04 Sep 2010 Torray Fund - Q2 2010 Commentary
As a result of this massive capital shift, the market remains locked in the doghouse, even though stocks, compared to bonds, are now the cheapest they’ve been in 60 years. This shows once again that investors can’t stop viewing life through a rearview mirror, favoring assets that have done the best and rejecting those that have performed the worst. Economic and business fundamentals play no role. It’s all about the direction and momentum of prices. Inevitably, when trends reverse, those on the wrong side of the equation suffer losses. Put another way, if all the money ends up in one place, you can be sure it’s the wrong place.

The situation today is dramatically different. While stock prices are up significantly since the spring of 2009, they remain undervalued and evidence suggests the financial crisis has passed. Earnings have risen and balance sheets are strong with cash at record levels. The price-to-earnings ratio on stocks in The Torray Fund averages about 12-to-1, representing an earnings yield of 8.3%. If these earnings are reinvested and P/E’s on the portfolio remain flat, the collective value of the businesses will double in less than nine years, although actual Fund returns may differ. Should earnings grow, which we’re confident they will, fundamental underlying results will be even more favorable. By comparison, a decade ago, the market’s P/E ratio was 26-to-1 for an earnings yield of less than 4%. At that rate, it takes 18 years for money to double. Just as important, the financial and competitive strengths of quality businesses provide a solid cushion against permanent loss. Over the nearly 40 years we’ve been in business, there have been nine market declines, three of them severe. The shares of most solid companies nevertheless recovered and rewarded their owners over time.

We have mentioned in past letters that in the early ‘80s, raging inflation drove bonds down and interest rates up by unimaginable percentages. Before the cycle ended, 30-year governments yielded over 15%, nearly four times present-day rates, yet investors wouldn’t touch them. We will add here that as it relates to the risk of inflation, government bonds are no more than I.O.U.’s, dependent for payback on the printing of money by an entity that can print all it wants. Our opinion is that investors, in the long run, will fare much better owning a diversified list of profitable growing businesses. If stocks were to take five years to advance a mere 10% — an unduly pessimistic scenario in our view — their return would exceed interest payments to maturity on today’s five-year government bonds (1.57%). Assuming dividends don’t increase, which seems unlikely, the total return would still be nearly three times that of the latest five-year issue. For those seeking a shorter-term investment, prospects are slim. Three-year IBM bonds pay 1% and 2-year governments, 1/2 of 1%.

In earlier letters we have critically addressed the numerous murky financial innovations that have rattled markets and frightened the public to the point where countless investors have abandoned stocks. Hardly a day goes by that we don’t hear about it from friends and acquaintances. Any faith they had in long-term investing is now gone and relentless criticism of the approach by doomsayers has only reinforced their skepticism. The new message is forget buy and hold, start trading, nail down profits and cut losses at the first sign of trouble. But this is not new. Speculative trading has been a prominent feature on Wall Street for over 100 years, though as far as we know, nobody’s ever made money at it for long.

This new paradigm has triggered a shift in focus by stock analysts and market strategists from studying long-term business fundamentals to predicting next-quarter earnings and guessing their likely impact on share prices. Regrettably, these forecasts and how they pan out have become the central theme of TV business shows. Our position is that quarterly earnings are largely meaningless in a long-term context, a point that’s been made over the years by a number of thoughtful corporate CEO’s. We suspect a lot of them wish analysts would just drop the subject. The only certainty about earnings is they fluctuate. Despite this reality, business show hosts work themselves into a frenzy every three months as the fabled “earnings season” comes around. When reports are due, there’s teeth gnashing and nail biting about whether sales, earnings and cash flow will beat, meet or miss analysts’ targets. Typically, if just one measure falls short by a percentage point or two, the stock sinks. Many of our holdings have succumbed to this, only to recover in subsequent days or weeks. In other cases, if the numbers meet expectations, the shares go down anyway. This often reflects bets by speculators that have bought in thinking the news will be good, intending to sell if they’re right. If they are, they unload in a flash, sending the price down before anyone can figure out what’s going on. It brings to mind the old Wall Street adage, “buy on the rumor, sell on the news.”

Without getting into detail — we’ve discussed this before — flash trading and other computer-controlled strategies, along with machinations of the type just noted, are the major cause of today’s market volatility. Their defenders claim these tactics benefit the public by improving liquidity. The truth is long-term investors don’t need liquidity. They’re not buying to sell the next day, week, or year, and, in any event, over time, how much difference can five or ten cents a share make? The fact is the operators of these schemes are in the business of making money the fast way, even if it’s only in fractions of pennies per share on positions reportedly held for only seconds or minutes. The gain may not sound like much, but on the billions of shares they trade each day — estimated at 40%-70% of the Exchange’s volume — it adds up. This has to be a zero sum game — that is, they can’t all be winning. If they are, someone else must be losing, and most likely it’s the public.

