New book out now! The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market

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From Amazon

The Acquirer’s Multiple is an easy-to-read account of deep value investing. The book shows how investors Warren Buffett, Carl Icahn, David Einhorn and Dan Loeb got started and how they do it. It combines engaging stories with research and data to show how you can do it too. Written by an active value investor, The Acquirer’s Multiple provides an insider’s view on deep value investing.

The Acquirer’s Multiple covers:

  • How the billionaire contrarians invest
  • How Warren Buffett got started
  • The history of activist hedge funds
  • How to Beat the Little Book That Beats the Market
  • A simple way to value stocks: The Acquirer’s Multiple
  • The secret to beating the market
  • How Carl Icahn got started
  • How David Einhorn and Dan Loeb got started
  • The 8 rules of deep value

The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market provides a simple summary of the way deep value investors find stocks that beat the market.

Excerpt

Media

(If you’d like to schedule an interview, please shoot me an email at tobias@acquirersmultiple.com)

Buy The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market through Amazon on Kindle and paperback.

Other Books

This Week’s Best Investing Reads

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Here’s a list of this week’s best investing reads:

The Next Bear Market (A Wealth of Common Sense)

Power Laws: How Nonlinear Relationships Amplify Results (Farnam Street)

The Biggest Killer of Investment Returns (Safal Niveshak)

Isaac Newton Learned About Financial Gravity the Hard Way (Jason Zweig)

Findings from our Research on Applying Deep Learning to Long-Term Investing (Euclidean)

ET NOW Interview on Compounding (Chai with Pabrai)

Some Value Funds Are Stuffed With Cash as Stocks Surge (Bloomberg)

John Rogers on Markets and Economy (CNBC)

Columbia Business School Research Exposes Volatility Within the Blockchain and Cryptocurrency System (Cardrates)

The Most Hated (And Most Loved) Investing Factor (Validea)

Add More Fama to Your Portfolio (Cliff’s Perspective)

Can asset bubbles be mathematically quantified before they burst? (Alpha Architect)

Do Activists Turn Bad Bidders into Good Acquirers? (papers.ssrn)

Robert Cialdini – Just How Do Uncertain Investors Pick Their Stocks

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The simple truth is that a lot of investors don’t have the time or won’t make the time to research the companies in which they’re going to invest. So how do uncertain investors pick their stocks? One answer can be found in the book, Influence: The Psychology of Persuasion, by Robert Cialdini. Here’s an excerpt from the book:

We first need to understand the nature of yet another potent weapon of influence: the principle of social proof. It states that one means we use to determine what is correct is to find out what other people think is correct. The principle applies especially to the way we decide what constitutes correct behavior.

We view a behavior as more correct in a given situation to the degree that we see others performing it. Whether the question is what to do with an empty popcorn box in a movie theater, how fast to drive on a certain stretch of highway, or how to eat the chicken at a dinner party, the actions of those around us will be important in defining the answer.

The tendency to see an action as more appropriate when others are doing it normally works quite well. As a rule, we will make fewer mistakes by acting in accord with social evidence than contrary to it.

Usually, when a lot of people are doing something, it is the right thing to do. This feature of the principle of social proof is simultaneously its major strength and its major weakness. Like the other weapons of influence, it provides a convenient shortcut for determining how to behave but, at the same time, makes one who uses the shortcut vulnerable to the attacks of profiteers who lie in wait along its path.

In general, when we are unsure of ourselves, when the situation is unclear or ambiguous, when uncertainty reigns, we are most likely to look to and accept the actions of others as correct.

In the process of examining the reactions of other people to resolve our uncertainty, however, we are likely to overlook a subtle but important fact. Those people are probably examining the social evidence, too. Especially in an ambiguous situation, the tendency for everyone to be looking to see what everyone else is doing can lead to a fascinating phenomenon called “pluralistic ignorance.”

[In social psychology, pluralistic ignorance is a situation in which a majority of group members privately reject a norm, but incorrectly assume that most others accept it, and therefore go along with it. This is also described as “no one believes, but everyone thinks that everyone believes”.]

Lynch & Munger – Becoming A Better Investor Requires Thinking Outside Of Investing

Johnny HopkinsCharles Munger, Peter Lynch1 Comment

A lot of investors believe that the more you can learn about investing and investing techniques the better you will be as an investor. A typical value investor might spend time studying the fundamental assumptions and approaches to value investing, techniques for assessing fundamental value – balance sheet and earnings power approaches, or structuring value-based portfolios to control risk and designing strategies for searching efficiently for value investing opportunities.

The reality is however is that while it’s important to have a basic understanding of your investment process sometimes the answers we seek in investing are greatly benefited by thinking outside of the investment discipline. This sentiment has been echoed by two of the greatest investors, Charles Munger and Peter Lynch.

Here’s an excerpt from Munger’s 2017 Daily Journal Annual Meeting:

Frequently, the problem in front of you is solvable if you reach outside the discipline you’re in and the idea is just over the fence. But if you’re trained to stay within the fence you just won’t find it. I’ve done that so much in my life it’s almost embarrassing. And it makes me seem arrogant because I will frequently reach into the other fellows discipline and come up with an idea he misses. And when I was young it caused me terrible problems. People hated me. And I probably shouldn’t have been as brash as I was. And I probably wouldn’t be as brash as I am now.

I haven’t completed my self-improvement process. But, it’s so much fun to get the right idea a little outside your own profession. So if you’re capable of doing it, by all means learn to do it. Even if you just want to learn it defensively. I do not observe professional boundaries.

And here’s an excerpt from Peter Lynch’s book, One Up On Wall Street:

I continued to caddy throughout high school and into Boston College, where the Francis Ouimet Caddy Scholarship helped pay the bills. In college, except for the obligatory courses, I avoided science, math, and accounting—all the normal preparations for business. I was on the arts side of school, and along with the usual history, psychology, and political science, I also studied metaphysics, epistemology, logic, religion, and the philosophy of the ancient Greeks.

As I look back on it now, it’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics. Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage. If stockpicking could be quantified, you could rent time on the nearest Cray computer and make a fortune. But it doesn’t work that way. All the math you need in the stock market (Chrysler’s got $1 billion in cash, $500 million in long-term debt, etc.) you get in the fourth grade.

Logic is the subject that’s helped me the most in picking stocks, if only because it taught me to identify the peculiar illogic of Wall Street. Actually Wall Street thinks just as the Greeks did. The early Greeks used to sit around for days and debate how many teeth a horse has.

They thought they could figure it out by just sitting there, instead of checking the horse. A lot of investors sit around and debate whether a stock is going up, as if the financial muse will give them the answer, instead of checking the company.

In centuries past, people hearing the rooster crow as the sun came up decided that the crowing caused the sunrise. It sounds silly now, but every day the experts confuse cause and effect on Wall Street in offering some new explanation for why the market goes up: hemlines are up, a certain conference wins the Super Bowl, the Japanese are unhappy, a trendline has been broken, Republicans will win the election, stocks are “oversold,” etc. When I hear theories like these, I always remember the rooster.

Carl Icahn: His Most Bizarre Acquisition Story

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One of our favorite investors here at The Acquirer’s Multiple is Carl Icahn, and one of my favorite Icahn interviews is one he did with Dealbook. In this interview he shares his most bizarre acquisition story. It’s a story about ACF. Following is an excerpt which I have edited for clarity:

So I was a kid, you know 31 years ago compared to today, and I see this ACF. I’m a workaholic. I keep working on companies. I see this company sells for 30 bucks and I’m looking at the rail-cars they own. I look at all the stuff that they got. They don’t make any money. I’m an old Graham and Dodd guy. I still am.

You look and say this is so cheap. I take all the money I’d made. I put in four or five hundred million or borrow it or whatever I did and I bought a lot of the stock.

So now we’re going in and we’re saying this is so cheap it’s 30 bucks and they’ve got all these assets that are not making any money. So I finally get control of the company. I get the company and now I go in. I’m a good math guy. I don’t believe in micromanaging so I meet the CEO. He says, “We would love to have you aboard”.

