David Kaiser reveals his model specifically limits exposure to financial stocks. Because financials frequently screen cheap on metrics like price-to-book, a pure value model can become dangerously over-concentrated in the sector. The limit is a pragmatic override to ensure diversification and avoid the unique, often hidden risks inherent in banks.
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Counter to conventional value investing wisdom, a low Price-to-Earnings (P/E) ratio is often a "value trap" that exists for a valid, negative reason. A high P/E, conversely, is a more reliable indicator that a stock may be overvalued and worth selling. This suggests avoiding cheap stocks is more important than simply finding them.
Success in community bank investing doesn't require complex esoteric analysis. It boils down to four key metrics: high capital levels (equity-to-assets), low non-performing assets (under 2%), stable or growing book value, and a low price-to-tangible book value (under 85%).
Despite its decline in popularity, Tim Guinness uses balance sheet gearing (debt to net tangible assets) as a critical risk tool. His experience through multiple banking crises taught him that when total debt and creditors exceed twice the net tangible assets, a company requires careful scrutiny.
David Kaiser's system doesn't try to predict cyclical peaks. Instead, it mitigates the risk of buying hot cyclical stocks by owning a diversified portfolio and rebalancing consistently. This structural approach ensures that if the model over-allocates to a sector at its peak, the error is contained and corrected relatively quickly.
Despite decades of evidence, there is no agreement on why factors like "value" (cheap stocks outperforming) work. The debate is split between rational risk-based explanations (Fama's view that they are inherently riskier) and behavioral ones (Shiller's view that investors make systematic errors). This uncertainty persists at the core of quant investing.
Despite managing a financials fund, Derek Pilecki is bearish on the average bank. He argues that intensifying competition from online banks and giants like JP Morgan will continuously compress margins and lower returns over the long run, making passive bank investing a poor strategy.
Methodical Investments' rule to only hold profitable companies serves a dual purpose. Beyond seeking better performance, it ensures data integrity for their models. Metrics like P/E become more reliable and comparable across the portfolio when the denominator (earnings) is consistently positive, avoiding statistical noise from unprofitable firms.
The firm doesn't just decide a factor is obsolete. Their process begins by observing within their transparent 'glass box' model that a factor (like book-to-price) is driving fewer and fewer trades. This observation prompts a formal backtest to confirm its removal won't harm performance.
Shifting capital between asset classes based on relative value is powerful but operationally difficult. It demands a "coordination tax"—a significant organizational effort to ensure different teams price risk comparably and collaborate. This runs counter to the industry's typical siloed, product-focused structure.
Methodical Investments' model doesn't simply buy the cheapest stocks. It actively removes the extreme outliers from its consideration set. This rule acts as a fail-safe, recognizing that companies appearing exceptionally cheap on paper are often value traps, facing severe corporate governance issues, or are a result of data errors.