VALUE: After Hours (S07 E15): Surviving 10 Straight Quarters of Massive Underperformance

During their recent episode, Taylor, Carlisle, and Rich Pzena discussed Surviving 10 Straight Quarters of Massive Underperformance. Here’s an excerpt from the episode:

Rich: So, I’ll tell you my story from 1999. We had started our business in 1996, and we had a good first couple years, and got to a break even and we were feeling good. And then, we went through this 10 straight quarters of massive underperformance compared to the broad market. I had a client who came in, sat in our conference room, and she walks in the door and says to me, “My grandmother’s a better investor than you.

[laughter]

Rich: And all you have to do is buy Cisco. Everybody in the world has figured this out except for you, and you’re just stubborn.” So, I tried to go through arithmetic with her [Jake chuckles] and I said, “You realize that Cisco is now at a half a trillion-dollar valuation. First company to ever achieve that mark. And you’re used to double digit returns. You would be unsatisfied with anything less than 15% a year. So, if you bought that whole company for $500 billion, they would have to earn $75 billion a year for you to get your 15% return, and they earn one. Don’t you think there’s something wrong with that?” She just looked at me and said, “You don’t get it, do you?” to which I agreed.

Jake: Yeah. “You’re right. I don’t get it.” [laughs]

Rich: And that was going to be the backbone of the internet. It was all just as exciting as it is today with artificial intelligence.

Jake: Was that a very painful time for you, or was it like you-

Rich: It was.

Jake: -just recognized that, you know what, this is just craziness and I know that the world will get back to reality at some point?

Rich: No. When you’re a struggling business that just achieved profitability and now your clients are telling you’re an idiot and they start closing their accounts, we weren’t sure we were going to make it. And in fact, Joel Greenblatt, who you mentioned earlier, that was my partner at Wharton in our little research project, he was my backer in getting going in this business.

We went in the red and we got an offer from another firm to buy us. It would have gotten all of us a job. Here was the deal, Joel could have get his money back and we would all have a job. [Jake chuckles] And I said, “Joel, it sounds like a really good deal. You should take it.” And Joel said, “No way. Whatever you need to make it through this period, you have a blank check.”

Jake: Wow.

Rich: That’s pretty much what he said.

Jake: Incredible.

Rich: He didn’t ask for any incremental equity in exchange for that. Now, he must have been really prescient, because that was in February of 2000 when that happened, and March 9th, it turned around and he never had to put another penny in. We were 6,000 basis points behind the S&P 500 cumulatively from the inception of the firm, hopeless, right? It’s hopeless.

Jake: [laughs] Is that tough to sell when you’re–

[laughter]

Rich: And by the end of 2000, in nine months, we were ahead of the S&P.

Jake: Oh, my God. Incredible.

Rich: Yes, that was what we lived. And believe me, that 10-quarters was not fun. We didn’t lose hope. We looked at these other things that everybody’s buying and saying, “I don’t get this. I’m not putting any of this into our portfolio.” By the way, it was fortune that that happened. It didn’t feel like fortune at the time, but so many of our traditional value peers caved. They closed down, they started putting things into their portfolio that you would quasi value, like they put IBM in. IBM was ridiculously priced too, but not anywhere near any of these other things. It’s a real company with real business, but it didn’t do too well after the bubble burst.

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