Robotti & Company Advisors Q1 2019 Letter

Theme and Background

This chapter opens Robotti's Q1 2019 letter to clients, discussing how core value investing convictions are maintained amid extreme market volatility. The backdrop is the S&P 500 experiencing its worst December since 1931, followed by its best January rally in over 30 years, reflecting a dramatic reversal in market sentiment.

Core Thesis

The author's central investment argument is that current market volatility precisely proves markets are not efficient, and inefficiency is a friend to value investors. Despite double-digit portfolio returns in Q1, holdings remain deeply undervalued with continuously improving fundamentals. The counterintuitive judgment is: investors should not sell after breaking even but should instead use downturns to enhance profitability, as style cycles and industry cycles are at inflection points with ample upside ahead.

Key Arguments and Data

• Volatility validates inefficiency: The S&P 500's worst December since 1931 followed by its best January rally in over 30 years shows market sentiment shifts far faster than business fundamentals.
• Three cycles bottom simultaneously: In Q4 2018, the equity cycle, industry cycle, and style cycle (growth vs. value) all hit bottom at once, akin to a hurricane making landfall during a full-moon high tide.
• Clear signs of industry recovery:
• Mortgage rates fell to their lowest in a year, easing housing market crash fears.
• Offshore activity has been recovering for a full year.
• Extreme valuation discounts: Despite Q1 stock price rebounds, portfolio companies remain deeply undervalued, with high insider ownership firms aggressively buying back shares (a hallmark of value-creating buybacks).
• Historical patterns unchanged: Passive investing, ETFs, and other new tools do not alter market cycles, as capital flows are determined by people, not tools.

Companies/Assets Mentioned

This chapter does not name specific companies but references the following characteristics:

• Portfolio holdings: All are cyclical industry companies that have weathered industry troughs, improving profitability through internal enhancements, opportunistic investments (including acquisitions), and buybacks.
• Buyback behavior: Executed by companies with high insider ownership, viewed as value-creating buybacks (as opposed to value-destructive ones).
• Industry exposure: Housing (sensitive to mortgage rates) and offshore activity.

Investment Implications

• Do not sell after breaking even: Current valuations remain deeply discounted, fundamentals continue to improve, and selling would forfeit subsequent upside.
• Use downturns to enhance profitability: Cyclical companies can improve long-term earnings during troughs through internal optimization and opportunistic investments (e.g., acquisitions), while also eliminating competitors.
• Style cycle shifting toward value: Growth has outperformed value for 11 years; with three cycles bottoming simultaneously in Q4 2018, value investing may be at an inflection point with "ample running room" ahead.
• Focus on insider buybacks: Share repurchases by companies with high insider ownership are a strong signal that valuations are undervalued.