Dear Fellow Investors and Friends

Welcome! I do appreciate you taking the time to read this.

I’m Piet Viljoen, and today is Thursday, the 14th of March, the 74th day of the year. There are only 292 days left until the end of the year. Today is also Pi Day, which, by coincidence, also happens to be Albert Einstein’s birthday. Math rocks!

Last week, a group of us cycled from Jeffreys Bay to Gordon’s Bay – and I’m happy to say we had a lot of fun, no accidents, and very few mechanicals. It was an honour and a pleasure to ride with this group of people. To top it off, we raised over R100k for the RECM Foundation.

Don’t worry, I won’t ask you for money again – the only thing we need is Panado for Amanda’s headache. Here are some pics from the ride:

RECM cycling

The bottom line is that we live in a beautiful country.

I am in Hermanus this week, where I spoke at Alec Hogg’s Biznews conference. I’ve spoken at the previous 5, which all took place in the Drakensberg. I’m not sure whether it’s the change of venue, but this year, there are over 500 attendees. It really is a special event that brings together lots of interesting speakers, from politicians to businesspeople to sportspeople. The high quality of the delegates is always a highlight of the event for me.

One might not always agree with all the points of view, but Biznews is one of the few media outlets that are not afraid to showcase different sides of a story. It makes for a fascinating conference. I was particularly struck by Sean Summers, RW Johnson, David Ansara and Christo Wiese’s talks.

As for my talk, I started off going on about perpetual motion machines and ended up with how value investing relates to them, as one does.

Does that even make sense? Judge for yourself:

This is a picture of Mr John Keely and his invention, which he called an “etheric force machine.” He also called it a “hydro-pneumatic-pulsating-vacu-engine.” No matter what name he gave it, he claimed it was a perpetual motion machine.

Perpetual motion machine

But such machines don’t work because they break the laws of physics. The first and second laws of thermodynamics state that energy cannot be created, just transferred or transformed. In this process, some energy is dissipated.

Now, people love free stuff, so it’s no surprise that fraudsters and conmen are attracted to ridiculous notions like perpetual motion. They then use the promise of “free energy” to extract cash from their unwitting targets.

One of these frauds was John W. Keely, who announced his newly invented ‘Perpetual Motion’ machine in 1872. In 1874, he announced the incorporation of the Keely Motor Company. The “Keely Motor” allegedly provided a new form of energy at a low cost, and the charismatic founder proclaimed his invention could fuel a round-trip train journey from New York to San Francisco using just one quart of water.

Keely’s use of scientific jargon gave him the appearance of a sophisticated scientist. Later, after Keely’s death, investigators discovered that all the “force” allegedly created by the Keely motor was actually powered by an enormous air compressor hidden beneath the floorboards on which his machine stood.

Of course, this being America, Keely sold stock in his company to the public; eventually, it turned out to be worthless.

Which, of course, brings me to value investing.

In the past, investors – the disciples of the father of value investing, Ben Graham, trawled the market for mispriced opportunities. Mispricing could be due to short-term business setbacks, complicated transactions, cyclicality or poor management. A value investor would analyse the situation and realise that the fundamental value was well above the market price. If the investor was correct, and the value aberration was temporary, the market would quickly latch on to that fact as well and buy it, repricing it towards fair value. This happened in the opposite direction as well: value investors would identify overvalued situations, sell them short, and wait for the market to reprice downwards.

Famed value investor Jeremy Grantham called mean reversion one of the strongest effects in financial markets.

It looks something like this:

Mean reversion

Fast forward 100 years. Value investing is out of favour, and the investing narrative driving the market has now been polished to a bright sheen. Doesn’t the  “Magnificent 7” sound so much more attractive, comfortable, and investable than “FANGS”?

One of the few surviving value investors globally, David Einhorn, has publicly stated he has had to change his investment process because “markets are broken”. Jim Chanos, the famous short seller, closed his hedge fund last year, saying, “It is no secret that the long/short equity business model has come under pressure and interest in fundamental stock pickers has waned”.

