East Coast Asset Management on Mispricings: Q1 Letter ~ market folly

Wednesday, April 25, 2012

East Coast Asset Management on Mispricings: Q1 Letter

Christopher Begg's East Coast Asset Management is out with their first quarter letter and in it they focus on mispricings.  We like to highlight their letters due to the focus on investment process.  After all, investing is a profession that requires continual education.

Begg shares his wisdom by writing, "Mispricing discovery is intelligent investing. We want to clarify that mispriced does not mean cheap - mispriced investments are not partial to any particular asset class nor are they partial to style boxes and growth rates."

We've previously highlighted how Greenlight Capital's David Einhorn looks for mispricing when investing, seeking to better understand situations to generate returns.

Begg goes on to breakdown mispricings into two types:

Structural - These exist "when an event occurs that forces a large population of owners to sell without any change in the investment's intrinsic value.  Examples of structurally induced selling would include: when an investment is deselected from an index, when a company is spun off from a larger parent company, or perhaps when a company's credit rating is reduced."

Psychological - He says that these mispricings "are driven from collective investor psychology which induces broad selling or a lack of buying in an investment."

East Coast feels that "our greatest source of mispricings occurs when myopic investors have difficulty focusing on the distant compounding merit of a great business (compounder category) or the inflection point of a material change in an industry that is improving (transformation category)."

Begg then goes on to highlight their investment in Colgate-Palmolive (CL) as a prime example.

Current Market Commentary

East Coast also summarizes their views on the current market, writing

"In aggregate, the market is reasonably priced at below 14 times 2012 projected earnings; inverting the multiple means that we are getting a 7.5% earnings yield.  If we include an economic growth rate of 2-3% we arrive at expected equity returns in high single digits."

Their letter also goes on to examine Apple (AAPL), concluding that, "We don't disagree with the quality of the business nor do we doubt that the valuation looks attractive.  What we do struggle with is the ability to truly compound at an attractive rate based on size."  We've also posted up on the subject with our post: The Apple Conundrum.

Embedded below is East Coast's first quarter letter:

For more from this firm, head to East Coast on embracing uncertainty as well as their great piece on gaining an investment edge.

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