Astute investors always search for a disparity between price and value. We argue there is a direct correlation between crowds and a lack of such disparity. Crowding takes place within many contexts- even the value investing space - often tarnishing returns even for intelligent investors.
Value investing, in all its incarnations, poses to allocate capital based on a disparity of price and value. Basic economic principles, however, demonstrate that even sound investing principles will generate mediocre returns when too much capital crowds a space.
As an example, consider the sub-market of spin-offs. A spin-off situation exists when a publicly traded company splits off a portion of its business into a separate, publicly traded entity. Historically one could earn excess returns by purchasing a newly spun-off company when it was significantly smaller, and in a different business, than the parent. There were sound, non-economical reasons for why this was the case. Perhaps the parent was a member of an index for which the spin-off company would not qualify. Index funds would become non-economical sellers. In other cases, institutional investors would become non-economical sellers based on market cap; the spin-off would be too small to be part of their portfolio. Lastly, other investors may have bought the parent to have exposure to a certain asset class or business. Because the child did not fit this investment criteria, they would also be non-economical sellers. All of this serves as a sound intellectual basis for why spin-offs should be an interesting investment category.
Crowding, however, has proven to be the Achilles heel of spinoffs. An increasing amount of capital continues to enter this space, pushing returns down to a humble level. The crowding is obvious- there now exist ETFs that operate this strategy exclusively, full-fledged investment news letters, etc. In essence access to the idea, information, and execution requires no work and de minimis cost. In such a situation we should expect no excess return.
Even the value investing community has itself experienced significant crowding in the last decade, especially within traditional value investing "buckets" (compounders, deep value, etc.). Perhaps the most egregious examples of crowing in this space is the explosion of (expensive) value investing conferences, courses, and information services. All of these strategies are valid intellectually, but not at any price. The popularization of any concept tends to increase prices and diminish returns.
Buffet argues to go where no one else is going. When you are the only bidder for something you have the pricing power, rather than being a price taker. Finding situations like this is, and should be, work. Ideas in newsletters and conferences by definition do not fit this context. This opportunistic approach is often overlooked by the value investing community.
In his early days, Buffett practiced this very idea. He invested in ways that no one else did. He went to annual meetings with only one other investor. He scoured stock manuals page-by-page that no one else looked at comprehensively. He bought quirky things, and if needed, added the sweat to make things happens. He sought the road less traveled where he could control price. Most certainly he would not have attended a shareholder meeting similar to the current Berkshire meeting.
All this discussion of safety in the crowd (yes, even the value club crowds into ideas and stories) has come up as Kingsway Financial (NYSE: KFS) continues to slide in price. Kingsway also preaches all the value investor tenants of capital allocation, low cost execution, leverage of float, etc. Also, they have been a warm value investor hang out for a few years now. Without going into the past, Kingsway has always seemed to to be fairly valued, with a strong following of "value guys" in the name.
That is until recently. Its super interesting that as Kingsway's story begins to get lonelier, the price starts to get intriguing. It is the Howard Marks idea of the perversity of risk in action. The less something costs, the less risky it is, and more the expected return should be. But its lonely. For an investor who needs crowd-confirming signals, it is a difficult place to be.
Please perform your own calculations, but my "valuation to worst" math for the business is:
25m for non-standard auto sale
80m for the warranty business
10m for leased RE
20m for hold co investments
30m for the NOL
(-)57m of preferred stock
=100m-ish (rough "valuation to worst")
Current MC is 72m
Not bad considering the caliber of the management team, their ability to do smart deals, and their execution on their growing warranty roll up business opportunity. The value of the warranty business is the real secret here. Also note (for the "needs-a-catalyst" investor): Kingsway turning profitable due to the sale of the non-standard auto insurance business and the warranty businesses growth could be a catalyst for the stock.
B.E. Capital is generally catalyst agnostic. If a security is bought for the right price, a lot of good things can happen that cannot be anticipated. And as Klarman would say (paraphrasing): "nobody knows where the bottom is, so you buy value the moment you find it".
In summing up - it is getting lonely at Kingsway, but frankly that is exactly when things begin to get interesting!
Happy investing- please remember to run your own numbers and analysis before making any investment decision.
P.S. I recently purchased some Kingsway in my personal account.