What can be said about the many such investments being undertaken by individuals who have demonstrated dramatic serial success over decades of managing their companies? They are expending, while the average company is husbanding, cash. They are buying cyclical or risky assets that others are selling. They are doing so with their own balance sheet capital-that is, they are not issuing shares to do so. They have not, surely, all become foolhardy simultaneously.
The Owner-Operators as Harbingers of a Bubble Reversal
They also, as a class, trade at remarkable, perhaps record discounts: near or below book value, or deeply below net asset value, or near or at single-digit earnings multiples. Over the past few years, they have sold at ever cheaper prices, even as their financial progress continues.
This circumstance feels much like our experience in the 1999-2000 bubble period, when the bluest of blue-chip holdings were - literally, as they now say - discarded in favor of technology, internet and telecommunications stocks. Here is the current version of that phenomenon. In the new world of portfolio variability control and asset allocation via indexation, equity investing is increasingly done via batches of stocks rather than individual stock selection. The goal, in part, is to avoid idiosyncratic security risk. The associated flow of funds is, accordingly, into stocks that are constituents of popular indexes and ETFs. This is evidenced by the percentage of the $4 trillion of domestic equity mutual fund assets that is invested in equity index funds: while virtually flat between 2004 and 2007, this measure rose by one-quarter, from 11.5 percent to 14.5 percent, between 2007 and 2010. These index funds received new assets, on a net basis, even in 2008 and 2009, when the equity markets were in decline.
As part of this trend and in order to accommodate larger fund flows, the various index providers began to adopt float-adjusted market capitalization methodologies several years ago. Under this system, inclusion or exclusion from an index is not based on the total stock market value of a company but rather, on the market value after excluding shares held by insiders. Accordingly, many owner-operator companies find themselves increasingly outside of the flow of funds. Other owner-operators that have sufficient float, yet which are multi-industry or portfolio-type owner-operators, such as Leucadia National or Brookfield Asset Management, have found themselves excluded due to the necessity, in the index-driven, ETF mode of investing, of conforming to a clearly defined industry sector. Paradoxically, as many of these owner-operator companies repurchase shares, their float decreases, which means that their index weights are reduced, if they are in an index, which in turn requires share sales by any index-based holders. Contrarily, companies that issue more shares may well increase their index weighting.
This, then, is a form of bubble, if one definition is the flow of funds into a sector or securities irrespective of fundamental merit or valuation. The value investors listed above all share the failing that they tend to purchase securities with idiosyncratic features, which tend to be excluded from indices. Like all bubbles, this one will reverse.
Murray Stahl is chairman, chief investment officer and co-founder of Horizon Kinetics. Stahl also serves as chairman of the firm's investment committee. He will be among the portfolio managers presenting at the 2nd Annual Fiduciary Gatekeepers Summit, sponsored by Financial Advisor and Private Wealth magazines. For more information on the event, click here.