Even Grantham threw in the towel on profit margin mean reversion, citing permanently elevated profit margins, sustained by globalisation, corporate political power, and most importantly, low real interest rates.

So what’s going on? Much of this has to do with the rise of indexing.

Make no mistake, for most investors, indexing makes a lot of sense – it provides market returns at a low cost. In the USA, at least, the market has been a good place to be for the longest time. The S&P 500 has compounded at just over 10% p.a. for the past 60 years. That means your money doubles in value every seven years. More importantly, inflation in the USA over that period has been just under 4%. So, the index has grown your capital by 6% p.a. in real terms.

That is huge.

No thought, work, research or special insight is required – just patience.

On top of that, according to Morningstar, 74% of U.S. large-cap blend managers underperformed the S&P 500 last year. The decade ending in 2023 saw 90.2% of U.S. large-cap blend managers underperform their benchmarks.

Given these numbers, indexing is not only a sensible strategy but also a compelling strategy.

It’s not surprising that, by now, more money is being indexed than being actively managed.

Active vs passive

Last year alone, Morningstar reported that passive US equity funds took in $244 billion while active funds suffered outflows of $257 billion. That continued a well-established trend:

Active vs. passive flows

Now, here’s the crux: active managers as a group are, relative to the market index, effectively long smaller, undervalued stocks and short big growth companies. Patrick Palfrey of UBS says active large-cap managers have “a natural propensity to underweight the biggest stocks.”

Concentrated markets

As money flows away from active managers, they are forced to sell what they own, which, by definition, differs from the index. So, the smaller non-index stocks face a continuous wave of selling, while the large index components face a continuous wave of buying. The big ones get bigger and the small ones get smaller.

Today, the indices have become quite concentrated. The Magnificent 7 now make up 30% of the S&P 500. 20 years ago, the top 10 stocks made up less than 10%.

And, as these very concentrated indices continue to outperform, they attract more money, leading to further concentration and further outperformance. And the narrative gets stronger with every iteration. But that’s all it is –  a narrative because no one really knows what the earnings power of these Magnificent 7 companies will be ten years from now.

Just like a perpetual motion machine, it’s a narrative, not a fact.

Let me show you why:

In 2015, Microsoft was on a P/E of 15, while as recently as 2016, Apple was trading on a P/E of less than 10. Nobody wanted to own either – they were seen as dinosaurs. The iPhone changed Apple’s fortunes for the better, while first, the cloud and then AI radically improved Microsoft’s fortunes. But if you look at any analyst report on those companies predating these products, you will see that they did not discuss the iPhone, the cloud, or AI. The success of these products was not predictable. The future looked bleak.

Today, the Magnificent 7 – Apple, Microsoft and the rest of the gang, trade on an average P/E of 48 times trailing earnings. They are seen as must-haves in any portfolio, and analysts all forecast a very bright future for them.

There are two questions you have to ask yourself when thinking about these stocks: why were the analysts wrong in 2015 on these stocks? And are they right today?

The answer is simply that the future is unpredictable, so when you pay a high price for a stock, you are not only assuming a rosy future, you are demanding it. You might find it comfortable to do so, given all the analysts are predicting exactly that. But their predictions are not worth very much – as we’ve seen.

If not predictions or narrative, what are some of the actual drivers of stock returns?

Drivers of stock returns



Since 1957, the biggest 10 stocks have underperformed an equally weighted index by 2,4% p.a.

Will it be different in future?

The market thinks that the outperformance since 2013 – which happens in the prelude to every bubble popping – will continue. History suggests otherwise.

Starting valuations

Today, starting valuations are even worse than they look. Consider Microsoft.

Microsoft’s net income over the past 12 months was $72bn. Depreciation and Amortisation was $14bn, so cash from operations was $86bn. Deducting their capex of $35 leaves cash belonging to shareholders (i.e. owners’ earnings) of just over $51bn.

Accounting earnings of $72bn translates into EPS of around $10 per share, which puts Mr. Softee on a P/E of 40. On owner’s earnings, they are on a multiple of almost 60 times – for a free cash flow yield of 1,5%.

