The investment trap of low valuation

If I tell you that you can win the world championship as long as you run to the speed of 9.58 seconds of 100 meters, you will be successful, so practice towards this goal quickly.

Do you think I'm crazy?

You wouldn't advise ordinary people to run 100 meters because it looks difficult, just like a lot of people like the low valuation strategy, just because it looks very simple.

For low-valuation investment methods to be successful, there must be two prerequisites: first, the market has made a mistake; second, the market will correct this mistake-which is much harder than you think.

First of all, markets rarely make mistakes in the long run.

Second, even if you make a mistake, you can't prove it.

Third, even if you can prove it, the market may be slow to correct.

Finally, even if you correct it, you may have given up a long time ago.

The previous article in this series"what kind of companies can maintain high valuations for a long time? "I'm talking about investment opportunities for highly valued companies. Some people commented: "once the logic of high valuation is falsified, it is very serious to kill the valuation."

This is true, but the reason why high valuation has been high for a long time is that its logic has never been falsified and is difficult to be falsified, so it is not easy to be killed.

We all know Buffett's saying: in the short term, the market is a voting machine, in the long run, the market is a weighing machine.

In other words, the stock price must be effective in the long run. A high valuation company that lasts for five years, its probability of killing valuation is still lower than that of the average company, even if it does kill valuation, the loss is actually about the same.

It's like falling from the 10th floor is certainly more dangerous than falling from the second floor, but when someone is lying on the bed in the 10th floor room and you are standing on the clothes rack on the second floor balcony, who do you think is dangerous?

Of course, the low valuation strategy is a little more difficult, but it is also more likely to make a lot of money, as long as you make a clear distinction:What are the real underestimates? Which ones just look undervalued?

The riddle of low valuation of banks

Generally speaking, there are two types of low valuation industries, one is low growth and low valuation, such as steel, coal, non-ferrous, shipping and other cyclical industries, most people have no objection to this, participants know that they are a cycle reversal, can also do light position participation, risk control, willing to gamble to lose

But another category of still growing industries, whose low PE has always been controversial, is most typical in industries such as banking, real estate and construction.

A Japanese drama about banks, Naoki Hanzawa, denounces banks as vampires who "send umbrellas in sunny days and collect umbrellas in rainy days". It sounds very relieved, but the business of banks really has to do this because it is a very risky business.

The benefit of the enterprise is good, and the income of the bank is the interest on the loan. Once the benefit of the enterprise becomes worse, the loss of the bank is the principal of the loan. As a result of this asymmetry between gains and losses, as long as there is an one-point difference in the quality of banks' assets (that is, loans), profits will be at least 10%.

But the problem is that banks continue to receive interest in the first few years, even if the company has failed, and the profit statement is "in a good position". Some banks know full well that the loans cannot be recovered, but in order to cover up the problem, there are always various ways to borrow the new and repay the old, resulting in how many hidden bad debts the banks have, no one knows.

The most confusing thing about the bank is that the ROE looks good, and the ROE of a good bank can reach 15%, but with DuPont analysis, you will find that its equity multiplier is 12 times.

So the bigger problem is the highly leveraged business model of banks. Almost all banks have an asset-liability ratio of about 93%. As long as your real bad debt exceeds 10%, you are substantially bankrupt.

For example, you and your brother went up to the mountain to learn to speculate in the stock market. After completing the study, master gave each of you 1 million yuan to compete. You used twice the leverage and bought 2 million stocks. He crazily added 12 times the leverage and bought 12 million stocks. As a result, you both made 150000 a year.

Do you think you two have the same ability to make money? Can you give the same valuation?

ROE is not omnipotent, there are good ROE and bad ROE, too high equity multiplier is bad ROE, not worthy of high valuation.

In order to cover up the nature of high-risk business, banks always spend their money on magnificent office buildings, high-end overalls of fabrics and advertising slogans that emphasize "soundness, sincerity and distance", coupled with the identity of state-owned enterprises. so that many investors really think this is a sound business.

