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Links of Interest – January 27, 2012
David Einhorn’s Greenlight Capital Q4 2011 Letter: Covered First Solar, Bought Dell ~ market folly
Bob Rodriguez’s FPA Funds Adds to Two Holdings after Significant Price Drops
Combs Hands Gains to Buffett by Raising Bets When Picks Slip – Bloomberg
FPA Crescent Fund Conference Call
Advertising spending online expected to surpass print this year – latimes.com
Berkshire Hathaway Raisess Tesco Stake to 5.1% – Bloomberg
Nick Morgan – Persuasive Public Speaking – Forbes
Yacktman Defies Demise of Stock-Picking Era
The Loser’s Game – Charles Ellis
100 Ways to Beat the Market: #28: Insist on “mistakability”.
One important element of the scientific method is having a properly constructed hypothesis. One of the essential characteristics of a good hypothesis is that it can be refuted or contradicted by an observation or physical experiment. Scientists call this characteristic falsifiability.
Likewise, one indispensible component of a market-beating investment process is being able to know if you made a mistake. Taking a page from science, we could call this characteristic “mistakability”. A good investing thesis is one that at some point in the future – as result of study and observation – you will be able to know if you were mistaken about, or not.
Speculating per se does not possess this quality. It often relies on nothing more that the notion that something is going up or down and that it will continue to do so. If it does not work out, it is insufficient – at least by the standard I am suggesting – to assert that you made a mistake because it stopped doing so. This is circular logic.
True mistakability is a substantive, positive, assertion grounded in logic and fact. “I think Microsoft’s current software royalties will continue to grow at five to seven percent over the next ten years and that its core software franchise is well protected by a strong moat grounded in high-switching costs and network effects.
If you do not have a clear, written investment thesis for each holding, each of which exhibits mistakability, you may be fooling yourself. If you manage money for others and an investment does not work out, you owe it to your investors to be able to provide a clear explanation of why you invested and what went wrong.
Market-beating investing is predicated on clear, rational thinking and avoiding dumb mistakes. Insisting that your investment theses possess mistakability is essential.
Links of Interest – January 20, 2012
Maria Bartiromo: JPMorgan CEO Jamie Dimon sees housing at bottom – USATODAY.com
Days of Easy Money Are Over for Fund Managers: Alice Schroeder – Bloomberg
Energy: think outside the barrel – FT.com
Energy Outlook 2030 | Statistical Review 2011 | BP
The Dow Jones at 17 000 in Five Years!
Charlie Munger – Bounded Rationality
How Michael Dell is reinventing Dell Inc. – MarketWatch
100 Ways to Beat the Market: #27: Look for disconfirming evidence.
At the USC Law Commencement Speech in 2007, Charlie Munger praised Charles Darwin as a model of rational, objective thought, particularly his habit of trying to consciously overcome first-conclusion bias. This is one of the many forms of over-confidence bias that can be damaging to your wealth.
Munger stated that Darwin, “tried to disconfirm his ideas as soon as he got’em. He quickly put down in his notebook anything that disconfirmed a much-loved idea. He especially sought out such things.”
Following Darwin and Munger, we too should seek out that which disconfirms our own investment theses. Put simply, you should try to kill our own ideas. It is far too easy to fall in love with a stock and then let your own rose-colored glasses glibly filter away anything negative about the business. Of course, this is delusional: the market does not care if you like a stock and reality will ultimately have its way.
This type of disconfirming thinking was on full display at the 4th Annual Pershing Square Challenge, in which Columbia Business School students compete for a $100,000 prize in an American-Idol like stock picking contest.
One of the finalist teams pitched Aeropostale (ARO). They argued that Aeropostale is a best-in-class retailer which earns consistently high returns on equity. They highlighted the company’s multi-year same-store sales growth, and growth opportunities coming from international expansion, e-commerce sales, and P.S. from Aeropostale, a new concept which targets pre-teens. Also, they liked Aeropostale’s valuation – the stock was then in the mid 20’s – because they thought it gave no credit for Aeropostale’s growth prospects and that the company’s unlevered balance sheet provided an attractive target to leveraged buyout firms.
The Aeropostale team received a respectful grilling from the judges, which comprised a cadre of value-oriented hedge fund heavyweights led by Bill Ackman. The hedge fund judges did not appear overly taken with the team’s thesis. The concerns the judges raised, which were summarized at the end of the presentation by Ackman, provides a text-book example of the types of things you should be looking for when you seek disconfirming evidence. Of course, it goes without saying that raising a concern is not tantamount to proving that it will come to pass, but the process of raising objections and dealing with them is critically important in reducing mistakes and generating market-beating performance. If you do this religiously, you will have a leg up on all your competitors and counter-parties who do not.