So they manufacture rail-cars. I won’t bore you with the details. But they had a lot of companies and in the rail-car business the secret is very simple, that you make rail cars but the government wants to incentivize you. So the government says you can depreciate the rail-car over five, six, seven years but you can keep them for 40 years. So you get this great depreciation. It’s great tax incentive. The secret is you got to make money though to use the tax benefits. These guys kept buying companies. But every company they bought they lost money so that was a real problem.

Now I go in and they’ve got 12 floors on 3rd Avenue when real estate was pretty good. I say ok you are the guys that lease the rail-cars, you are the guys that do all the darn work. This is a true story and it’s sort of amazing but it still applies a lot today, maybe not as much, well pretty much, this is hard to believe.

I go in, I’m a good math guy. I’m gonna go understand what they do.

We go to 12th floor, I write on my yellow pad and they try to explain it. You do this and these guys do this. These guys do that. I spend the whole day. I go home take a look at my yellow pad and I can’t figure out what the hell they do so I go back the next day. The 7th floor, the 9th floor, 8th floor boom, boom, boom. I say I’m not an idiot I can’t figure out what the hell they do.

They say, “This guy does that. This is very arcane stuff you’re not gonna understand it.”

I say, “Okay fine so finally I say to him I’m going to St. Louis. I want to see the guy who’s the COO. I want to see the guy that manages the stuff that makes the rail-cars.”

They say, “Don’t go Mr. Icahn don’t go. They’re scared of you. They depend on us and we tell them what to do and they are very worried that you might do something with us.”

I’m not threatening to do anything but I’d like to see. So I go back 8th floor, 9th floor, 7th floor, I go back home. Can’t figure out what the hell’s going on. So I said screw these guys. I called the guy his name is Joe he’s in St. Louis.

I say, “Joe I want to come see you.”

He says, “Of course I’d love to see you.”

I said, “Do me a favor don’t tell the CEO I’m coming, I just want to come myself and talk to you, but don’t get nervous about anything.”

He says, “Why should I be nervous?”

This guy Joe is like a John Wayne character. He was a captain in the Marines. A tough guy. I was scared of him. I’m sitting there looking at him, we’re talking and laughing and he’s showing me stuff. I understand what he does here so I want to have a drink with him. I say, “Joey I want to ask you something. I don’t want you to think that we intend to do anything because I don’t want you to be nervous.”

He says, “Why should I be nervous?”

I say, “I just want you to tell me how many of those guys in New York you need to support your operation here because I honestly can’t figure out what they do.”

He says, “I’ll tell you what you should do. I’ll tell you how many supports I need. I need minus 30.”

I say, “Joe, what the hell’s that mean, minus 30?”

He says, “Cuz you don’t have the balls to do what I’ll tell you to do.”

I say, “What’s that?”

He says, “Get rid of all of them tomorrow. Get rid of all of them and I’ll need 30 people less that have to support them with the numbers that they don’t need from me.”

I go and I say hey it’s unbelievable I can’t believe this. Today I would have done it immediately, get rid of all 12 floors but then I was still wondering maybe this guy’s Joe’s a little crazy. How could I get rid of twelve floors of people?

So I figure how to do that and meanwhile I knew the guy who owned the building and he said, “Carl I could use the lease if you get out.”

I figure what the hell do I do. So there’s a consultant around. I brought these guys in. Nice guys, Columbia University and they were the great leasing experts of the world. I call him and three guys come in and one is the professor at Columbia and he says, “Mr Icahn we understand your problem, very arcane.”

I say, “Yeah I heard that word before. Really arcane! I want to know what they do.”

He says, “Don’t worry about it, three weeks we’ll be back it’s quarter of a million dollars.”

I say, “Okay I’ll pay a quarter of a million, come back in three weeks.”

They come back in three weeks, now this is sort of hard to believe but it typifies America. They come back in after three weeks with this big book. Yellow graphs, grid graphs, green graphs.

I say, “Hey I ain’t gonna read this book. I’m colorblind anyway. All I want you to do, here’s a yellow pad, I did very well in school, I’m a numbers guy. Tell me what they do and I said here’s your quarter of a million bucks.”

I give it to him and he looks at me and smiles. He says, “You know something you’ve been square with us Mr Icahn. You seem like a good guy so I’m gonna tell you something. We don’t know what they do either!”

I’m not joking!

I said screw it I call Joe up. He comes over. I gave them their severance. Nobody was mad. I got rid of the whole 12 floors. Sold the lease for 10 million dollars.

But here’s the thing, if you shut down a grocery store, let’s say you own a grocery store. If you shut it down you hear from somebody. Somebody didn’t get the apples right. Somebody says the pears were rotten or something.

But this was like out of a science fiction movie. It’s like they never existed. I never got a letter I never got anybody calling me. It was like one of those bombs just hit the thing, killed all the people and the building stays.

You can watch the entire interview here:

Marks on Taleb And The Self Inflicted Anxiety That Investors Create For Themselves

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One of the best books ever written on investing is – Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, by Nassim Taleb. Howard Marks recommended the book in this interview with 5 Good Questions, saying:

“I like the book Fooled by Randomness by Nassim Nicholas Taleb. I think it’s got some very very valuable ideas. Dealing with understanding risk and dealing with risk and uncertainty is a very big part of investing and also of life. I think that it’s easier to conceptualize risk and uncertainty if you start from the premise that the underlying process is fairly disorderly. There’s a tendency to say that the future is uncertain but the past… The past is history. The past is in the books. But I think if you look at the past and you say to yourself, you know lots of different things could have happened. The past that actually happened was only one of the many things that could have happened that but for randomness the others would have happened. I think if you look at history that way it informs how you look at the future. So I recommend Fooled by Randomness to everyone.”

There is one particular passage in the book that eloquently describes the self inflicted anxiety that investors create for themselves by endlessly checking the performance of their portfolio and listening to the latest media soundbites. Here’s an excerpt from the book:

The wise man listens to meaning, the fool only gets the noise. The modern Greek poet C. P. Cavafy wrote a piece in 1915 after Philostratus’ adage: For the gods perceive things in the future, ordinary people things in the present, but the wise perceive things about to happen. Cavafy wrote:

in their intense meditation the hidden sound of things approaching reaches them and they listen reverently while in the street outside the people hear nothing at all.

I thought hard and long on how to explain with as little mathematics as possible the difference between noise and meaning, and how to show why the time scale is important in judging an historical event. The Monte Carlo simulator can provide us with such an intuition. We will start with an example borrowed from the investment world (that is my profession), as it can be explained rather easily, but the concept can be used in any application.

Let us manufacture a happily retired dentist, living in a pleasant sunny town. We know a priori that he is an excellent investor, and that he will be expected to earn a return of 15% in excess of Treasury bills, with a 10% error rate per annum (what we call volatility). It means that out of 100 sample paths, we expect close to 68 of them to fall within a band of plus and minus 10% around the 15% excess return, i.e. between 5% and 25% (to be technical; the bell-shaped normal distribution has 68% of all observations falling between —1 and 1 standard deviations). It also means that 95 sample paths would fall between —5% and 35%.

Clearly, we are dealing with a very optimistic situation. The dentist builds for himself a nice trading desk in his attic, aiming to spend every business day there watching the market, while sipping decaffeinated cappuccino. He has an adventurous temperament, so he finds this activity more attractive than drilling the teeth of reluctant old little Park Avenue ladies.

He subscribes to a web-based service that supplies him with continuous prices, now to be obtained for a fraction of what he pays for his coffee. He puts his inventory of securities in his spreadsheet and can thus instantaneously monitor the value of his speculative portfolio.  We are living in the era called that of connectivity.

A 15% return with a 10% volatility (or uncertainty) per annum translates into a 93% probability of making money in any given year. But seen at a narrow time scale, this translates into a mere 50.02% probability of making money over any given second as shown in Table 3.1. Over the very narrow time increment, the observation will reveal close to nothing. Yet the dentist’s heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows in red on his screen. He feels some pleasure when the performance is positive, but not in equivalent amount as the pain experienced when the performance is negative.

At the end of every day the dentist will be emotionally drained. A minute-by-minute examination of his performance means that each day (assuming eight hours per day) he will have 241 pleasurable minutes against 239 unpleasurable ones. These amount to 60,688 and 60,271, respectively, per year. Now realize that if the unpleasurable minute is

worse in reverse pleasure than the pleasurable minute is in pleasure terms, then the dentist incurs a large deficit when examining his performance at a high frequency.