Twenty years ago, China's banking industry "went bankrupt once as a whole". The four major asset management companies stripped off their bad debts and injected capital with special treasury bonds before they rebounded. However, the governance structure of banks has not changed and their dependence on the government has not changed. There is no guarantee that they will not die again 20 years later.

Well, some people say that the valuation of the bank is already very low, which should be reasonable, right?

As mentioned earlier, as long as there is an one-point difference in the quality of assets (that is, loans), the profit will be at least 10% water, coupled with 12 times the equity multiplier, the true value of net assets will at least double, while China Merchants Bank and Ningbo Bank, which have relatively good A-share asset quality, how is the asset quality different from a large number of urban commercial banks and agricultural commercial banks?

As the 1.4-1.7 times PB of China Merchants is similar to that of excellent foreign banks, if we think it is reasonable, then the four major banks should give at most 0.7 times, most urban commercial banks, agricultural commercial banks, can give 0.3 times, and the asset quality is a little worse, it should be delisted at all.

In my opinion, the valuations of the banks are similar to those of the four major banks, while the rest are undervalued and overvalued.

Undervaluation of real estate and construction enterprises

After understanding the bank's low PE, real estate enterprises are easy to understand.

Vanke's equity multiplier used 9.48 times leverage, Poly is a relatively conservative real estate developer, also has 7 times, and Vanke's valuation is higher because Vanke's property scale and industry status are higher, income diversification is better, and these businesses have nothing to do with leverage, and rapid growth, deserve a high valuation.

Construction companies have the same problem. China Construction's equity multiplier is also 7.5 times leveraged (some real estate businesses), and Jiaojian, Railway Construction and China Railway are also 5 times leveraged. To make matters worse, the net profit margin of construction companies is much lower than that of real estate companies, coupled with huge receivables, poor cash flow and high risk.

In addition, construction enterprises also have opaque assets, and some of the overseas operations of some central enterprises are in Asia, Africa and Latin America, where credit is relatively poor.

Of course, because the cash flow of real estate enterprises is OK, the financial security of leading enterprises is generally safe, and their low valuation is mainly due to policy restrictions, resulting in growth being questioned.

On the other hand, construction enterprises are congenital defects of the business model. ROE is maintained entirely by the high turnover and low interest rates brought by the credit of central enterprises. Once something goes wrong in the downstream industry (such as real estate), or the interest rate environment is slightly unfavorable, its operation will encounter major risks.

There is still room for implementation of policy issues, so that the real estate industry can periodically outperform the market, but there is no cure for the congenital defects of the business model, and the stock price can only drift with the tide.

Do not easily suspect that the market is wrong, all kinds of capital is constantly digging for opportunities, and there must be a reason for not getting a normal valuation that matches the growth rate of performance for a long time.

Don't put too much faith in mean regression.

Another trap of low valuations is the "percentage of historical valuations".

The theoretical basis of "percentage of historical valuation" is mean regression, that is, the default historical median is reasonable valuation, and both overvaluation and undervaluation of the industry will return to the median, but it ignores the change of the development logic of the industry itself.

Because of China's rapid development and many policy changes, many industries have experienced changes from sunrise industries to sunset industries in a short period of ten years. If an industry spends most of its time in the historical valuation range of less than 20%, and continues to expand downward, it is likely that the development logic of the industry itself has changed.

Take bank stocks as an example. More than a decade ago, bank stocks had a PE of 20 to 30 times, because the performance growth rate was also more than 10% every year, and everyone thought that this was a reasonable valuation.

So when the PE of bank stocks falls from 10 times to 10 times, many people think that banks are undervalued, and when they fall to 8 times, they feel undervalued, and when they fall to 5 times, some people also feel undervalued-- in terms of historical valuations, most of the time they are in a very low percentile range.

And this change in valuation essentially reflects the logical change in the banking industry: more than a decade ago, in order to go public as a whole, banks with better asset quality were rebuilt with "plastic surgery" because the operating mechanism did not change. it took more than a decade to change back to the state-owned bank that had accumulated for a long time, which is not easy to solve-- please call me "Tianshan child grandmother".

