In a hot market, value hunters try to stick to their rules

THE irony couldn’t have been lost on the 350 people who gathered for the Value Investing Congress West in Hollywood last week.

Normally, a crowd is exactly the last place a serious value investor wants to be. True value typically is found in investments that are hidden gems, things that are underappreciated and relatively unwanted.

But in today’s streaking stock market, there’s very little that no one wants. And that’s the problem for the value camp.

Shares of Contango Oil & Gas Co., a small Houston-based exploration company, have soared 75% since mid-March -- including a 5% price jump on Tuesday after the stock was mentioned by a fund manager at the value congress.


Real value investors are supposed to do extensive homework, digging deep into a company’s income statement and balance sheet. They also tend to abhor chasing hot stocks.

“I’m sure you’ve all done your due diligence,” joked Whitney Tilson, a co-founder of the conference, as he opened the afternoon session on Tuesday and noted the moves in some of the stocks mentioned just hours earlier.

This is no knock on Contango or the value get-together, the second annual such conference held in L.A. For all I know, Contango is a future Exxon Mobil Corp. And even Warren Buffett, the most revered living value investor, gathers his acolytes once a year (at the annual meeting of his investment company, Berkshire Hathaway) to talk ideas.

The fund managers, professional analysts and individual investors who paid the $3,695 standard rate to attend the value congress surely didn’t do so to hear whining about a lack of good stock choices. They came for names and numbers.


Still, the cloud that hangs over any meeting of value-minded investors these days is the sense that pickings are slim in the fifth year of the global bull market.

Most people with money in stocks take joy in this spring’s ongoing rally. Not so Steven Romick, manager of the value-focused First Pacific Advisors Crescent mutual fund in L.A.

As he puts it: “My wife says, ‘How come all the other people are happy and you’re not?’ ”

His $1.4-billion fund has more than 40% of its assets in cash -- an unheard-of sum for most stock fund managers. He’s sitting on his hands rather than giving in to the temptation to reach for stocks that are out of his value range, he said.


“People are being scared into stocks -- it’s fear of missing out,” says Romick, who spoke at the conference.

He’d rather wait for prices to come back to him. “I’m used to buying on distortions or bad news,” he said.

The bull market that began in October 2002 has lifted stocks across the board, but it has been particularly good for shares that historically have sold for low prices relative to earnings and other measures, which is the classic definition of value. Many energy, utility and machinery stocks are in this category.

By contrast, many growth stocks -- shares of companies whose earnings growth rates are supposed to be above average over time -- have lagged. Look no further than the technology and healthcare sectors.


This decade has reversed the trend of the late 1990s, when growth stocks ruled and value issues were all but ignored.

I fully concede that the problem with any discussion of growth and value is that it lends itself to gross generalizations. Here are two more: Do value investors wish stocks were cheaper? You bet. Does that mean there’s no value anywhere in the market? Unlikely.

The question, of course, is how you define value. Many of the money managers who spoke at the conference kept returning to a central tenet of the value school since the 1930s: the idea of having a “margin of safety” in a security, so that your downside risk is much less than your upside potential.

Boil it down and that simply means: Don’t overpay. And the only way to be confident you aren’t overpaying is to have a well-grounded sense of what the underlying business is worth.


That, in turn, requires doing the math. A lot of math. Serious number-crunching is what separates true value investors from the pretenders.

The math is what led Mark Sellers, the 38-year-old head of Sellers Capital in Chicago, to Contango Oil & Gas.

The company is beginning to pump significant natural gas from a find in the Gulf of Mexico. Its revenue jumped to $5.4 million in the first quarter from just $123,199 a year earlier.

Investors besides Sellers have noticed, which is why the stock has surged in recent weeks, to $34.90 on Friday.


But by Sellers’ calculations of the value of Contango’s energy properties and its stake in a partnership that is building a liquefied natural gas delivery terminal in Freeport, Texas, the stock could be worth $50 to $60, he says.

And yes, if you buy now, you would be benefiting Sellers and his clients, who own 10% of Contango.

Romick, despite finding very little he likes in the stock market at current prices, says he’s still happy with ConocoPhillips, a major holding in his fund.

Again, the math: Romick runs through the cash ConocoPhillips generates relative to its spending needs. Then he looks at the company’s market value, which hasn’t risen nearly as fast as the market values of other big energy companies since the end of 2005. He figures ConocoPhillips is being penalized because some investors fear it overpaid for natural gas giant Burlington Resources last year.


ConocoPhillips stock, at $70.19 on Friday, is down 2.4% year to date. That’s just fine with Romick, who focuses on the cash the business is throwing off. “I don’t see how I lose long term,” he says.

His shareholders have reason to trust him. Over the last 10 years his FPA Crescent fund (which is closed to new investors) has had just one losing year, a 6.3% decline in 1999.

For many hard-core value investors, the fun is in finding smaller companies with potential earnings power that the market may not fully appreciate.

Zeke Ashton, managing partner of Centaur Capital Partners in Southlake, Texas, and a speaker at the conference, said he liked the prospects for a new line of business that Santa Ana-based Collectors Universe Inc. is developing.


The company, best known as an authenticator of collectibles such as coins and autographs, has been investing heavily to build a grading franchise for diamonds and colored gemstones. For now, that expansion is depressing earnings -- which means Collectors’ investors have to be willing to be patient. The stock, at $13.76 on Friday, has made no net progress in two years.

Bona fide value investors pride themselves on their calm, self-control and willingness to wait for their reward.

To paraphrase Buffett, before buying a stock, ask yourself whether you’d still do it if you knew you couldn’t trade out of it for five or 10 years, and you had to rely on your faith that the business would be worth much more when that period was up.

If you don’t have that faith, you may have identified a trading opportunity but not an investment that qualifies as a genuine value.