Returning to the Aeropostale pitch, here is Ackman’s summary of the disconfirming concerns.
1. Aeropostale does not do anything proprietary; in other words, they do not have a moat. They piggyback off the intellectual property of other teen retailers such as Abercrombie & Fitch.
2. Aeropostale’s thinner margins vis-à-vis its competitors makes it more vulnerable to higher commodity prices.
3. The growth opportunity is overstated. Aeropostale has already saturated the United States. In fact, Ackman questioned whether the total number of U.S. stores already exceeds the number of quality U.S. malls.
4. There is upward rent pressure and Aeropostale is susceptible to negative leverage if margins compress, given its fixed costs.
5. The market is used to strong same-store sales growth and could re-adjust Aeropostale’s multiple downward if the business generated negative numbers. [Note: the stock subsequently sold off to under $10 a share on poor same-store sales, among other factors, and has since rebounded to $16 per share.]
The lesson here is to look for disconfirming evidence, write it down (given the brain’s seemingly unlimited capacity to rationalize away this type of information), and take the time to give it serious thought before going forward.
Links of Interest – January 13, 2012
I Love Apple, But Enough Already – Seeking Alpha
Sir John Templeton’s 16 Rules for Investment Success
Summary of Ray Dalio Interview with Charlie Rose
Buffett’s apprentice makes strong debut | Investing | Financial Post
Siri as Google Challenger: Sorting Fact from Fiction | PCWorld
Answers From Tom Gayner’s Interview With GuruFocus
Great interview from Gurufocus with Tom Gayner. It is worth a careful read.
Tom Gayner, a renowned investor, has been executive vice president and chief investment officer of Markel Corp and president of Markel Gayner Asset Management, the investment subsidiary of Markel Corp., since 1990. He manages about $2 billion.
Recently, he joined GuruFocus for an interview and took question from readers. His answers are below:
GF: How did you get started with value investing?TG: Well, I started out life as an accountant, from the University of Virginia. Then a CPA, working at PriceWaterhouseCoopers. I found as I got into accounting that I was more interested in dollars than numbers, so investing seemed to be a little more in tune with business itself and the world of finance. Now, I think accounting is a phenomenally good way to begin to be an investor because accounting is the language of business, and you need to understand the language and what accounting entries mean in economic sense. But once I had that language down, I found the craft of investing was just very attractive to me. So that was sort of my mental switch. There was a local investment firm in town called Davenport and Company of Virginia, which was a small group here in Richmond. They had an interesting practice where they were brokers, and they did research on regional companies in Virginia and North Carolina. I had the opportunity to go there and work as a stock broker, and as a research analyst covering companies in Virginia and North Carolina, to be exposed to a lot of different industries, a lot of different companies, and I enjoyed it thoroughly. One of the companies that I covered starting in 1986 when they went public was Markel. I got to meet Steve Markel, and from 1986 through 1990, I covered the company. He was doing acquisitions for Markel, then Markel did the second half of the Shand acquisition, which more than doubled the size of the company and the investment portfolio. Steve was managing things himself and decided that he would like a wingman to help him out. He mentioned something to me about coming out here, and I said, “Great,” because I saw an insurance company that I liked and respected, that made underwriting profits, and was willing to invest underwriting profits for the long term. I knew that that was the formula that Buffett, at Berkshire practiced. And I got to stay right here in Richmond, Virginia. That sounded great, sign me up. That is the short story of how it happened.
GF: So you made it all the way up to the Chief Investment Officer and President. But, we know that accounting is different from value investing, right. Over the process, were there any persons or books that influenced you?
100 Ways to Beat the Market #26: Buy stocks that will double in five years.
For many years, Warren Buffett’s stated goal was to increase the intrinsic value of Berkshire Hathaway by 15% per annum. By doing this, investors could expect Berkshire’s value – and, with time, its stock price – to double every five years. (In the Berkshire Owner’s Manual, Buffett candidly states that this is the upper limit of what investors should expect today given Berkshire’s massive amount of capital and the difficulty for any large business to compound intrinsic value at 15%.) Prem Watsa’s stated goal at Fairfax Financial is to increase book value by 15% per year.
Finding stocks that will double in five years is, I believe, an aggressive but realistic objective for an active individual investor who develops the requisite skills and works hard at it. If you achieve this goal over the long term – regardless of whether your annual returns are lumpy along the way – you can expect to soundly beat the S&P 500. Your much smaller capital base is a distinct advantage vis-à-vis large investors such as Buffett or Watsa who need to deploy billions of dollars.
