Course 401: Shades of Value
Absolute Value
In this course
1 Introduction
2 Why Shadings Matter
3 Relative Value
4 Absolute Value
5 When Value Managers Sell

Managers such as the team at Longleaf Partners (LLPFX) follow an absolute-value strategy. They don't compare a stock's price ratios with something else. Rather, they try to figure out what a company is worth in absolute terms, and they want to pay less than that figure for the stock.

Absolute-value managers determine a company's worth using a variety of factors, including the company's assets, balance sheet, and likely future earnings or cash flows. They may also study what private buyers have paid for similar companies.

At Longleaf, the managers look for companies that trade at discounts of 40% or more to the team's estimates of their intrinsic value, using discounted cash-flow analysis, asset values, or sales of comparable firms to determine the latter. The managers place much importance on the ability of a company's management to run the business on an operational level and to effectively allocate capital. They often take sizable positions, and the fund typically holds 20-25 names. The turnover rate is typically very low.

Because of this approach, the Longleaf portfolio isn't broadly diversified, and its concentrated approach means that trouble in a few top holdings can have a significant negative impact on returns. Indeed, for six of the past seven years (as of early 2011), the fund has landed in either the top decile or bottom decile of the large-blend category. However, over the long term (10- and 15-year periods), the fund lands solidly in the top 10% of its category.

This case study illustrates the patience required of investors in an absolute value fund. Because such a fund may look very different than the broad market, and its performance may deviate as a result, it can look very out of step over shorter time periods. Of course, some absolute value funds are better than others, but even the best absolute value funds can be misused by investors who can't stomach the rougher ride.

Next: When Value Managers Sell >>

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