Consider the situation where the dentist examines his portfolio only upon receiving the monthly account from the brokerage house. As 67% of his months will be positive, he incurs only four pangs of pain per annum and eight uplifting experiences. This is the same dentist following the same strategy.

Now consider the dentist looking at his performance only every year. Over the next 20 years that he is expected to live, he will experience 19 pleasant surprises for every unpleasant one!

This scaling property of randomness is generally misunderstood, even by professionals. I have seen Ph.D.s argue over a performance observed in a narrow time scale (meaningless by any standard). Before additional dumping on the journalist, more observations seem in order.

Viewing it from another angle, if we take the ratio of noise to what we call nonnoise (i.e., left column/right column), which we have the privilege here of examining quantitatively, then we have the following. Over one year we observe roughly 0.7 parts noise for every one part performance. Over one month, we observe roughly 2.32 parts noise for every one part performance. Over one hour, 30 parts noise for every one part performance, and over one second, 1796 parts noise for every one part performance.

A few conclusions:

  1. Over a short time increment, one observes the variability of the portfolio, not the returns. In other words, one sees the variance, little else. I always remind myself that what one observes is at best a combination of variance and returns, not just returns.
  2. Our emotions are not designed to understand the point. The dentist did better when he dealt with monthly statements rather than infrequent ones. Perhaps it would be even better for him if he limited himself to yearly statements.
  3. When I see an investor monitoring his portfolio with live prices on his cellular telephone or his PalmPilot, I smile and smile.

Finally I reckon that I am not immune to such an emotional defect. But I deal with it by having no access to information, except in rare circumstances. Again, I prefer to read poetry. If an event is important enough, it will find its way to my ears. I will return to this point in time.

The same methodology can explain why the news (the high scale) is full of noise and why history (the low scale) is largely stripped of it (though fraught with interpretation problems). This explains why I prefer not to read the newspaper (outside of the obituary), why I never chitchat about markets, and, when in a trading room, I frequent the mathematicians and the secretaries, not the traders. It explains why it is better to read The Economist on Saturdays than the Wall Street Journal every morning (from the standpoint of frequency, aside from the massive gap in intellectual class between the two publications).

Finally, this explains why people who look too closely at randomness burn out, their emotions drained by the series of pangs they experience. Regardless of what people claim, a negative pang is not offset by a positive one (some behavioral economists estimate the negative effect to be up to 2.5 the magnitude of a positive one); it will lead to an emotional deficit.

Some so-called wise and rational persons often blame me for “ignoring” possible valuable information in the daily newspaper and refusing to discount the details of the noise as “short-term events”. Some of my employers have blamed me for living on a different planet.

My problem is that I am not rational and I am extremely prone to drown in randomness and to incur emotional torture. I am aware of my need to ruminate on park benches and in cafes away from information, but I can only do so if I am somewhat deprived of it. My sole advantage in life is that I know some of my weaknesses, mostly that I am incapable of taming my emotions facing news and incapable of seeing a performance with a clear head. Silence is far better.

This Week’s Best Investing Reads

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Here is a list of this week’s best investing reads:

Considerations for Cashing Out of the Stock Market (A Wealth of Common Sense)

Is This How The ‘Winner-Take-All’ Era Comes To An End? (The Felder Report)

Bill Miller: What’s luck got to do with it? (Jason Zweig)

Q&A with Tobias Carlisle Author of The Acquirer’s Multiple (Abnormal Returns)

Summaries of Recent Investment Conferences (Market Folly)

The Case Of Wilbur Ross’ Phantom $2 Billion (Forbes)

Investors expect returns of 10.2% with millennials hoping for more (Schroders)

A Bull Market Should Make Investors Happy. This One Isn’t. (New York Times)

Jack Bogle bashes ‘FANG’ investing, says this trading mentality is a ‘loser’s game’ (CNBC)

The Best Investing Books for a Budding Value Investor to Read (Gannon on Investing)

My new book The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market is out now on Kindle and paperback.

Lou Simpson – Investors That Use Hot Tips Or Listen To CNBC Are Playing A Losers Game

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Last week investing great Lou Simpson, former chief investment officer for Geico—a Berkshire Hathaway subsidiary, did a Q&A with Robert Korajczyk, a professor of finance at the Kellogg School to discuss his successful investment strategy. Simpson provides a warning to investors saying, “If somebody’s going to invest using hot tips, or listening to CNBC, or investing with so-called wealth managers at brokerage firms, I think it’s a loser’s game for them.”

Here’s an excerpt from that interview:

Bob Korajczyk: What would you say is the essence of your investment philosophy?

Lou Simpson: The essence is simplicity. The base case for investing in any area of the market is a passive product, such as an index fund. That’s something any investor can access.

If you’re a professional investor, the question is: How can you add value? The more you trade, the harder it is to add value because you’re absorbing a lot of transaction costs, not to mention taxes.

What we do is run a long-time-horizon portfolio comprised of ten to fifteen stocks. Most of them are U.S.-based, and they all have similar characteristics. Basically, they’re good businesses. They have a high return on capital, consistently good returns, and they’re run by leaders who want to create long-term value for shareholders while also treating their stakeholders right.

Korajczyk: So you concentrate your investments in your very best ideas.

Simpson: You can only know so many companies. If you’re managing 50 or 100 positions, the chances that you can add value are much, much lower.

So far, this year we bought one new position, and we’re looking pretty seriously at one more. I don’t know what we’ll decide to do. Our turnover is 15, 20 percent. Usually we add one or two things and get rid of one or two things.

Warren [Buffett] used to say you should think of investing as somebody giving you a fare card with 20 punches. Each time you make a change, punch a hole in the card. Once you have made your twentieth change, you have to stick with what you own. The point is just to be very careful with each decision you make. The more decisions you make, the higher the chances are that you will make a poor decision.

One thing a lot of investors do is they cut their flowers and water their weeds. They sell their winners and keep their losers, hoping the losers will come back even. Generally, it’s more effective to cut your weeds and water your flowers. Sell the things that didn’t work out, and let the things that are working out run.

Korajczyk: Are investors afraid to let the goods ones run?

Simpson: If I’ve made one mistake in the course of managing investments it was selling really good companies too soon. Because generally, if you’ve made good investments, they will last for a long time. Of course, things can change. Amazon is changing the retail business quite dramatically.

Korajczyk: What is the correct balance between quantitative and qualitative skills in your approach to investing?

Simpson: Well, I think you need a combination of quantitative and qualitative skills. Most people now have the quantitative skills. The qualitative skills develop over time.

But, as Warren used to tell me, “You’re better off being approximately right than exactly wrong.” Everyone talks about modeling—and it’s probably helpful to do modeling—but if you can be approximately right, you will do well.

For example, one thing you need to determine is: Are the company’s leaders honest? Do they have integrity? Do they have huge turnover? Do they treat their people poorly? Does the CEO believe in running the business for the long term, or is he or she focused on the next quarter’s consensus earnings?

Korajczyk: It sounds like the qualitative skills can help you assess the downside of having a concentrated portfolio—namely, concentrated risk. What are some of the factors you look at when you’re worried an investment might blow up and damage your portfolio?

Simpson: There are a few factors that we look at. First, is this the business we thought it was? If you figure out that a business is not what you thought it was, that’s a bad sign.

The second factor is the management, which can also differ from what you thought. Unfortunately, a lot of managements are very short-term oriented, and that can be another reason to sell. This goes back to the basic integrity and the focus of people in charge.

The third factor is an overly high valuation, and this is often the most difficult, because you’re investing in something you wouldn’t buy at current prices, but you don’t want to sell because it’s a really good business and you think it’s ahead of itself on a price basis. It might be worth holding on to it for a while.

Korajczyk: My sense is that you and Warren Buffett have very compatible investment styles. Are there any interesting differences between you and Warren?

Simpson: The biggest difference between Warren and me is that Warren had a much harder job. He was managing 20 times the amount of money we were. We were managing five billion. In equities, he might have been managing 80, 90, 100 billion. So he was much more limited in what he could buy if he wanted to have a concentrated portfolio, which he did.