What you are essentially trying to do is to figure out what a business’s shares will be worth in five years and then to look to buy them at half of that today. How you get there will be some combination of growth in intrinsic value and buying shares at a discount to intrinsic value. One example is to find a company that can grow earnings at 15% for the next five to ten years and then buy it at fair value. You then sit tight as the stock price rises in tandem with earnings growth. Another approach is to find a stable, high quality business and buy it for 50% of its intrinsic value with the expectation that, over the subsequent five years, the market will re-price the security to reflect its intrinsic value. If it happens sooner, your rate of return is even higher. Finally, there is the combination approach where your double comes not only from growth in intrinsic value, but also the closing of a valuation gap.
One more thing: however you get to your double, you should always include a consideration of certainty. One way to think of it is that your outcome will be a function of your expected return and the certainty with which you will obtain it. Ideally you want investments where the expected mathematical annual return is 15% and the certainty with which you will obtain it is near 100%. You may want to consider changes in your portfolio if you can exchange your current holdings – after consideration of taxes, if any – for ones that offer a higher expected return or a higher certainty of obtaining generally the same return as an existing holding.
There are other frameworks for beating the market, but this is a good one. It is both conceptually simple and within reach. It goes without saying that compounding at this rate over long periods can generate real wealth.
Links of Interest – January 6, 2012
Why Best Buy is Going out of Business…Gradually – Forbes - The impact of the Internet is an essential question when analyzing a business.
Interview: Jeffrey Ubben of ValueAct Capital | Frankly Speaking - Very smart guy. Profitable to listen to how he thinks about investing and businesses.
Quotes from Charlie Munger on Intelligent Investing - Pure gold. Deceptively simple – very profitable.
INVESTING; An Academic Way to Beat the Market – New York Times - Dr. Arbel has a book (just got a used copy) that is on the recommended book list at Columbia’s value investing program.
Cara Goldenberg: Analyst to hedge fund founder in 6 years – Dec. 28, 2010 - On the wisdom of focusing on great management teams
100 Ways to Beat the Market #25: Ask the right questions.
Investing is simple but not easy.
Likewise, basketball is simple but not easy. All you need to do is put a ball with a 9″ diameter into a hole with a 17″ diameter. Simple, right? That is until you have a great athlete in your face playing defense along with the pressure of performing when it really matters.
Investing is simple because all you need to do is buy a meaningful amount of a business that is selling for less that it is worth and hold on until the market recognizes its miscalculation. This is not easy because it requires a rational framework that fully respects both the intelligence and skill of your counter parties and the high degree of efficiency often present in markets, along with the emotional discipline to act rationally in the face of fear and greed.
One common error of investors is to make things too complicated. One embodiment of this is the complex financial models found in analysts’ spreadsheets. Without a grasp of the right questions and a good dollop of wisdom, these can often obfuscate as much as enlighten. There is a reason Buffett does not even use a calculator when valuing a company.
The key to being a great investor is knowing how to ask the right questions and then only investing when you can actually answer them with a high degree of certainty and conviction. You do not need to do this very often. In fact, it is probably not possible to do it very often.
When NBA rookie Derrick Williams worked out with Kobe Bryant over the summer, he asked Bryant what moves he should work on. Bryant told him it was not a question of having a lot of moves, but rather having a small number that he could actually execute and finish – that were unstoppable.
If you want to have that kind of success as an investor, spend your time figuring out the pivotal questions upon which your investing thesis is based. Eschew false precision and seek broad certitude.
Consider how Greenberg explained at Columbia how he decided to invest in Google. Greenberg admits that there is a lot that he does not know about Google. But he does know that people now spend 30% of their time online and that 10% of advertising is done online. He is willing to bet that over the next five to ten years the percentage of advertising done online will catch up with the percentage of people’s time spent online. He does not know exactly how it will play out, but he does believe that Google, with a 50% market share in online advertising, will get its fair share.
Focus on asking the right questions – the big, broad ones that really matter. If you get these right, the answers will shakeout out into the knowable and unknowable. If you focus on investing in the first camp and have the discipline to not overpay, you are well on your way to beating the market.
Links of Interest – December 30, 2011
The Manual of Ideas: Aquamarine Library Tour with Guy Spier | ValueWalk.com
Grant’s Interest Rate Observer Winter Break 2011 Issue
Guy Spier ‘Equities May Be Poised for `Massive’ Shift’ | ValueWalk.com
Why Warren Buffett’s Berkshire Hathaway owns Wells Fargo – Apr. 20, 2009
Buffett: The lower stocks go, the more I buy – The Term Sheet: Fortune’s deals blog Term Sheet
David Winters and Chris Davis Interviewed By Wealthtrack
Coca-Cola’s Fayard on Growth, Market Strategy
Warren Buffett Invests in Bank of America: Not a Buy Signal
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