May 29, 2006
You Never Know the Value of Liquidity Until You Need It and Don’t Have It
FPA Capital Fund Annual Report
Robert Rodriguez is an investor I respect and follow closely.
Your Fund’s liquidity level rose to nearly 44% at March 31, 2006, which held back its performance … During the year, we added to several of the Fund’s holdings on price weakness. Unfortunately, these periods have been few and far between.
Portfolio liquidity is at a record level since we began managing your Fund in July 1984. This elevated liquidity level is not a statement that we feel the stock market is going to decline imminently, but rather that we are finding it difficult to uncover sufficient investment opportunities that meet our valuation requirements.
We have always written that we consider the level of liquidity to be the residual of investment opportunities. As an example, the value screen that I have used for many years recently identified only 73 names, close to the record low of 47, out of a universe of 9,440 in the Compustat database. This screen included stocks with market capitalizations between $150 million and $3 billion. Of the 73 names, 53 were between $150 million and $1 billion. When I expanded the screen to include stocks with market capitalizations up to $20 billion, only 20 additional companies were identified. Finally, below $150 million, 97 companies were identified.
What these results convey to us is that between market capitalizations of $1 billion and $20 billion, the market’s valuation landscape is very flat. Only when you get into very small market caps and micro caps do a greater number of companies begin to be identified. Most of these companies are not viable investment candidates for us, primarily because of their lack of stock trading liquidity.
The results of this screen are a far cry from the output that we got in late 1998, early 1999 and 1994. The stock market’s flat valuation landscape is proving to be a challenge for us in the rational deployment of your capital.