11 Mar 2010 Torray Fund - Q4 2009 Report
When we wrote to you a year ago, stocks had taken a terrible beating and our country was in the midst of the most severe economic turmoil since the 1930s. Despite the gloomy backdrop, our January letter expressed optimism about America’s future, saying, “The damage is done and, in our opinion, largely reflected in stock prices.” Highlighting the risks of expressing such views publicly, the market promptly fell another 25% in about two months, bringing its loss since October 2007 to 57%. (By coincidence, The Wall Street Transcript interviewed Bob on March 9, the day stocks bottomed. That article, published in the March 23 issue, appears on our website, www.torray.com.)

Even though the news was worse by mid-year, shares had rallied to a small gain, and our July letter expressed “room for more optimism than at any time since the financial crisis began.” We emphasized this was a long-term view, not a forecast of where stocks were headed over the next few months or quarters. As it turned out, we would have looked a lot smarter claiming a turnaround was imminent — between March 9 and year’s end, stocks advanced 65%. While this came as a tremendous relief, it was, unfortunately, too late for countless investors that fled the market during the downturn, pouring billions of dollars into Treasury bills, money market funds, CDs, U.S. government bonds and bond funds. By the end of the year, domestic equity funds alone had experienced net withdrawals of $38 billion, while bond funds took in $375 billion — a 10-to-1 ratio. Treasury bills, yielding nothing, have been in such great demand, their prices, on several occasions, have risen above par, meaning holders were paying to ensure they got their money back. Huge sums have also been put into one, two, and five-year government bonds, despite the fact they yield only 0.3%, 0.9% and 2.4%, respectively.

Leaving taxes aside, we believe none of these rates will compensate for inflation, which has averaged 4% for more than 75 years, or the possible negative consequences of our country’s massive deficit and debt issuance. More importantly, they will never produce enough money to retire on. Had the Pilgrims, landing at Plymouth Rock in 1620, bought money market funds at today’s rates, it would have taken until now — nearly four centuries — to double their investment. Better, but still not good, a quality bond portfolio diversified across today’s yield spectrum would probably generate an income in the neighborhood of 3% a year, doubling money in 24 years. By comparison, our Fund, in spite of the last decade, has multiplied in value 5.7 times in 19 years. Over the last 70 years, bonds, net of inflation, turned $1 into $2.70, while $1 in stocks grew to $103.00. Despite this record, untold numbers of investors are positioned today as though they expect the opposite result going forward.

Meanwhile, top-quality stocks, many paying dividends exceeding current short-to-intermediate-term interest rates, are now rejected at prices more than 25% below their levels of 2007, a time when investors were loaded with them, often on margin. (They are also 24% lower than they were at the close of 1999.) When the market collapsed last year, those that sold and moved to cash and bonds not only sustained big losses, but also missed the rebound. Victims of the worst timing ended up with 65% less money than if they’d simply stayed put — admittedly a very hard thing to have done under the circumstances. They are now faced with having to nearly triple their money to get even with where they were last March. Assuming a 10% annual return going forward — the stock market’s long-term average — it will take about 12 years to do it. Even this understates the challenge. Investors have come nowhere near matching the market over the long haul, mainly because they persist in jumping in and out of stocks at the wrong time. Having observed this behavior for almost 50 years sustains our conviction that the buy-and-hold approach — declared dead by the pundits at last year’s lows — is the only one that works.

At this point, we feel the average investor is too heavily committed to bonds and cash equivalents — a no-win situation from our perspective. In the early 1980s, investors wouldn’t touch depressed 30-year U.S. governments yielding 15 1/2%. Today, they’re buying them at yields around 4.6%. If history is a guide, when the economy recovers and stocks go up, the money in bonds is certain to shift into equities at prices far higher than they were sold. This illustrates, once again, the problem people have differentiating risk from opportunity. They invariably think risk is low when prices are high, and vice-versa. This applies to stocks, houses, commercial real estate, commodities, and anything else that trades. At critical junctures, investors bet heavily they’re right, and no amount of reasoning can change their minds.

In the present case, we doubt fixed income investors are convinced they’re right; it’s just they’re afraid to do anything else. Recognizing this, we nevertheless believe investors with low stock positions should consider gradually moving back into high quality shares or funds that own them. There’s no need to hurry. The best strategy is to invest amounts one’s comfortable with on a regular basis — monthly or quarterly, for example. When prices fall, (which they did during nine of the 37 years we’ve been in business), each new investment will buy more shares and earn a higher dividend return. Ironically, while this is a big advantage for the long-term investor, the average person tends to associate falling share prices not with opportunity, but with losing money. Some losses, of course, are inevitable, but a well-diversified portfolio should provide a cushion against them.