Korajczyk: You emphasize a long-term focus and low turnover. It seems to be true that the more you trade, the lower your returns.

Simpson: Yes, I think there’s a strong correlation. There’s also a negative correlation between the number of people making the investment decisions and the results. If you have a lot of people involved, you tend to have the least competent person making the decision, because you need consensus.

One thing I say to people is if you really don’t think that you can add value—and most people can’t—then I think your base investment case should be a passive product with a low cost.

Korajczyk: Is there a way for somebody to be an active investor, but only spend a few hours over the weekend doing research?

Simpson: You probably could. But even among professionals who trade full time, the majority do not add value. Because, again, you have fees, you have transaction costs.

Yes, I think there are people who have the right mindset and maybe contacts, and certainly luck, who could outperform the market. But if somebody’s going to invest using hot tips, or listening to CNBC, or investing with so-called wealth managers at brokerage firms, I think it’s a loser’s game for them.

You can read the full interview at KelloggInsight here.

Interview with Tadas Viskanta’s Abnormal Returns

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Here’s a fun Q&A with Tadas Viskanta on his incredible Abnormal Returns. First question and answer and then the link:

AR: As you note early in the book, contrarian investing is based on the idea of mean reversion. I hate to be the ‘it’s different this time’ but is the digital, winner-take-all, age different enough that we need to re-think the power of mean reversion for companies and by extension as investments?

TC: It is cyclical or secular? That’s the million-dollar question. The reality is this, it always looks different this time. Creative destruction has been going on since, say, the beginning of the industrial revolution. But value investors have prospered disproportionately by buying cheap earnings and assets. And the only place to find those is among the seeming losers in this digital, winner-take-all economy.

It’s a behaviorally unpleasant position to take. For example, everyone knows Amazon is going to crush all before it. And everyone knows the history of retail is that new concepts destroy legacy retailers. You’d have to be blind or an idiot to buy retail. But Amazon is expensive and some retail is cheap. Some will adapt. There are spots to make smart bets on mean reversion there.

See the Q&A with Tobias Carlisle author of The Acquirer’s Multiple post here on Abnormal Returns.

Buy The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market through Amazon on Kindle and paperback.

Li Lu – Investing Is About Intellectual Honesty. Know What You Don’t Know

Johnny HopkinsLi LuLeave a Comment

One of our favorite value investors here at The Acquirer’s Multiple is Li Lu. He is the founder and Chairman of Himalaya Capital Management and was one of the student leaders of the 1989 Tiananmen Square student protests. He famously convinced Charlie Munger to become interested in BYD [a Chinese company which manufactures electric cars, batteries, electronics and solar equipment]. A technology-oriented company that Berkshire Hathaway would typically avoid.

Charlie Munger once said about Li Lu “it is a foregone decision” that he would be a member of Berkshire’s top investors team after Warren Buffett retires.

Li Lu is a true value investor who was inspired to get into investing after hearing a Warren Buffett lecture at Columbia in 1993. Following is a great interview with Li Lu from the Graham & Doddsville Newsletter. Here’s an excerpt from that interview:

G&D: How did your unique experience as a Tiananmen Square protest leader lead you to where you are today, running Himalaya Capital?

Li Lu (LL): When I first came to Columbia University, I was dirt poor. I did not choose to come here – I just ended up here because I had nowhere else to go, having just escaped from China after Tiananmen. I was in a new country where I didn’t understand the language, didn’t know anybody, and didn’t have a penny to my name. So I was desperate and afraid.

In retrospect, that is good inspiration for trying to figure out how to make money! I just wanted to know how to survive. For the first couple of years, I really struggled with the language, but I eventually became much more comfortable. I always had this fear in the back of my mind of how I was going to make a living here. I didn’t even think about success at the time – I just wanted to pay my bills.

I grew up in Communist China and never had much money to my name, and then all of a sudden I had giant student loans. So naturally I tried to make a buck or two. One day, about two years after I arrived, a friend of mine who knew my issues said, “If you really want to make money you have to listen to this fellow. He truly knows how to make money.” I wasn’t sure what it was all about. I just remember thinking that there was a “buffet” involved.

So I assumed that it was some kind of talk with a free lunch! I said it was a good combination – a free lunch plus a talk about how to make money. So I went. To my dismay there was no lunch. There was just a guy with the name “Buffett.” Mr. Buffett really made a lot of sense during that talk. It was like a punch in my eyes. It was like I had just woken up and a light had switched on.

His honesty came through right out of the gate. And I thought this fellow was just so intelligent – he could put very complex ideas into such simple terms. I was immediately drawn to value investing. By the time the lecture was over, I thought that this was what I was looking for; I could do this.

At the time, I couldn’t really start companies, and I didn’t want to work in a big company because of the differences in language and culture. Investing, on the other hand, sounded like it required a lot of reading and mathematics, hard work, and good judgment – I was confident that I could do those things well. And the fundamental principles of value investing appealed to me – buy good securities at a bargain price.

If you’re wrong, you won’t lose a lot, but if you’re right you’re going to make a lot. It fit my personality and temperament very well. Warren used to say, “Value investing is like an inoculation – either it takes or it doesn’t.” I totally agree with him. There are few people that switch in between or get it gradually. They either get it right away or they don’t get it at all. I never really tried anything else. The first time I heard it, it just made sense; and I heard it from the best. I guess it turned out better than a free lunch.

G&D: How did your investing process develop differently from Buffett’s?

LL: Part of the game of investing is to come into your own. You must find some way that perfectly fits your personality because there is some element of a zero sum game in investing. If you buy, somebody else has to sell. And when you sell, somebody has to buy. You can’t both be right. You really want to be sure that you are better informed and better reasoned than the person on the other side of the trade.

It is a competitive game, so you’re going to run into a lot of very intelligent, hardworking fellows. The only way to gain an edge is through long and hard work. Do what you love to do, so you just naturally do it or think about it all the time, even if you are relaxing, and even if you’re just walking in the park.

Over time, you can accumulate a huge advantage if it comes naturally to you like this. The ones who really figure out their own style and stick to it and let their natural temperament take over will have a big advantage.

The game of investing is a process of discovering: who you are, what you’re interested in, what you’re good at, what you love to do, then magnifying that until you gain a sizable edge over all the other people. When do you know you are really better? Charlie Munger always said, “I would not feel entitled to a view unless I could successfully argue against the best counterargument of the smartest opponent.”

He is right about that. Investing is about predicting the future, and the future is inherently unpredictable. Therefore the only way you can do it better is to assess all the facts and truly know what you know and know what you don’t know. That’s your probability edge. Nothing is 100%, but if you always swing when you have an overwhelmingly better edge, then over time, you will do very well.

G&D: How did you become friends with Charlie Munger? Do you have a friendship with Warren Buffett as well?

LL: Charlie and I have some very close mutual friends. Over time, we started talking about businesses, and then it evolved into a strong bond. I view him as a mentor, teacher, partner, and friend, all in one. I am also friendly with Warren, but not nearly as close as with Charlie because Warren is in Omaha. I admire him, and I learn more about him from his writings and deeds than through interpersonal interactions. I have a lot of interaction with Charlie, so I know him both as person and through his writing and personal deeds.

G&D: Do you have a favorite Charlie Munger quote?

LL: Oh, there are so many. We share a fundamental ethos about life and about approaching investing. So I learn more about how to conduct myself personally as much, if not more, than investing.

G&D: How would you define your circle of competence?

LL: I let my own personal interests define my circle of competence. Obviously I know something about China, Asia, and America – those are things that I am really familiar with. I have also over the years expanded my horizon [in terms of analyzing businesses]. I started out looking for cheap securities. When you start out, you really have no choice. You don’t have enough experience, and you don’t want to lose money, so what do you do? You end up buying dirt-cheap securities. But over time, if you are interested in businesses in addition to securities, you begin to become a student of businesses. Eventually, one thing leads to another and you begin to learn different businesses. You learn the DNAs of businesses, how they progress, and why they are so strong.

Over time, I really fell in love with strong businesses. I morphed into finding strong businesses at bargain prices. I still have a streak in me that favors finding really cheap securities – I just can’t help it! But over time, I’ve become more attracted to looking for great businesses that are inherently superior, more competitive, easier to predict, and with strong management teams. I’m just not quite satisfied with the secondary market. As I said, there is an aspect of the securities business that is zero-sum. And that’s the area in which I don’t feel entirely comfortable. I’m more interested, by my nature, in win-win situations.

