns or distractions. 

Hortz: Any final thoughts or advice for advisors and investors from your experience of hunting for value in today’s markets?

Kempner: Look, I don’t have any brilliant observations. We are just fighting a defensive war against those who don’t think that value investing should exist or that there is not that much validity in our approach anymore. We firmly believe that our investment perspective and methodologies add great benefit to investors and their portfolios. Even when markets are at their highs, there are always areas of the markets or individual companies which we think can provide long-term opportunities for investors, because there are always sectors that are out of favor. These are areas that deep value investors, like myself, do not fear to tread.

Also of importance is if your objectives are reasonable, and it really is important, as an investor, to have reasonable objectives. In the active versus passive debate, I would argue that if you lock into the perspective that you have to do better than the indexes as your goal - from an investing point of view – I feel that is a mistake. That is because indexes can gyrate all over the place, indexes change, and if that is your discipline, it seems to not guide you at all as to how you should invest. Rather, its net effect seems to be making you twitch in pain or delight, like something giving you an electric shock, every time you do a little better or a little worse around that index. Many use it as a rule of thumb, but some use it as a holy writ. I don’t think it makes any sense, but it does make sense to me if your portfolio is based on the tangible value of consistently good dividend yielding companies with strong managements bought at low risk entry points.


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