Please ensure Javascript is enabled for purposes of website accessibility

The Prudent Speculator on Value Investing

Today’s Investment of the Week features the second installment in our occasional series of interviews with contributors to the Dick Davis Digests. This week, I’m talking to John Buckingham, chief investment officer at Al Frank Asset Management and editor of The Prudent Speculator. Here’s what he had to say. Chloe Lutts:...

Today’s Investment of the Week features the second installment in our occasional series of interviews with contributors to the Dick Davis Digests. This week, I’m talking to John Buckingham, chief investment officer at Al Frank Asset Management and editor of The Prudent Speculator. Here’s what he had to say.

Chloe Lutts: Al Frank founded The Prudent Speculator in 1977 — when did you join the team?

John Buckingham: I started part-time in February 1987 when I was a senior in college at the University of Southern California. After graduation a couple of months later, I came on board full time in May 1987. Over the next three years, I was able to work my way up the proverbial totem pole (Al Frank was a computer “geek” and I was a computer science major with knowledge of spreadsheets and databases, so we hit it off right away), eventually becoming Director of Research in 1989 and Chief Portfolio Manager in 1990.

CL: What has changed about The Prudent Speculator over the past 35 years? What has stayed the same?

JB: As I learned at the foot of one of America’s greatest value investors, much remains the same — I very much believe that a long-term-focused strategy based on planting and patiently harvesting a broadly diversified portfolio of undervalued stocks is the key to success in the equity markets. Sure, technology has allowed us to be more disciplined in our objective reviews of what constitutes a “value” stock, but the core premise that stocks that trade for inexpensive multiples of sales, earnings and book value will deliver the best long-term returns remains intact.

That said, since Al Frank’s passing in 2002, we have augmented our analytics by explicitly including dividends and the income they generate into our decision-making process. Market history shows that anywhere from 25% to 40% of total return has been derived from dividends, so we think that there is strong evidence to support their inclusion in the analytical framework.

Also, as many may be aware, Al Frank was a heavy user of margin leverage through the years. While this augmented his gains in the favorable periods, it smacked overall returns in 1987, 1990, 1998 and 2002. While I believe that a judicious use of margin (my upper bound is generally in the 25% range, meaning that a $100K in equity portfolio might control $125K in stocks) is O.K. for some folks, and I have personally used a modest amount of leverage in years past in my own Buckingham Portfolio, we presently use no leverage in our newsletter portfolios, including Al Frank’s TPS Portfolio, which I still manage, and only a handful of our managed account clients choose to utilize the tool.

CL: Can you give us a brief explanation of the newsletter’s investing system or philosophy? How do you pick the stocks you recommend?

JB: As value investors, we seek to buy stocks that are on sale, similar to what most folks do in their everyday lives. Whether it is a box of cereal, a washing machine or a new car, most of us prefer to pay as little as possible and we generally walk away if we think that the price is too rich. On the other hand, the stock market, as the old adage goes, is the only place where they hold a sale and few people show up.

Though we find this puzzling, given that history shows value stocks outperform growth stocks, we are grateful that investors often overly punish companies for short-term transgressions while they drive ‘hot’ stocks to unreasonably high levels. It is this dynamic that allows us to implement our strategy as we are able to make a reasonable assessment of fair value based on a variety of historical valuation “norms” for each company, its sector and the overall market. When a stock is priced at a significant discount to that determination of fair value, we buy. When it approaches fair value or when we find another stock with much better reward to risk potential, we sell.

CL: What’s one of your favorite stocks to buy today?

JB: Given that we believe in broad portfolio diversification, we find great difficulty in selecting just one name as we’ve seen time and again where a couple of stocks don’t pan out while the overall portfolio does just fine. For example, at the start of this year, we selected 13 stocks in our 2012: Time for Value Special Report. As of March 16, that portfolio is up nearly 17%, even as one of its members is down more than 30% and another is off more than 10%.

With this as a caveat, I am a fan of Navios Maritime Holdings, Inc. (NM - yield 5.8%), the dry-bulk shipping company that has remained quite profitable (thanks to long-term fixed-price contracts) despite a tremendous decline in shipping rates brought about by the slowdown in the global economy and the glut of new ships that have been built in recent years. With both of the headwinds likely to not blow as hard in coming years, we like the fact that Navios today trades for a single-digit P/E ratio, and at a big discount to its historical price to sales ratio and at less than 50% of book value, all while boasting a dividend yield of more than 5%.

CL: What’s one important piece of advice you think more investors need to know?

JB: I think investors would do well to understand the time horizon for each component of their investment portfolio as that will allow them to use the proper measuring stick. Money that is needed to pay the bills, send Junior to college in the fall or even provide a one-or-more-year emergency “cash” cushion should be invested very conservatively, though yields on available instruments are microscopic today.

Assets earmarked for retirement or with at least a three-to-five-year time horizon can be invested, in my view, in more volatile instruments including the stock market. Unfortunately, the 24/7 media coverage of the equity markets and smart phone access to tick-by-tick portfolio valuations make it difficult to focus on the long term, which often leads to a much more conservative stance too early in life. Consider that depending on the “lens” used, 2011 was either an extremely volatile market year (there were 7% daily moves up and down in August, for crying out loud), or one of the least volatile years (the S&P 500 was virtually flat for the full year).

Remember that retirement funds may need to last 20 years or longer, so what happens in a day, week or even month in the stock market, should not cause one to deviate from a long-term investment plan.

CL: What do you see as the biggest challenge in the market right now?

JB: While the twists and turns in the European sovereign debt crisis, subdued growth in corporate top and bottom lines, the slowdown in the rate of growth in China, the likelihood of higher domestic tax rates and a potentially nasty presidential election campaign are some of the challenges, fickle investor psychology is probably the biggest risk to stocks. We’ve seen markets suffer significant (though temporary) declines in recent years as “group-think” has never been more prevalent and risk-mitigation has become the most important tenet for many investment professionals. This has exaggerated moves to the downside, though it has created fantastic entry points! After all, consider that the unemployment rate is the same today as it was in March 2009, yet stock prices on average have more than doubled!

CL: Let us get to know you better—what else do you like to do besides investing?

JB: I am truly fortunate to be able to say that my occupation is my avocation, but I enjoy playing basketball, travelling and spending time with my family, in addition to following the exploits of my beloved Minnesota Twins baseball team.

CL: Thanks to John Buckingham for taking the time to talk to us today!

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.