I want to create wealth together with the business operators and employees when I invest. So that led me to venture businesses. I try to apply the principles of intelligent investing there, but I actually can contribute quite a bit, so it becomes a win-win situation.

Over my career, I’ve had the satisfaction of building a number of different venture businesses. Some of them became enormously successful, even after we sold them. You could say we sold them too early! I was the first investor in Capital IQ, and then look at what happened. If we would have kept it, we would have been far richer! It’s not like we didn’t make a lot of money in that investment. We did. But I like it that way.

I like to create something that everybody finds useful. We created employment, and we created a beautiful product that’s sustainable, and everybody made a lot of money, even the people who bought the business from us. I like win-win situations. I do not complain about selling Capital IQ too early. We made a lot of money on that investment, and we contributed a great deal. I remain friends with the founders. That aspect gave me enormous pleasure. But the venture side is hard to scale; you must put in a lot of effort. So, over time, I gradually moved into helping in a different way. Even in public securities, you can still be very helpful and constructive. So, that’s who I am. I’m still learning, and I’m still interested. I’m still young, and still incredibly curious. So, who knows? Hopefully, I will continue to gradually expand my circle of competence.

G&D: How were you able to figure out that Capital IQ would become so successful?

LL: In the beginning it was Bloomberg. We wanted to create something just like Bloomberg, and in the process, we grew to appreciate Bloomberg much more because it was so hard to compete with them.

Then we realized the investment banking side was not fully penetrated. So we basically applied what we learned about Bloomberg and created a similar product for the investment banking side. Over time, we also penetrated different businesses like private equity. We learned quickly that we couldn’t really compete with Bloomberg.

G&D: You don’t short stocks at Himalaya, correct?

LL: That’s right; not any more. That change occurred nine years ago. Shorting was one of the worst mistakes I’ve made.

G&D: Is your lack of a short book due to your desire to be a constructive third-party for companies and their management teams?

LL: Yes. But also, you can be 100% right, and you could still bankrupt yourself. That aspect of shorting just frustrated me too much!

Three things about shorting make it a miserable business. On the long side, you have 100% downside but unlimited upside. On the short side, you have 100% upside and unlimited downside. I do not like that math.

Second, the best short has some element of fraud. However, a fraud can be perpetrated for a long time. Of course you borrow to short, so they could really just wear you down. That’s why I could be 100% right and bankrupt at the same time. But, you know what, you go bankrupt first!

Lastly, it screws up your mind. Shorts just grab your mind and take away from the concentrated effort that is required to do proper long investing. So, those are the three reasons why I just stay away from shorting. It was a mistake on my part. I shorted for a couple of years. I don’t discard people who are really doing well at shorting – it’s just not me.

If I want to add a fourth reason, it is that the economy overall has been really growing at a compounding rate for 200-300 years, ever since the modern science technology era. So, naturally, the economic trend favors long positions rather than short. But you cannot live life without making a mistake. Every time I make a mistake I learn something.

G&D: How were you able to get Charlie Munger interested in a company like BYD [a Chinese company which manufactures electric cars, batteries, electronics and solar equipment] given that Berkshire Hathaway typically shies away from technology-oriented companies?

LL: I don’t think that Warren and Charlie are ideological. Neither am I. It’s really how much you know. The story of BYD is relatively simple. This guy, who is a really terrific engineer, started the business from just a $300,000 loan with no additional money until the IPO. He created a company with $8 billion in revenue and 170,000 employees and tens of thousands of engineers. He solved a whole bunch of different problems. So you have to admit the record is impressive. They also happen to be in the right industry and the right environment, and they get the right support from the government. Their engineering culture consistently demonstrates its ability to tackle big, difficult problems. It works. So it’s hard not to be impressed by the record the guy has. At the time we invested, we had quite a bit of a margin of safety.

They play in a big field with open-ended possibilities and have a reasonable chance of being successful. As I said, nothing is a sure thing, but this strikes me as having as good of a chance as any.

Charlie was equally impressed by the company, which then led to the investment. Berkshire is not ideologically against technology stocks. They’re just against anything they don’t feel comfortable with. They have that $11 billion investment in IBM, which, I can argue, is a technology company. But I can guarantee that’s not how they think about things. It has nothing to do with whether it’s a technology stock or not.

G&D: Buffett admitted in a 2009 Fortune article that he doesn’t really understand BYD.

LL: That is true. Warren and Charlie have a great partnership and Charlie knows more about BYD than Warren. But I would not bet against the collective track record of those two. It’s not that they don’t make errors from time to time. Everybody is capable of doing that. They have a few, but very, very few over a long investment career.

G&D: Can you talk about your investment process?

LL: Ideas come to me from all sources, principally from reading and talking. I don’t discriminate how they come, as long as they are good ideas. You can recognize good ideas by reading a great deal and also by studying a lot of companies and constantly learning from intelligent people – hopefully more intelligent than you are, especially in their field. I try to read as much as I can. I study all of the interesting and great companies, and I talk to a lot of intelligent people. You know what? In some of those readings or conversations, ideas just click. Then you do more research and then you get comfortable or you don’t get comfortable.

G&D: Are the people that you talk to fellow investors or are they people like customers, suppliers, and management?

LL: All of them. I don’t talk to as many investors – very few. I am more interested in talking to people who are actually running businesses and entrepreneurs or CEOs or just good businessmen. I read all of the major newspaper publications and annual reports of the leading companies. I get a lot of ideas out of those too.

G&D: How do you assess if the management is being forthright with you? How useful is it to speak with the management?

LL: Well, management always has a big influence on your success, no matter how good or how bad the business is itself. Management is always part of the equation of making the company successful, so the quality of management always matters. But to assess that quality is not that easy.

If you can’t assess the quality of management, you may have to make a decision in spite of that. That’s just part of the process. So you have to figure out other ways such as looking at the quality of the business, the valuation, or something else until you can justify an investment. If you do have a way to assess the quality of the management team, either because you’re an astute student of human psychology, or you have a special relationship with the people, then you’ll take that into consideration. Why wouldn’t you?

The management team is part of what really makes a company. But, it’s not that easy. It’s not that easy to have an indepth, solid understanding of the management team. Very few people are able to do that. I admire people that say, “Hey, look. Whatever the information, whatever the kind of presentation they make, I will never be able to learn about management beyond that. I know it’s a show for me, so I might as well just discard it.” I respect that. Investing is about intellectual honesty. You want to know what you know. You want to know, mostly, what you don’t know. If understanding the management team is not in the cards, it’s not in the cards.

G&D: How do you make your sell decisions?

LL: One should make sell decisions on one of three occasions.

Number one, if you make a mistake, sell as fast as you can, even if it’s a correct mistake. What do I mean by a correct mistake? Investing is a probability game. Let’s say you go into a situation with 90% confidence that things will work out one way and a 10% chance they work out another way, and that 10% event happens. You sell it. Then there’s a mistake that your analysis is completely wrong. You thought it was 99% one way but it was actually 99% the other way. When you realize that, sell as fast as you can. Hopefully at not too much of a loss, but even if it is a loss it doesn’t matter – you have to sell it.

The second time you want to sell is when the valuation swings way too much to the other end of the extreme. I don’t sell a security because it’s a little overvalued, but if it is way overboard on the other side into euphoria, then I will sell it. If you are right and hold a company for a long time, you have accumulated a large amount of unrealized gains. A big portion of those unrealized gains act like borrowings from the government interest free and legally. So when you sell that position, you take all the leverage and you take a bunch of the capital out, so your return on equity has just become a little less.

The third occasion when to sell is when you find something that is better. Essentially, a portfolio as I said is opportunity cost. Your job as a portfolio manager is to constantly improve on your basket. You start with a high bar. You want to increase the bar higher and higher. You do that by constantly improving the opportunity costs; you find something better. Those are the three reasons that I would sell.

G&D: Do you have any advice for students who are interested in getting into investment management, especially for those readers who can’t go and listen to Warren Buffett speak during their lunch break?

