JANUARY CLIENT LETTER: THE THING ABOUT CONSENSUS VALUE
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Some of the greatest opportunities in the financial markets are those where value is allowed to be cultivated through an incentivized management team. The more difficult to assess the value of a company, as a result of a mix of esoteric assets and restructured operations, the more likely it is that the market will misrepresent the value of the company. The smaller the market cap, the greater the discrepancy in value. The aforementioned are all fairly obvious points to the experienced investor. Obviously, in areas of the market where less individuals and institutions are paying attention, those areas will be prone to substantial dislocations in value. And perhaps even more obviously, individuals are driven by incentives. Without them we become lackadaisical, mouth-breathing neanderthals that would be perfectly content spending our days trying to beat the high score in Candy Crush. Incentives drive human behavior, creativity and in the end, the realization of value in undervalued corporations. What is missing from the formula is everything that takes place in between the realization that value exists in a company and an incentivized, experienced management team put in place to expertly help in realizing the value. There are literally countless individuals who have spotted the correct alignment between value and incentives, yet there are few who are consistently able to outperform the market. The realization, in fact, that a value/incentive aligned situation exists is very often a consensus event. A consensus value event is one where a majority of individuals observing the company believe that value exists in the corporation and eventually the share price will be substantially higher. A consensus value event is not attempting to pick the bottom in a violent, macro driven decline in oil, for example, as we experienced exactly 12 months ago. A consensus value event is also not attempting to pick the exact bottom of the financial crisis by purchasing a basket of stocks in March of 2009. These are contrarian value events, which is a topic for another letter. The difficulty investing in a consensus value event comes from an inherent conflict with the basic functioning of the financial markets, generally. Consensus is essentially an abomination in the financial markets. Markets will go through inordinately painful measures that completely lack any rationality to eradicate consensus allocations and investments in the markets. In fact, many popular quips exist that attempt to simplify the action: The markets can stay irrational longer than you can stay solvent; losers average losers and so on. In order for the markets...