Stocks, as we all know, can deliver unpleasant surprises. The market has been very volatile in recent weeks, making people that were already nervous even more so. Some may fear a collapse with no recovery. While there are obviously no guarantees, they should keep in mind that it’s never happened before. We remain confident about America’s future based on its record of prosperity and resilience in the face of adversity. Beyond that, we are reassured by the solid, economic fundamentals of companies in The Torray Fund. As we’ve often said, “If the business performs, the stock will take care of itself.” Everything else is guesswork, and we don’t know anyone that’s guessed right for long.

hese are tough times, the worst any of us have seen. Experts are everywhere. You can’t turn on the television or pick up a newspaper without being inundated with predictions on the market’s direction and what to do about it. They should be ignored. Investors will do far better sticking to the fundamentals, secure in the knowledge that, over time, sound, growing businesses have produced higher returns than any of the alternatives widely available to the general public. Despite the many challenges our country has faced, things have always worked out, and we believe this case will prove no different.

08 Sep 2009 Torray Fund - Q2 Report
When stocks recover from a crash, speculative issues often perform best, and last quarter’s rally proved no exception. In fact, it may have been a record-setter in that regard. Shares priced under $5 out-ran stocks trading above $50 by 91%. Those of companies losing money or breaking even beat profitable ones by 24%, and, belying the notion investors crave income, stocks paying dividends trailed those that didn’t. These are truly extraordinary statistics.

As we write, these trends have reversed, with higher-quality stocks taking the lead. There are signs the economy and financial system are stabilizing, and reported earnings, so far, have been running ahead of expectations. All of this is encouraging. While one can never know the future, we think there’s more room for optimism now than at any time since the financial crisis began. In saying this, we’re talking longer term, not just a few months or quarters.

In response to the tremendous beating they’ve taken, desperate investors are looking for cures in what we see as all the wrong places. Stocks of the best companies have been sold and the proceeds put into money market funds, CDs, savings accounts and bonds. Huge sums have also moved to overseas markets, especially those in lesser-developed countries. Sooner or later, we believe this money is bound to end up back where it started, but probably not until stock prices are much higher. We’ve seen it happen too many times to think otherwise.

Despite our economy’s ups and downs, and the market’s unpredictable erratic gyrations, patient long-term holders of stocks have fared very well. In fact, stocks are the only widely available option that has directly tracked America’s prosperity. Fixed income options have run far behind. Yet, as noted, people have been buying them anyway, largely in response to punishing losses they fear may only get worse. Ironically, at the top in October 2007, they were doing just the opposite. The national savings rate was negative, and investors chased stocks, many at twice today’s levels, often on margin. They also bid up houses and commodities. This is the only business we can think of where the customer goes into a frenzy over a rising price. Think about it. Who would reject a new car at $10,000 only to buy two at $30,000? But, that’s what people tend to do when it comes to investing.

Unfortunately, in the present circumstance, we think investors sitting on 2% CDs and five and ten-year government bonds yielding 2 1/2% - 3 1/2% are once again heading for disappointment. Taxes aside, long experience suggests these choices, net of inflation, will return little or nothing. Beyond that, it’s even more foolish to be selling quality stocks after they’ve dropped 30% - 50% to buy speculative ones just because they’re going up.

09 Mar 2009 The Torray Fund - Annual Report
...a market environment characterized by low volumes and high volatility which has attracted speculators but scared off long-term investors. Sources at the New York Stock Exchange have told us there are an estimated several million day-traders gambling with their 401(k) plans - some, unfortunately, unemployed. These trading accounts can be leveraged four-to-one ($100,000 of equity supports a $400,000 portfolio) provided the positions are liquidated by the end of each day. You may have noticed the market’s recent gyrations and heavy volume between 3:40 and its 4:00 close. It is during this period that many large blocks of stock and most of the outstanding day-trading margin debt are cleared, a phenomenon that occasionally has caused volume to as much as double in 20 minutes. (The orders are entered into the Exchange’s electronic system, nicknamed “the dark hole,” where they are matched by computers.) This activity has triggered wild swings in the Dow Jones and S&P 500 indices, heightening investors’ anxiety...

Also worth noting is the Federal Reserve’s measure of assets available for immediate spending - i.e. cash or equivalents - jumped 86% to $8.9 trillion in the first 11 months of last year. That is enough to buy 75% of all domestic stocks. By contrast, at the market’s peak in early 2000, the same Fed measure totaled $5 trillion, or 20% of the market’s total value, suggesting that investors are more fearful of losses at today’s low prices than they were when the market was twice as high. If history is a guide, when the current financial distress passes and the economy recovers, investors will quickly change their minds and pile back into stocks, causing them to rally sharply. This classic “buy high - sell low - buy high” syndrome has afflicted investors since the earliest days of exchanges.