LL: If you do get a chance to meet Mr. Buffett, I’d run to it if I were you. I wouldn’t even take an airplane; I would just run to Omaha! Start by learning from the best – listening, studying, and reading. But the most important thing in understanding the investment business is by doing it. There is no substitute to actually doing it.

The best way to do it is to study one business inside and out for the purpose of making the investment – you may not actually invest. But having gone through the discipline of understanding one business as if you own 100% of that business is very valuable.

To start, take an easy -to – understand business. It could be a tiny business – a little concession store, a restaurant, or a small publicly traded company. It doesn’t matter. Understand one business and what really makes it tick: how it makes money, how it organizes its finances, how management makes its decisions, how it compares to the competition, how it adjusts to the environment, how it invests extra cash, and how it finances the business.

You should understand every aspect of one business as if you own 100% but you don’t actually run it. This causes you to be desperate to understand every aspect to protect your investment. That will give you a sense of a disciplined approach. That’s how you truly understand business and investing.

Warren always says that to be a good investor, you need to be a good businessman, and to be a good businessman, you need to be a good investor in terms of capital allocation.

Start by understanding one thing within your control that you can understand inside and out. That is a terrific starting point. If you start from that basis, you are fundamentally in the right direction of becoming a great security analyst.

G&D: It was a pleasure speaking with you, Mr. Li.

You can read the full interview at Graham & Doddsville here.

Michael Burry – Search For Unpopular Companies That Look Like Road Kill

Johnny HopkinsMIchael BurryLeave a Comment

One of our favorite value investors here at The Acquirer’s Multiple is Michael Burry. Burry was the founder of the hedge fund Scion Capital, which he ran from 2000 until 2008. He later closed the fund to focus on his own personal investments. Burry was one of the first investors to recognize and profit from the impending subprime mortgage crisis. The story of which was told in the 2015 movie – The Big Short.  But a lot of investors may be surprised to know that Burry was a true value investor saying, “All my stock picking is 100% based on the concept of a margin of safety, as introduced to the world in the book Security Analysis“.

Following is a great article titled – MSN Money Articles – By Michael Burry 2000/2001, that outlines Burry’s value investing strategy. Most noticeable is his use of the Enterprise Value/EBITDA valuation ratio, which is very similar to the one we use here at The Acquirer’s Multiple. Here’s an excerpt from that article:

Strategy

My strategy isn’t very complex. I try to buy shares of unpopular companies when they look like road kill, and sell them when they’ve been polished up a bit. Management of my portfolio as a whole is just as important to me as stock picking, and if I can do both well, I know I’ll be successful.

Weapon of choice: research

My weapon of choice as a stock picker is research; it’s critical for me to understand a company’s value before laying down a dime. I really had no choice in this matter, for when I first happened upon the writings of Benjamin Graham, I felt as if I was born to play the role of value investor. All my stock picking is 100% based on the concept of a margin of safety, as introduced to the world in the book “Security Analysis,” which Graham co-authored with David Dodd. By now I have my own version of their techniques, but the net is that I want to protect my downside to prevent permanent loss of capital. Specific, known catalysts are not necessary. Sheer, outrageous value is enough.

I care little about the level of the general market and put few restrictions on potential investments. They can be large-cap stocks, small cap, mid cap, micro cap, tech or non-tech. It doesn’t matter. If I can find value in it, it becomes a candidate for the portfolio. It strikes me as ridiculous to put limits on my possibilities. I have found, however, that in general the market delights in throwing babies out with the bathwater. So I find out-of-favor industries a particularly fertile ground for best-of-breed shares at steep discounts.

How do I determine the discount? I usually focus on free cash flow and enterprise value (market capitalization less cash plus debt). I will screen through large numbers of companies by looking at the enterprise value/EBITDA ratio, though the ratio I am willing to accept tends to vary with the industry and its position in the economic cycle. If a stock passes this loose screen, I’ll then look harder to determine a more specific price and value for the company. When I do this I take into account off-balance sheet items and true free cash flow. I tend to ignore price-earnings ratios. Return on equity is deceptive and dangerous. I prefer minimal debt, and am careful to adjust book value to a realistic number.

I also invest in rare birds — asset plays and, to a lesser extent, arbitrage opportunities and companies selling at less than two-thirds of net value (net working capital less liabilities). I’ll happily mix in the types of companies favored by Warren Buffett — those with a sustainable competitive advantage, as demonstrated by longstanding and stable high returns on invested capital — if they become available at good prices. These can include technology companies, if I can understand them. But again, all of these sorts of investments are rare birds. When found, they are deserving of longer holding periods.

Beyond stock picking

Successful portfolio management transcends stock picking and requires the answer to several essential questions: What is the optimum number of stocks to hold? When to buy? When to sell? Should one pay attention to diversification among industries and cyclicals vs. non-cyclicals? How much should one let tax implications affect investment decision-making? Is low turnover a goal? In large part this is a skill and personality issue, so there is no need to make excuses if one’s choice differs from the general view of what is proper.

I like to hold 12 to 18 stocks diversified among various depressed industries, and tend to be fully invested. This number seems to provide enough room for my best ideas while smoothing out volatility, not that I feel volatility in any way is related to risk. But you see, I have this heartburn problem and don’t need the extra stress.

Tax implications are not a primary concern of mine. I know my portfolio turnover will generally exceed 50% annually, and way back at 20% the long-term tax benefits of low-turnover pretty much disappear. Whether I’m at 50% or 100% or 200% matters little. So I am not afraid to sell when a stock has a quick 40% to 50% a pop.

As for when to buy, I mix some barebones technical analysis into my strategy — a tool held over from my days as a commodities trader. Nothing fancy. But I prefer to buy within 10% to 15% of a 52-week low that has shown itself to offer some price support. That’s the contrarian part of me. And if a stock — other than the rare birds discussed above — breaks to a new low, in most cases I cut the loss. That’s the practical part. I balance the fact that I am fundamentally turning my back on potentially greater value with the fact that since implementing this rule I haven’t had a single misfortune blow up my entire portfolio.

I do not view fundamental analysis as infallible. Rather, I see it as a way of putting the odds on my side. I am a firm believer that it is a dog eat dog world out there. And while I do not acknowledge market efficiency, I do not believe the market is perfectly inefficient either. Insiders leak information. Analysts distribute illegal tidbits to a select few. And the stock price can sometimes reflect the latest information before I, as a fundamental analyst, catch on. I might even make an error. Hey, I admit it. But I don’t let it kill my returns. I’m just not that stubborn. In the end, investing is neither science nor art — it is a scientific art. Over time, the road of empiric discovery toward interesting stock ideas will lead to rewards and profits that go beyond mere money. I hope some of you will find resonance with my work — and maybe make a few bucks from it.

You can read the entire article here, MSN Money Articles – By Michael Burry 2000/2001.

Klarman And Pabrai – Just How Important Are Catalysts To Investing Success

Johnny HopkinsMohnish Pabrai, Seth KlarmanLeave a Comment

One topic that gets a lot of discussion in the world of investing is the importance of catalysts.

A catalyst in investing terms is an event that triggers a change to a stock price. Catalysts can include things like a latest earnings release, a positive or negative result in a lawsuit, or an activist investor taking a position in a company. These events cause investors to become more positive or negative about the future of a company which results in a change in the stock price. To highlight the difference in opinion on the subject of catalysts let’s take a look at two opposing views from Seth Klarman and Mohnish Pabrai.

Following is Seth Klarman’s view, which can be found in his best selling book – Margin of Safety. Here’s an excerpt from his book:

Once a security is purchased at a discount from underlying value, shareholders can benefit immediately if the stock price rises to better reflect underlying value or if an event occurs that causes that value to be realized by shareholders. Such an event eliminates investors’ dependence on market forces for investment profits. By precipitating the realization of underlying value, moreover, such an event considerably enhances investors’ margin of safety. I refer to such events as catalysts.

Some catalysts for the realization of underlying value exist at the discretion of a company’s management and board of directors. The decision to sell out or liquidate, for example, is made internally. Other catalysts are external and often relate to the voting control of a company’s stock. Control of the majority of a company’s stock typically allows the holder to elect the majority of the board of directors. Thus accumulation of stock leading to voting control, or simply management’s fear that this might happen, could lead to steps being taken by a company that cause its share price to more fully reflect underlying value.

