The following are my notes from Michael Price’s lecture at the Columbia business school in the spring of 2006. I thought his remarks on how he values pharmaceuticals, how he uses the newspaper to generate investment ideas and how he sizes his positions were noteworthy. He pays great attention to publicly disclosed data in acquisitions calling it a treasure trove of information for valuing companies.
Here is Michael Price’s profile from gurufocus.com:
Michael F. Price is the 271st richest person in the world, according to Forbes. A renowned money manager, he learned finance as a $200-a-week research assistant under Max Heine. Mr. Price earned reputation for buying undervalued companies, and raising he@#. He has often tussled with management of companies held in his portfolios. He sold Heine Securities in 1996 to Franklin Resources for $670 million. Now, Price manages the private firm, MFP Investors, with $1.6 billion under management, much of it his own money.
Bruce Greenwald mentions that Price helped train Seth Klarman when he worked for Max Heine.
Price thinks that the capital structure comes down to two things: 1) equity, where you own part of a company, and 2) debt, where you lend money to a company. Everything, in Price’s view, else has been invented by Wall Street to rip you off and generate fees.
He tries to boil down a potential investment to these two components to help him evaluate the opportunity. He tries to simplify things and focus on the essentials.
He likes to focus on the balance sheet and the notes to the financials. He is not interested in complex securities such as CDO’s. It is hard enough to figure out what is cheap and buy it. He tries to focus on the steak, not the sizzle. He tries to figure out the worth of the steak and buy it at big discount – $.60 on the dollar. He doesn’t like to pay anything for sizzle.
He does not believe that Graham’s net-nets are generally available, but they do show up from time to time. In general, you will wait a long time – perhaps too long, if you limit your investments to net-nets.
If you can’t find cheap stocks, you wait.
He gave the example of 3M that was doing well in 2006, but the stock had been knocked down from $90 to $70 because Wall Street was focused on how 3M was going to keep up its performance. My takeaway was that Wall Street’s focus on this type of superficial headline risk can make stocks available at a bargain (Mr. Market).
He doesn’t mind style drift if you are pursuing the best value available. The context here was that he usually focuses on smaller companies and special situations, but, at the time of lecture, a number of large caps offered compelling value not usually available.
Proxy Statements Hold Value
You must read the proxy statements because they reveal the self-dealing and cheating. The merger proxies also give rich data that you can use to do comparables of other companies. Price likes to compute intrinsic value using what smart investment banks pay for companies after doing lots of due diligence. This is a lot more meaningful than Morgan Stanley saying a stock should be trading at 17x earnings and you can buy it for 13x earnings.
To Price, when a businessman buys control of a business using cash or securities, that indicates intrinsic value. He does not approach valuation by discounting a stream of future earnings which he views as much too hard to do, nor does he use price-to-book or price-to-EBITDA, which he views as awful. You have to go to where there are transactions and see what companies are doing with their cash flows.
Read the merger proxies and bankruptcy disclosure documents which are a treasure trove of industry data. Typically many buy and sell side analysts are not going to read these documents. As an analyst and investor, you must read these documents.
The real way to make money is to do original research. This is different from inside information. Meaningful data from original research are hard to find. It takes getting creative – reading trades, going to court, talking to reporters, etc.
His mentor was Max Heine who did not like buying shares without voting rights. Price is sympathetic to this viewpoint. Two classes of stock can become an issue if the company is an acquisition candidate. You can buy two-class shares if you have high confidence in the management or family that controls the company. He carefully considers the incentives of the controlling parties. Are there 4th generation family members who are creating pressure to monetize their holdings?
On How He Reads Newspapers to Generate Investment Ideas
He reads the WSJ, New York Times and Financial Times every day. He also suggests reading trade papers such as American Banker. He loves the Lex Report in the FT. He is looking for examples of change – new management, restructuring, restatements, acquisitions, busted deals, lawsuits, etc. Also, he looks at who is wasting money on large ads. He likes to look at the worst performing groups domestically and globally. He looks at tender offer tombstones and dividend cuts.
You need to do your work when a stock starts going down on news so that, if it opens down a huge amount, you are in a position to buy – preparation meeting opportunity.
On How He Sizes His Positions and Trades Around Positions
He won’t buy unless he can identify value. He wants 3-5% in his top five names. He wants 2% in his next ten names and then 20-30 positions with 1%. With the 1% positions he is looking to build larger positions, because if he bought them cheap and they go down he wants to buy more. With the 5% positions – which is his size limit – he is looking whether he should leave them alone or bring them down.
He trades around positions where he has done the research and where the stock will do well over time. For example, if he buys 500,000 shares at $10 and the stock moves up, he won’t buy more. If it goes to $20, he might sell 100,000 shares. If the stock drops back to $11, he won’t buy more because it is not cheap enough. He’s OK with that because he has confidence based on his research that it will do well over time. You need to constantly re-evaluate if you want to be in a given stock; that is why you don’t want to have 300 names – it’s too many to track.
How He Values Pharmaceuticals
Value investors never traditionally looked at pharmaceuticals because they sold at high P/E’s. Price bought Merck when its stock price declined under the specter of HillaryCare.
To value a pharmaceutical company, he takes all the drugs they are currently selling, assumes an 85% profit margin, and does a discounted cash flow projection based on the remaining life on each drug’s patent. Ideally, you want to buy the stock at a discount to these cash flows and get the pipeline for free; this, according to Price, doesn’t happen very often. He noted that pharmaceutical companies have good balance sheets, the prospects of consolidation – because the industry needs it, and strong dividends that provide a floor for the stocks.
The investment business is all about having a point of view, after having done the work, and acting upon it.