As a result, most blue chip valuations hit lows in 2013, except for the PB lows of the big four banks in 2014, 2016, 2019 and this year-no lowest, only lower.

Small and big opportunities for low valuation investment

After talking about the reasons for the low valuation, we still need to talk about the investment opportunities with low valuation.

There are two kinds of opportunities for low valuation, one is a normal investment opportunity, which is available every quarter, and the other is a big opportunity in the industry, which takes only one or two years.

A normal undervalued investment opportunity means that when the logic of the industry and the logic of corporate growth remain unchanged, the valuation of the company or industry is lower than the historical average because of style, and once the style is reversed, you can make money with rising valuations.

Of course, this method requires you to ambush in advance, be patient, and have a certain risk of killing logic.

Another kind of industry big opportunity, that is, the industry logic and corporate growth logic have undergone fundamental changes, at this time, the number of the valuation itself is not important, or even in most cases, it is always in the highest valuation range in history. what matters is whether there is a possibility of qualitative change in the industry.

This approach requires you to have more insight into the industry than ordinary people. Of course, the future is random, and a large part of it depends on luck.

A typical example in the near future is the automobile industry.

Take SAIC as an example, this industry has changed from a high gross margin, low debt and low week transformation enterprise more than a decade ago to a high week transformation enterprise with low gross margin and high debt now, resulting in a slight change in downstream consumption, which will lead to a huge rise and fall in profits. this is a typical case of changing from a growth industry to a cyclical industry, so the valuation range has been falling.

If you follow this logic, the auto industry is currently overvalued, and even if you consider a return to growth next year and the year after next, the room for growth is very limited.

However, the emergence of Tesla, Inc. probably means that the logic of the development of this traditional manufacturing industry has changed completely. I can sum up the following three points:

1. The trend of electrification and intelligence has caused the automobile to become a mobile terminal, which leads to a revolutionary change in the business model of automobile manufacturing, using value-added services and maximizing the value of the industrial chain. the whole vehicle industry may become a high-margin industry like Apple Inc in the future.

2. Domestic consumers' sense of identity with new brands and independent brands is strengthening.

3. The ability to expand in overseas markets may be further improved in the future.

Obviously, this logic is unlikely to belong to old leaders like SAIC, but new car-building forces like Tesla, Inc., BYD or NIO Inc. that have more advantages or no historical burden in the electric car industry chain.

This is not to say that this logic can be realized, it still needs time and performance to prove, but because it has been reflected in the trend of revenue growth, it is the first to reflect in the valuation, and finally lead to a directional change in the valuation of the entire automotive sector.

Like all new opportunities in investment, the valuation of the automotive industry will continue to unfold with the realization of performance, which is bound to have twists and turns and eventually become bubbly due to excessive emotional fermentation.

But on the whole, as long as this logic is neither fully proved nor falsified, the theory exists and there is no inflection point in performance, its valuation is likely to remain at a relatively higher level for a long time.

Low valuation, high risk, high return

Contrary to the imagined impression of "high valuation and high risk, low valuation and low risk", companies that have achieved high valuations for a long time are mostly familiar white horses with lower fundamental risks, while industries or companies with low valuations, more or less, have some congenital defects, and the greatest chance comes from the repair of these congenital defects-which is rare.

So the low-valuation investment method is essentially high-risk and high-return-Graham, the founder of the low-valuation strategy, also went bankrupt.

Of course, there are some great experts who can continue to seize the high margin of safety opportunities caused by very few excessive emotions in a large number of undervalued companies, but this is the difficulty of what I called the "100-meter world champion". It is not worth imitating by ordinary investors.

The bigger problem is that compared with US stocks and Hong Kong stocks, the valuations of A-share low-valued companies are not low enough. Many companies seem to have low valuations, but there is a possibility of further killing.In the analysis of banking stocks, I have covered it initially, but a more detailed analysis will be in the last article in this series.