Catalysts vary in their potency. The orderly sale or liquidation of a business leads to total value realization. Corporate spinoffs, share buybacks, recapitalizations, and major asset sales usually bring about only partial value realization.

Value investors are always on the lookout for catalysts. While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market.

Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value. Catalysts that bring about total value realization are, of course, optimal. Nevertheless, catalysts for partial value realization serve two important purposes.

First, they do help to realize underlying value, sometimes by placing it directly into the hands of shareholders such as through a recapitalization or spinoff and other times by reducing the discount between price and underlying value, such as through a share buyback.

Second, a company that takes action resulting in the partial realization of underlying value for shareholders serves notice that management is shareholder oriented and may pursue additional value-realization strategies in the future. Over the years, for example, investors in Teledyne have repeatedly benefitted from timely share repurchases and spinoffs.

Now let’s take a look at Mohnish Pabrai’s view on catalysts, which can be found in a presentation that he did at Google. Here’s an excerpt from that presentation:

Question: What do you think about the importance of the catalyst?

Mohnish Pabrai: For the most part, you’re right. I have ignored the importance of a catalyst. I think catalysts are not required. In most cases, value is its own catalyst. I would also say that when you’re buying businesses, let’s say below liquidation value for example, in my book, there’s no such thing as a value trap.

I think there are mistakes in investing, but not value traps. So in the end, everything is fairly valued to the extent that you end up with a less than satisfactory return on investment. It probably has less to do with whether the catalyst is there or not and more to do it with just the nuances of intrinsic value of that business.

I have actually found, in many cases, that in fact, the catalyst actually flies in the face of uncertainty. Because if you have a catalyst, you don’t have uncertainty. It’s just the nature of the type of investor I am. I prefer to buy low risk high uncertainty and let the catalyst work itself out.

And it has, for the most part.

I would say that from ’94– which is what? Five years before I started my fund, until 2013, before fees and all that, it’s been a little over 26% a year, and that engine has not needed catalysts. But there’s more than one way to skin the cat.

The Seth Klarman format of investing, even though it’s value investing, because value investing is a very big tent, is very different from the Buffet method of investing. One simple difference is Baupost has more than 100 investment professionals, and at Berkshire there’s one. You might say one and a half, with Charlie. But that’s it.

So I think there are many different ways to skin the cat. A set approach certainly has worked for a long time. But my personal preference and approach is to not bother with catalysts.


(Source:YouTube)

This Week’s Best Investing Reads

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

For A Strategy To Outperform In The Long Run, It Has To Be Hard To Stick With (Thinknewfound.com)

Has Value Investing Lost Its Shine? (Euclidean)

Everything Regresses To The Mean (Morningstar)

Thoughts on Cost of Capital and Buffett’s $1 Test – Part 1 (Base Hit Investing)

David Einhorn says value investing will make a comeback, just like it did after dot-com bubble (CNBC)

The Wrong Side of Right (Farnam Street)

My Interview with Morgan Housel (Safal Niveshak)

Two Ways 2017 Differs From 2000 and 2007 (Fortune Financial)

Episode #77: Tobias Carlisle, “In Order to Find Something Genuinely Undervalued…There’s Always Something that You Don’t Like” (Meb Faber)

Value Investing Deadpool (The Macro Tourist)

Low Returns Are a Feature of Markets, Not a Bug (Bloomberg)

The Economy’s Performance vs. the Stock Market’s Outcomes (Betterment)

Tobias Carlisle On Beating ‘The Little Book That Beats The Market’ (The Felder Report)

The Freakishly Strong Base (Collaborative Fund)

Will Amazon Kill All Retail? (Advisor Perspectives)

Stanley Druckenmiller – The Greatest Lesson I Ever Learned From George Soros

Johnny HopkinsGeorge Soros, Stanley DruckenmillerLeave a Comment

What separates average investors from superinvestors is their ability to make big bets when they think they’re right. The question is, how do you develop such an aggressive mindset. Fortunately, one answer can be found in the book – The New Market Wizards, by Jack Schwager. There is one passage in particular in which Stanley Druckenmiller discloses a conversation he had with George Soros which perfectly illustrates what it takes to make big bets when you think you’re right.

Here’s an excerpt from that book:

Your long-term performance has far surpassed the industry average. To what do you attribute your superior track record?

George Soros has a philosophy that I have also adopted: The way to build long-term returns is through preservation of capital and home runs. You can be far more aggressive when you’re making good profits. Many managers, once they’re up 30 or 40 percent, will book their year [i.e., trade very cautiously for the remainder of the year so as not to jeopardize the very good return that has already been realized]. The way to attain truly superior long-term returns is to grind it out until you’re up 30 or 40 percent, and then if you have the convictions, go for a 100 percent year. If you can put together a few near-100 percent years and avoid down years, then you can achieve really outstanding long-term returns.

What else have you learned from Soros?

I’ve learned many things from him, but perhaps the most significant is that it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong. The few times that Soros has ever criticized me was when I was really right on a market and didn’t maximize the opportunity.

As an example, shortly after I had started working for Soros, I was very bearish on the dollar and put on a large short position against the Deutsche mark. The position had started going in my favor, and I felt rather proud of myself. Soros came into my office, and we talked about the trade.

“How big a position do you have?” he asked.

“One billion dollars,” I answered.

“You call that a position?” he said dismissingly. He encouraged me to double my position. I did, and the trade went dramatically further in our favor.

Soros has taught me that when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig. It takes courage to ride a profit with huge leverage. As far as Soros is concerned, when you’re right on something, you can’t own enough. Although I was not at Soros Management at the time, I’ve heard that prior to the Plaza Accord meeting in the fall of 1985, other traders in the office had been piggybacking George and hence were long the yen going into the meeting. When the yen opened 800 points higher on Monday morning, these traders couldn’t believe the size of their gains and anxiously started taking profits. Supposedly, George came bolting out of the door, directing the other traders to stop selling the yen, telling them that he would assume their position.

While these other traders were congratulating themselves for having taken the biggest profit in their lives, Soros was looking at the big picture: The government had just told him that the dollar was going to go down for the next year, so why shouldn’t he be a pig and buy more [yen]?

Soros is also the best loss taker I’ve ever seen. He doesn’t care whether he wins or loses on a trade. If a trade doesn’t work, he’s confident enough about his ability to win on other trades that he can easily walk away from the position. There are a lot of shoes on the shelf; wear only the ones that fit. If you’re extremely confident, taking a loss doesn’t bother you.

Superinvestors Agree That Business Schools Don’t Make You A Better Investor

Johnny HopkinsCharles Munger, Joel Greenblatt, Mohnish Pabrai, Peter Lynch, Warren Buffett1 Comment

While a lot of investors believe that a good finance course at one of the world’s most prestigious business schools is a sure-fire way to becoming a better investor, it seems that some of the greatest investors disagree. Here’s what Buffett, Munger, Greenblatt, Pabrai, and Lynch have to say about learning about investing at business school.

In Warren Buffett’s 1996 Berkshire Hathaway Shareholder Letter he says:

To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses – How to Value a Business, and How to Think About Market Prices.

In Charlie Munger’s speech – A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management & Business, he says:

So the most useful and practical part of psychology—which I personally think can be taught to any intelligent person in a week—is ungodly important. And nobody taught it to me by the way. I had to learn it later in life, one piece at a time. And it was fairly laborious. It is so elementary though that, when it was all over, I just felt like a total horse’s ass. And yeah, I’d been educated at Cal Tech and the Harvard Law School and so forth. So very eminent places miseducated people like you and me.

In Joel Greenblatt’s book – You Can Be A Stock Market Genius, he says:

We start with some good news about your education: simply put, if your goal is to beat the market, an MBA or a Ph.D. from a top business school will be of virtually no help. Well, it’s good news, that is, if you haven’t yet squandered tons of time and money at a business school in the singleminded quest for stock market success. In fact, the basic premise of most academic theory is this: It is not possible to beat the market consistently other than by luck.

