My investment philosophy is deeply rooted in the teachings of the late Ben Graham and those who practice his approach, such as Mason Hawkins, Seth Klarman, Warren Buffett. They have proven that buying pieces of a business after rigorous evaluation and only at a margin of safety works well in any environment over a period of years. Therefore, I generally favor concentration over diversification, securities that aren't overly popular at the time, less debt to more debt and exceptional management whenever possible.
However, there are instances when entire industries or markets are so profoundly mispriced, it becomes difficult to truly handicap the ultimate winners. But the opportunity looks so compelling from a valuation and risk/reward perspective. In those instances, I'm a big fan of creating a basket of stocks from that industry or market -- make one of your portfolio holdings a basket of various holdings. In a sense, you are creating your own ETF.
I suggested this a couple of years ago with respect to Japanese stocks: After 20 years of continuous stock market declines, many Japanese stocks were selling for nothing more than the cash on the balance sheet and had underlying businesses that were consistently profitable. But because it was Japan and it was hard to handicap one position, creating a basket of Japanese stocks made sense.
Buffett did this with Korean stocks a decade ago and the late great Sir John Templeton did this back in 1939 when he created a basket of 104 companies trading for less than $1 a share.
The steel industry today looks ripe for a basket investment approach. Steel stocks have not participated in the stock market rally over the past five years. Many of them are trading at fractions of the valuations they commanded pre-recession. You don't need pre-2008 prices to do well. Consider the following:
- ArcelorMittal (MT) today trades at $14, compared with $100 a share just over five years ago.
- Posco (PKX) trades at $76, compared with $180 a share over five years ago.
- AK Steel Holding (AKS) trades for $4 today, compared with $70 five years ago.
- U.S. Steel Corp (X) trades for $20.55, compared with $180 over five years ago.
The steel cycle will inevitability improve; steel is the foundation for economic and urban growth. Yet it's likely as the steel market improves, greater efficiency and competition will change the dynamics of the industry with some faring better than others. It may not be that biggest is necessarily best. You may find that a company such as AK Steel does better than ArcelorMittal. In any event, creating a basket of these companies and holding on to them for the next two to four four years will likely produce big winners and some laggards. But in such a scenario the outperformers will typically more than make up for the losers.
Don't think of baskets as over diversifying. Instead, think of making a single investment in steel equivalent to what you would deem an appropriate portfolio allocation. Then take that allocation and chop it up among the names you like the most. In addition to the four above, quality names including Nucor (NUE) should be in any steel allocation. After that, the hardest part is being patient. But the patience usually pays off.