“The wisdom of the crowd only works when everyone knows something about the thing they are evaluating.”- James Surowiecki
Irrational Pessimism is the Perfect Breeding Ground for Outperformance
Over the past few months, the most common question has been whether iolite’s holdings (currently, the portfolio is predominantly invested in international small caps) are “too small to attract buyers”. I’ll address this more fully in my upcoming annual letter. For now, please keep these three points in mind:
Our holdings are actively buying back their own shares.
No fish is too small to be eaten by a bigger fish.
The real money is in the waiting, not in frequent trading.
In my 20 years of managing money, I’ve never seen sentiment toward international small caps this dismal. While this negative trend has been building for several years, it feels as though the dam finally broke in 2024, with many investors capitulating and stockpicking funds seeing record outflows of US$450 billion.
Buyer vs. Seller
In any market, you’re either a buyer or a seller. Buyers want low prices; sellers want high prices. If your holdings allocate cash to share buybacks, you are effectively a buyer - which means you benefit from lower prices over a longer period. Every share repurchased at a discounted price amplifies potential future gains.
Counterintuitively, if you’re a saver and you own good businesses, you want prices to stay low so these companies can deploy cash in the most capital-friendly way. You only want prices high if you need liquidity.
Case in Point: International Petroleum
International Petroleum (IPC), a leading oil producer, trades at around 1/50th of its intrinsic value under moderate oil price assumptions. Despite investing US$800 million in a major Canadian project, it continues buying back shares aggressively - up to US$1 million worth each day. When IPC’s share price dipped in Q4 due to lower oil prices, I saw it as an opportunity, as the company repurchased shares at an even deeper discount.
For a low-cost producer on the verge of tripling its output - and with an 80-year resource life - it makes little sense to be priced based on short-term oil price fluctuations. Fortunately, IPC’s savvy management is exploiting this market dislocation by allocating its generated cash to share buybacks. Few market participants have this mindset, and those invested in IPC are fortunate to own a top-tier asset with excellent capital allocators at a heavily discounted valuation.
Investing Is Like Farming
Investing is akin to farming: there’s a season for sowing, another for nurturing, and eventually one for harvesting. Know which phase you are in.
Don’t Get Caught in the Mania
Avoid getting caught up in the current market mania driven by only a few stocks. Seventy percent of the MSCI World Index is now allocated to the US and the US dollar - both appear expensive by multiple historical measures. Investors passively holding the index are effectively buyers of a highly concentrated, richly priced market.
On Christmas Eve, Apple hit a record $3.9 trillion valuation at 37.5x earnings (a 2.7% earnings yield). The “Mag 7” tech giants alone now exceed the total size of the S&P 500 just a decade ago - and match its size as recently as March 2020. Meanwhile, the S&P 500’s forward P/E has surged to 25, a level last seen in 2000, just before the dotcom crash. Index concentration - a reliable market inflection indicator - is also at historical highs.
Historically, returns following such lofty valuations have been mediocre at best. Price matters - even if it may not seem so today. In late December, Thomas Peterffy (Founder and Chairman of Interactive Brokers, the world’s largest online brokerage) remarked: “Over the last 3 months, our margin loans are up by 16%… I think equity prices are somewhat overextended. And I hope that as they come down, they will not come down too fast, so we can liquidate as it happens…” It’s rare for “the house” to sound such a warning.
Europe’s Market Concentration
Europe’s markets are just as concentrated. Half of the DAX’s value comes from only six companies: SAP, Siemens, Deutsche Telekom, Allianz, Airbus, and Munich Re. Excluding SAP, the index has barely moved for years. Consider whether these six firms are truly representative of Germany’s economy - or whether they are especially compelling investments.
Dollar Strength Makes Shopping Abroad More Attractive
Throughout 2024, the US dollar continued to strengthen against most currencies, despite the US running a 7% fiscal deficit amid a strong economy and still-low effective interest rates. Consequently, international stocks are becoming even more discounted for dollar-based investors.
Many currencies remain fundamentally more robust than the US dollar, with lower debt-to-GDP ratios, smaller fiscal deficits, and stronger trade balances. Investing abroad not only provides an additional discount on already low valuations but also serves as a hedge against a potential future weakening of the US dollar.
Investing vs Speculation
Speculators obsess over price movements, while investors aim to acquire quality assets at discounts to their intrinsic value. Don’t let FOMO (fear of missing out) or greed turn you into a speculator - it’s a path to disaster. Staying disciplined and value-focused is crucial for long-term success.
Owning Outstanding Businesses
Almost every large fortune can be traced to owning (and holding) great businesses. If you own exceptional companies far below their intrinsic value - just as those same firms are aggressively repurchasing shares - you are in a very favorable position to be in.
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