What is deep value investing?
Everything you need to know about investing for long-term deep value.
Tim Travis is CEO/CIO and founder of T&T Capital Management, an investment advisory firm based in Orange County, California. T&T uses a deep value investment approach and offers personalized portfolio management to its clients across the country. The firm is celebrating its 10th anniversary this year and Travis has been in the investment business for almost 20 years. Seeking Alpha (SA) sat down with Travis to discuss why he also looks for the downside of potential long ideas, how/why he uses options, and why persistence is an undervalued investment trait.
HER: Tell us about your investment decision-making process. Which market sector do you focus on and what strategies do you employ?
Travis: Our investment process is focused on maximizing risk-adjusted returns. We start by trying to identify stocks that are trading at significant discounts to their intrinsic value to provide an adequate margin of safety and create strong upside potential. When we’ve narrowed down our favorite opportunities, we look at how best to exploit them. This often means buying stocks, or perhaps debt is the best bet. It can also mean a more conservative, income-generating strategy, such as cash-safe puts or covered calls. This is where portfolio customization comes into play and taking into account clients’ risk tolerances and investment goals.
We do not focus on any particular area of the market, but are generally attracted to areas that are temporarily disadvantaged, as we tend to find more attractive investment opportunities in these areas. One of the benefits of being in the business for a long time is that we are constantly expanding our skill set to other industries and businesses. Our knowledge of financial stocks is an advantage, but fortunately we have invested and succeeded in a wide range of sectors.
HER: Do you think that “time arbitrage” (a longer holding period) has an advantage? Is this an advantage that will never be challenged? Are there any specific lessons you’ve learned from owning (and intensely following) a stock for years?
Travis: I absolutely think there is a time trade-off with holding stocks for a longer period of time. Undervalued stocks are often priced low due to difficult short-term conditions. It is uncomfortable to buy stocks when you know that the next few quarters are likely to be disappointing, due to a difficult economic environment or otherwise. I think being a true long-term investor is a harder sell on Wall Street, and an even harder practice to employ psychologically, so I think that’s a sustainable competitive advantage.
Following a stock for years is extremely beneficial. You get a good idea of management and how they react to challenges and opportunities. Typically, company warts emerge under the microscope of time. Sometimes, as we saw last year, stock prices will drop to truly absurd prices on companies you know deeply, allowing you to bet big and with conviction. ALLY Financial (NYSE: ALLY) is a prime example. The stock fell from $30 to below $10 on C-19/lockdown fears, implying far larger losses than seen during the Great Recession. I couldn’t justify the price, which meant buying big and taking advantage of that drop. Now the stock is trading in the mid $50s, and I still wouldn’t be shocked to see a major bank buy it if they could get past the regulatory hurdles, but I no longer see the clear and obvious headroom and potential of rise which he had before.
HER : How do you use management advice and investor presentations in your analysis? Can you give an example?
Travis: Rarely does anyone know the company better than management, so I certainly use their advice and investor presentations in my analysis. I’m not focusing on a particular quarter, but rather on their evolution over time. This includes investor conferences where the investment bank organizing it can target specific areas of the business such as technology or drug development, etc. Over time, the mosaic comes together. Is the management respecting its forecasts? Are they too promotional? Is there a lot of steering rotation? ALLY is a great example of a management team that has consistently beaten its forecasts and achieved its goals, without being overly promotional. This gives you a lot of confidence, especially when facing a recessionary environment. Other companies such as Cleveland-Cliffs (NYSE:CLF) and Assured Guaranty (NYSE:AGO) have also been very strong in how they communicate publicly with investors. Cliffs earnings calls are generally my favorite due to the style of the CEO and his ability to deliver on his promises.
HER : If you own a stock (and/or are considering buying it), are you looking for the downside? If so, how do you separate legitimate bearish arguments from less legitimate arguments and determine if it is already priced in? Have you ever exited a long (or unbought in the first place) position after reading a compelling bearish thesis?
Travis: I will absolutely study the bearish thesis, as I think it would be foolish not to. The bearish case of David Einhorn on the stock of Assured Guaranty is a good example. Most of the arguments were based on insinuations and overly pessimistic projections about future losses that in no way matched my analysis. I had seen the current management of AGO being too conservative in its RMBS loss reserves during the financial crisis. I had seen them accurately earmark billions of dollars in representation and warranty litigation recoveries in the wake of the financial crisis. We now see that the company is at least fully booked in Puerto Rico after the latest regulations on their most troublesome exposures, which the market doesn’t yet seem to fully understand. When the bear case is a bunch of bluster with little merit after careful and thorough analysis, it may make you want to back the truck.
HER : How do you use options at the individual and/or portfolio level? Can you give an example? What are the risks with this strategy?
Travis: We use options as a tool to generate income, reduce risk and instill disciplined selling principles. We do not speculate with them. Over the past several years, we have invested in CLF common stock, typically by buying on declines or selling put options on the stock. From time to time, we were exercised on these puts, and then sold out-of-the-money calls at prices at which we were willing to sell the stock. With the recent spike in steel and iron ore prices, CLF shunned us and we sold our shares, although we still like the company and the management team. We would, however, be willing buyers at cheaper levels, so we sold put options throughout the year and took advantage of the relatively high premiums available. Until recently, we were getting 7-8% annualized median returns selling $10 puts on CLF, despite the stock trading around $20 per share. Granted, if the stock goes back to $30, we would have been better off just buying stocks, but this is cyclical activity and we are concerned about overall market levels, and for us it is is simply a very attractive risk-reward opportunity. When you compare that risk-reward versus high yield bonds, for example, I would attempt to sell the puts because we’d be happy to hold the stock if it fell to those levels and held the upside from there .
HER : What are the main lessons learned from your investment models? Can you explain how you applied one (or more)?
Travis: All of my investment models communicate openly and honestly with their investors. No one can control the outcome, but you can control your process, your work ethic, and the integrity with which you conduct your business. We feature this on our blog and newsletter, as well as our articles such as those published on Seeking Alpha. A lesson I’ve learned with experience is to go your own way. Surfing on the ideas of other investors without doing your own deep dive into the business is a mistake in my opinion. By the time you learn which stocks the funds you respect are buying, the information and opportunities can often be outdated or incomplete. I respect investors such as Bill Miller who have been able to really broaden their circle of skills and recover from the ridicule after the difficult time he went through during the financial crisis, to become a star again. Perseverance is an underestimated trait.