Tom Gayner is another one of my favorite value investors.
Gayner is Co-Chief Executive Officer of Markel Corporation. Markel is a holding company for insurance, reinsurance, and investment operations around the world. Headquartered in Richmond, Virginia and founded in 1930. The company has over $3 billion in Assets Under Management.
Gayner has an outstanding track record as a portfolio manager and value oriented investor.
Back in 2009, Gayner did an awesome interview with the The Manual of Ideas where he shared his thoughts on what makes a great value investor, the importance of thinking long term, and why he prefers equities over gold or bonds. It’s a must read for all value investors.
This is an excerpt from Gayner’s interview with The Manual of Ideas:
MOI: You have stated that the businesses you seek should have (1) a demonstrated record of profitability and good returns on total capital, (2) high measures of talent and integrity in management, (3) favorable reinvestment dynamics over time, and (4) a purchase price that is fair or better. Perfection, however, is rarely attainable in the stock market. Have you had to compromise on these criteria, and if so, could you illuminate for us how you decide on acceptable versus unacceptable trade-offs?
Tom Gayner: While you say that perfection is rarely obtainable in the stock market, I would go so far as to say that it is never obtainable in the stock market. Perfection doesn’t exist in this world. All of my choices involve various degrees of compromise and tradeoffs. As an accountant, I can tell you that my wife and children are sick of hearing me use the phrase “opportunity cost”. Every decision is also another decision (at least) and every non-decision is also a series of other decisions.
The challenge is to get the balance roughly right between the choices that actually exist. All of the four points I lay out are north stars that guide me. I admit though, that I have never personally been to the North Pole.
The one area where I will not compromise is in the area of integrity. I may not make every judgment correctly when I’m trying to make sure I’m dealing with people of integrity but I will never knowingly entrust money to people when I am concerned about their integrity. Even if you get everything else right, the integrity factor can kill you. My father used to tell me that, “you can’t do a good deal with a bad person.” And he was right.
The other factors can be thought of as shades of gray and nuances. We look for as much of the good as we can find and weigh that against what we have to pay for it, our expectation of how durable the business will be, and what our other alternatives are. I don’t have a formula or algorithm to get that precisely right, I just spend all my time thinking, reading, and adapting as best as I can.
MOI: You emphasize the impact of the passage of time on your investments. With the trend toward compression of time horizons and a focus on short-term performance in the investment industry, we are seeing many investors—even those who consider themselves value investors—emphasizing near-term stock price catalysts. Do you see a growing inefficiency in the pricing of “boring” investments that will deliver returns over time versus investments that are expected to pay off at a foreseeable point in time?
Gayner: Yes. To expand on that one word answer, I think there is a real time arbitrage opening up right now. An old saying is that in a bull market, your time horizons grow longer and longer. In a bear market, they grow shorter and shorter. The bear market experience of the last few years compresses time horizons for a lot of people. Even if they want to remain focused on the long term, there are inevitable career risks in not putting results on the books today when people are so anxious about every aspect of their lives.
I think that means the playing field for longer term investing is getting less crowded. Fewer people are able to think about the long term and I believe that creates an opportunity to buy wonderful, long duration investments, at better prices than has been the case in the last decade or so.
MOI: What is the one mistake that keeps investors from reaching their goals?
Gayner: I’ve made so many mistakes over the years that I struggle to isolate just one as the biggest single mistake. Among the choices though I think excessive leverage has been the most personally painful. I did not fully appreciate the degree of leverage that existed in so many aspects of so many businesses and how painful the unwinding of that leverage would prove to be.
Leverage also can be a good guide on the integrity factor that I mentioned earlier. One of the great investors I’ve tried to learn from is Shelby Davis. Shelby said that you almost never come across frauds at companies with little or no debt. If you think about it, that statement makes perfect sense. If a bad person is going to try and steal some money, they will logically want to steal as much as possible. Typically, that means they will have as much debt on the books as possible in addition to equity in order to increase the size of the haul. Staying away from excessive leverage cures a lot of ills.
Another huge mistake that I think people in general make is to mislabel risks. Specifically, people seem to think about risks in nominal rather than real terms. To have a lot of cash or government bonds has been a comforting thing in the past few years, but I think it is a mistake to think that means you are not taking risks. You are, it’s just that you are taking real risks as opposed to nominal ones. The purchasing power of the currency continues to decline. It is a huge mistake not to take that into account.
The other types of mistakes are well known and probably not too valuable to rehash. Chasing performance, thinking you can really effectively trade in and out of the market, using volatility as a precise quantitative measurement of risks etc… are all potential mistakes that investors tend to make.
To circle back to your original question about what is the single biggest risk, I would try to summarize all of these things as examples of not thinking. You can never put things on autopilot in this world. You must be constantly and continuously engaged with what is happening in business, technology, marketplaces, governments, social trends, demographics, science and absolutely everything you can possibly process in order to be as good a thinker as possible.
When you go to sleep each night, be prepared to get up in the morning and do it all again for as long as you are responsible for taking care of people’s money. There are no days off.
MOI: You define a “fair” price as one that allows you to earn long- term returns in line with the returns on equity of the business in which you invest. When paying a “fair” price, the expected return therefore comes entirely from the business rather than from multiple expansion. Based on this definition, the recent market carnage has created an opportunity to pay less than a “fair” price for many great businesses. In Wall Street parlance, does this make you a bull?
Gayner: Yes. This too is a complicated question and I run the profound risk of oversimplifying again. Investing to me is the ownership of an interest in a business. Business to me is the form and organization by which people creatively apply their skills and talents to solving problems or serving other people. The more a business serves others, and the more problems they solve, the more profitable they will be and the more an investor in those enterprises should make.
I believe that the path of human progress will continue forward. We are not going into a new dark age and I think comparisons with the great depression are over done. Frankly, I am bullish not just because of the valuation opportunity you describe but because of my fundamental belief that as a world we continue to make secular progress amid cyclicality.
The good news to come will surprise me just as much as the bad news did in the last few years but I believe good news will happen. The most energizing activity for me is spend time with my high school and college age children and their friends. They are not scarred by looking at their lower 401k balances. They don’t have 401k’s. They don’t talk about the market and a lot fewer of them are talking about going to Wall Street. They talk about alternative energy, biofuels, technology and other things that will propel human progress in real ways.
I would rather own a piece of their dreams and future economic prospects than a bar of gold or a government bond. Those pieces of dreams are called equities. Equities are congealed intellectual capital and that is what I want.
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