In Mohnish Pabrai’s book – The Dhando Investor, he says:

Most of the top-ranked business schools around the world do not understand the fundamentals of margin of safety or Dhandho. For them, low risk and low returns go together as do high risk and high returns. Over a lifetime, we all encounter scores of low-risk, high-return bets. They exist in all facets of life. Business schools should be educating their students on how to seek out and exploit these opportunities.

In Peter Lynch’s book – One Up On Wall Street, he says:

After that interlude at Fidelity, I returned to Wharton for my second year of graduate school more skeptical than ever about the value of academic stock-market theory. It seemed to me that most of what I learned at Wharton, which was supposed to help you succeed in the investment business, could only help you fail. I studied statistics, advanced calculus, and quantitative analysis. Quantitative analysis taught me that the things I saw happening at Fidelity couldn’t really be happening.

Buffett on Lou Simpson And His Successful Investing Strategy

Johnny HopkinsLou SimpsonLeave a Comment

One of our favorite investors here at The Acquirer’s Multiple is Lou Simpson. Simpson, the Vice Chairman of GEICO, was mentioned in Buffett’s 1986 Berkshire Hathaway Shareholder Letter in which he said:

“The second stage of the GEICO rocket is fueled by Lou Simpson, Vice Chairman, who has run the company’s investments since late 1979. Indeed, it’s a little embarrassing for me, the fellow responsible for investments at Berkshire, to chronicle Lou’s performance at GEICO. Only my ownership of a controlling block of Berkshire stock makes me secure enough to give you the following figures, comparing the overall return of the equity portfolio at GEICO to that of the Standard & Poor’s 500 (below).

These are not only terrific figures but, fully as important, they have been achieved in the right way. Lou has consistently invested in undervalued common stocks that, individually, were unlikely to present him with a permanent loss and that, collectively, were close to risk-free.

In sum, GEICO is an exceptional business run by exceptional managers. We are fortunate to be associated with them.”

(Source: 1986 Berkshire Hathaway Shareholder Letter)

Simpson later outlined the five principles of his successful investing strategy in an interview he did with The Washington Post. Here’s an excerpt from that interview:

Simpson says there is no mystery to his stock market magic. A voracious reader, the 50-year-old vice chairman of Geico searches daily newspapers, magazines, annual reports and newsletters for clues that might spark investment ideas. His four-member investment team uses computer screens to identify stocks that, on the basis of financial data, appear to be bargains.

“Lou has made me a lot of money,” Buffett said. “Under today’s circumstances, he is the best I know. He has done a lot better than I have done in the last few years. He has seen opportunities I have missed. We have $700 million of our own net worth of $2.4 billion invested in Geico’s operations, and I have no say whatsoever in how Lou manages the investments. He sticks to his principles. Most people on Wall Street don’t have principles to begin with. And if they have them, they don’t stick to them.”

According to Simpson, his investment principles are as follows:

1. Think Independently. “We try to be skeptical of conventional wisdom and try to avoid the waves of irrational behavior and emotion that periodically engulf Wall Street. We don’t ignore unpopular companies. On the contrary, such situations often present the greatest opportunities.”

2. Invest in High-Return Businesses Run for the Shareholders. “Over the long run appreciation in share prices is most directly related to the return the company earns on its shareholders’ investment. Cash flow, which is more difficult to manipulate than reported earnings, is a useful additional yardstick. “We ask the following questions in evaluating management: Does management have a substantial stake in the stock of the company? Is management straightforward in dealings with the owners? Is management willing to divest unprofitable operations? Does management use excess cash to repurchase shares? The last may be the most important. Managers who run a profitable business often use excess cash to expand into less profitable endeavors. Repurchase of shares is in many cases a much more advantageous use of surplus resources.”

3. Pay only a reasonable price, even for an excellent business. “We try to be disciplined in the price we pay for ownership even in a demonstrably superior business. Even the world’s greatest business is not a good investment if the price is too high.”

4. Invest for the long-term. “Attempting to guess short-term swings in individual stocks, the stock market or the economy is not likely to produce consistently good results. Short-term developments are too unpredictable.” (Simpson’s one exception to this long-term principle is his occasional purchase of stocks of companies that are targets of publicly announced, friendly takeover bids.)

5. Do not diversify excessively. “An investor is not likely to obtain superior results by buying a broad cross-section of the market. The more diversification, the more performance is likely to be average, at best. We concentrate our holdings in a few companies that meet our investment criteria. Good investment ideas — that is, companies that meet our criteria — are difficult to find. When we think we have found one, we make a large commitment. The five largest holdings at Geico account for more than 50 percent of the stock portfolio.”

Simpson’s antidiversification principle contradicts the advice that financial planners often give to less sophisticated, individual investors. Individuals often are encouraged to diversify their holdings, to minimize the downside risk of any single bad investment.

But Simpson said that for him, one of the keys to successful investing has been to make a relatively small number of investments. He said Buffett illustrates that concept with the notion of a lifetime fare card with only 20 punches, so they must be used wisely.

“One lesson I have learned is to make fewer decisions,” Simpson said. “Sometimes the best thing to do is to do nothing. The hardest thing to do is to sit with cash. It is very boring.”

Simpson said that his biggest mistakes in the stock market have been that he sold stocks too early. His technique of buying bargain stocks apparently leads him to sell stocks after they are discovered by other investors and move up in price. But some of those stocks continued their ascent after he sold.

“We do not have any hard and fast rules on selling,” Simpson said. “We do not sell that well.”

You can read the full interview at The Washington Post here.

Seth Klarman – Value Investing Is A Large-Scale Arbitrage Between Security Prices And Underlying Business Value

Johnny HopkinsSeth KlarmanLeave a Comment

The one book that all investors should read is Margin of Safety, by Seth Klarman. A new copy of Klarman’s book is going to set you back around $1000 on Amazon and used copies can be bought for around $750. But it’s money well spent if you wish to be a successful value investor.

There’s a great piece in the book where Klarman illustrates how value investing is a large-scale arbitrage between security prices and underlying business value. He also explains some of the reasons why the gap narrows between price and value. Klarman concludes the chapter with his thoughts on why value investing is simple but difficult to implement for most investors. Here’s an excerpt from the book:

A central tenet of value investing is that over time the general tendency is for underlying value either to be reflected in securities prices or otherwise realized by shareholders. This does not mean that in the future stock prices will exactly equal underlying value. Some securities are always moving away from underlying value, while others are moving closer, and any given security is likely to be both undervalued and overvalued as well as fairly valued within its lifetime. The long-term expectation, however, is for the prices of securities to move toward underlying value.

Of course, securities are rarely priced in complete disregard of underlying value. Many of the forces that cause securities prices to depart from underlying value are temporary. In addition, there are a number of forces that help bring security prices into line with underlying value. Management prerogatives such as share issuance or repurchase, subsidiary spinoffs, recapitalizations, and, as a last resort, liquidation or sale of the business all can serve to narrow the gap between price and value. External forces such as hostile takeovers and proxy fights may also serve as catalysts to correct price/value disparities.

In a sense, value investing is a large-scale arbitrage between security prices and underlying business value. Arbitrage is a means of exploiting price differentials between markets.

If gold sells for $400 per ounce in the U.S. and 260 pounds per ounce in the U.K. and the current exchange rate is $1.50 to the pound, an arbitrageur would convert $390 into pounds, purchase an ounce of gold in the U.K. and simultaneously sell it in the U.S., making a $10 profit less any transaction costs. Unlike classic arbitrage, however, value investing is not risk-free; profits are neither instantaneous nor certain.

Value arbitrage can occasionally be fairly simple. When a closed-end mutual fund trades at a significant discount to underlying value, for example, a majority of shareholders can force it to become open-ended (whereby shares can be redeemed at net asset value) or to liquidate, delivering underlying value directly to shareholders. The open-ending or liquidation of a closed-end fund is one of the purest examples of value arbitrage.

The arbitrage profit from purchasing the undervalued stock of an ongoing business can be more difficult to realize. The degree of difficulty in a given instance depends, among other things, on the magnitude of the gap between price and value, the extent to which management is entrenched, the identity and ownership position of the major shareholders, and the availability of credit in the economy for corporate takeover activity.

Conclusion

Value investing is simple to understand but difficult to implement. Value investors are not supersophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value. The hard part is discipline, patience, and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.