Exciting long-term shareholder returns do not start from here.

What can we take from all of this?

Very simply, markets tend to ignore the immutable laws of economics and finance when the price of an asset soars. If you’re raking in money on an investment, why question its merit?

The alternative

Instead of buying into this perpetual motion machine, rather look for something similar, except based on actual fundamentals.

Instead of looking for businesses with strong fundamentals (free cash flow, earnings, etc.) which are being ignored and hoping the market will “mean revert” them, rather buy shares with these characteristics:

  1. A good business with a low initial rating.


  1. A management team that prioritises share buybacks with its cash flow.


  1. A small market capitalisation.

A P/E of, say, 5 translates into an initial earnings yield of 20%. If the business does nothing but maintain its current earnings power – which a fair business should be able to do, that is what you will earn. So you don’t care about mean reversion. Remember, these stocks aren’t cheap because there is something wrong with them; they’re cheap because of forced selling – especially the tiny little small caps.

If the company can use its cash flow-generating ability to buy back its shares, then your return will be even higher!

So now you have something with a starting high return, plus it counteracts the forced selling by active managers with its own buying.

Here are two examples, Argent and Calgro M3:

Argent chart

Shares outstanding in Argent reduced by 33% between March 2018 and February 2024. Earnings per share grew from R1.01 for FY19 to R4.13 for FY23. Estimates for FY24 are R5.00.

Calgro chart

Shares outstanding in Calgro M3 reduced by 25% between March 2020 and February 2024. Earnings per share grew from 14.88 cents for FY21 to R1.53 for FY23. Estimates for FY24 are R1.84.
Note – both of these – and many others like them, are small companies, which the big, index-tracking managers cannot buy.

It’s no longer good enough for value investors to research and identify cheap stocks and rely on mean reversion to rerate them. As long as the index pulls in investor flows, reversion will stay broken. We now have to go one step further – buy cheap stocks with strong fundamentals and get them to buy back their shares.

This brings me to the old Irish joke about the lost tourist who stops and asks a local Irishman for directions. He answers: “Well, if you want to get there, I wouldn’t have started here.”

We are at a similar place when it comes to indexing. Overvalued assets like Microsoft now play a dominant role in almost all indices.

My take: if you want good returns going forward, don’t start with the index. You have to do something very different.

I know this flies in the face of your lived experience over the past 15 years. But things always feel pretty good at the top of a bull market. Or, as Warren Buffett likes to put it, bull markets are like sex: it feels best at the very end.

My bet – the magazine cover curse will strike again.

Magazine cover

I will keep the rest of the letter shorter than usual, as I’ve already taken up much of your time.

Did you know?

Our listed investment company, Astoria, increased its holding in Leatt Corporation this week. Leatt Corporation designs, develops, markets and distributes personal protective equipment for participants in all forms of motorsports and leisure activities, including riders of motorcycles, bicycles, snowmobiles and ATVs. It is a global business headquartered in Durbanville.

It is a company we admire, and we are now proud to be their second-largest shareholder.

What I’m listening to

Josh Brown and Drew Dickson on indexing, size and Europe relative to the USA in this podcast.

Barry Ritholtz and David Einhorn discuss the problems with value investing in the current market structure in this podcast.

One of our shareholders sent us a link to this 4 part podcast on the post-COVID travails of the bicycle and related apparel industry, which affects Leatt directly. They have weathered the storm well, and in their latest results they talk about some light at the end of the tunnel. Find it here.

What I didn’t watch

The Oscars. Remember them? No? Well, I’m not surprised – their popularity has declined steadily for years. Sport is the king of the entertainment hill. This chart is from Bianco Research and this post on X in particular, where they compare NFL Superbowl viewership with that of the Oscars. If you think Taylor Swift dating Travis Kelce is pure happenstance, think again.

Oscars vs. Superbowl

That’s it for this week, except to wish all the Muslim readers Ramadan Mubarak!

Piet Viljoen