(Image Credit, wsj.com)
Leon Cooperman CFA, is another one of my favorite value investors.
In 1967 he started with Goldman Sachs. He held a number of key positions in the firm, he was founder, Chairman and Chief Executive Officer of Goldman’s Asset Management division. For nine consecutive years while at Goldman Sachs, Cooperman was voted the number-one portfolio strategist in Institutional Investor Magazine’s “All-America Research Team” survey.
In 1991 he founded Omega Advisors, Inc., a value oriented hedge fund. Omega has approximately $5.2 billion under management (as of July 31, 2016). With a significant amount of personal general partner capital invested in the Omega funds. The Omega Advisors website states, “we (to quote Warren E. Buffett) eat our own cooking; our interests are very much aligned with that of our investors”.
Clearly, he’s a value investor that we need to listen to.
In the Fall 2011 edition of the Graham and Doddsville newsletter I read a great interview with Cooperman. I loved his thoughts on what types of stocks you should own, and when is the best time to sell.
Let’s take a look…
You can find the original newsletter here,
Here’s an excerpt:
G&D: What are the characteristics of a business that you‘d want to own for a long period of time?
LC: To me, it‘s free cash flow sine qua non because that gives you the ability to intelligently redeploy your money. If you don‘t have the free cash flow, you don‘t have anything.
Number two is a business that has a moat around it, where it‘s competitively insulated to some large degree. There are very few businesses that actually have a monopoly position today.
Quality of, and incentives for, management are also very important. We look at management ownership to see whether their interests are aligned with the shareholders‘ interests and we look for their compensation levels to be reasonable.
The compensation levels in corporate America are ridiculous in my opinion, and this is a big problem today. Hedge fund guys are overpaid but the good news about that is, you don‘t make the money unless you make the money for the investor. In corporate America, you‘re being paid to fail.
A lot of times, guys are kicked out of companies and they leave with $10, $15 or $20 million checks, which I think is ridiculous. Back to free cash flow; I would obviously weigh-in the growth of the company too. I would love to own a company that has great investment opportunities in which it‘s investing a lot of cash.
I just want to make sure the money is invested wisely. A company has a number of uses for free cash flow.
Management could choose to reinvest in the business through capital expenditures, buy other businesses, reduce debt loads, or pay out dividends. I just want to make sure management is channeling their cash into the right opportunities.
Corporate America has been very busy, particularly in 2008, buying back stock. Most of them have not known what they‘re doing. There‘s been a large amount of money wasted. I gave a presentation at the Value Investing Congress in 2007 where I said a lot of companies were mispricing what they were buying.
I was highly critical and provided many examples of this development. Analysts tend to be cheerleaders for corporate repurchase programs. In my view, these programs only make sense under one condition – the company is buying back shares that are significantly undervalued.
Most management teams have demonstrated the total inability to understand what their businesses are worth. They‘re buying back shares when the stock is up, and have no courage to buy when the stock is down.
G&D: How has your approach to investing changed since 1991?
LC: Not in an appreciable fashion. The bulk of our portfolio is long-term oriented bets. We do a certain amount of trading – a quarter of our portfolio turns over more actively. I think the major change was a result of the drubbing most of us took in 2008.
I did not do a good job of controlling losses. I invested a certain amount of responsibility in my associates and they showed, in the end, an inability to sell. So now I‘m more willing to sell when things don‘t look like they‘re going in the right direction. I would sell a security for one of four reasons.
The first reason is the highest quality reason. That is when you buy something with a price objective. When it appreciates to that price objective, and you think it‘s fully valued, you sell it.
The second reason is when, based on calls to our companies, their competitors and their suppliers, things are not moving along the originally anticipated lines so you get out before you get murdered. It is very hard in this market, which is choppy and not really going anywhere, to make up for big losses so you have to sell before you get creamed.
A third reason we sell is when we find an idea that‘s more attractive than the idea we‘re acting on already. So we‘ll sell something to buy something that we think has a better risk/reward ratio.
Finally, the fourth reason we sell something is when our market outlook changes. Since I don‘t tend to buy and sell market futures to an appreciable degree, to effect this macro driven re-positioning, I have to sell specific securities.
So I would say the big change is my willingness to sell. This is very difficult for a value investor because if, for example, you liked Ford Motor at $20, you should like it more at $18 and even more at $15. But there are times when the market has figured out what‘s going on before you, the fundamentalist, have figured it out.
Let‘s face it, although not perfect, the stock market is one of the better leading indicators. Some people are wary of the information the stock market is imparting because, they would say, it has priced in 10 out of the last 7 recessions.
In my opinion, however, that‘s a better record than most economists.
Can you talk about how you construct your portfolio?
LC: My portfolio construction is some combination of top-down and bottoms-up.
We try to make money for our investors in a number of different ways. Stocks are high risk financial assets and short term bonds and cash are low risk financial assets.
First, we spend a great deal of time trying to figure out whether the market is going up or going down because that will determine both the predominant performance of our portfolio and how much exposure we want to have to risky assets.
The second way we try to make money is looking for the undervalued asset class. We look at government bonds versus corporate bonds versus high yield bonds. We think about bonds versus stocks, whether in the U.S. or in Europe. We‘re trying to look for the straw hats in the winter.
In the winter, people don‘t buy straw hats so they‘re on sale. We‘re basically looking for what‘s on sale. In 1993, we made a great deal of money in non-dollar bonds because we made a play on interest rates that was very right. In 1995 through 1997, we made a great deal of money in the debt of Brazil, Turkey and other emerging markets.
In 2002, we made a lot of money in high yield bonds, and the same is true for 2009 and 2010. So we‘re looking for the right asset class. Any study you‘ll read on portfolio returns will tell you that being in the right asset class is more important than being in any individual stock in any one year.
Third, which is the bread and butter business where I spend the bulk of my time, is looking for undervalued stocks on the long side. I have a very value-oriented approach.
Fourth, which has not been particularly productive for us, is finding overvalued stocks on the short side.
Finally, we take 2-3% of our capital and invest in macro strategies. We might be long or short the dollar, we might be long or short a commodity. It‘s a small part of what we do but I like the macro strategies. The returns are not necessarily correlated to equities and at times you get a trend of opportunity that you can capitalize on.
In my own opinion, the next big trended opportunity – though we haven‘t put the trade on just yet – is being short U.S. government bonds. They don‘t belong at 2%. They‘re just way too low.
Historically, the ten year U.S. government bond yield has tracked nominal GDP. If you think we‘re in a world of 2-3% real growth and 2-3% inflation or potentially more, that would give you nominal GDP of 4-6%. So if the ten year government bond yield was in that range of 4-6% that would not be unusual.
I would also add that, over the years, our portfolio has on average been 70% net long, though right now we‘re about 80% net long. We tend to be more invested than most hedge funds.
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