Monthly Archives: October 2011

Links of Interest – October 28, 2011

Morningstar.com interviews Will Browne and Tom Shrager

Books | The Heilbrunn Center for Graham & Dodd Investing

Exclusive Interview with Famous Investor Tom Russo | ValueWalk.com

Charlie Munger on Berkshire’s Investment in BYD – Fox Business Video – Fox Business

Tom Gayner’s Address to Value Investing Conference May 2011

Charlie Rose Transcript With Ray Dalio, CEO of World’s Biggest Hedge Fund

Analysis: Fairfax Financial’s hedges shelter it from the storm | Reuters

“The Best Advice I Ever Got” – March 21, 2005

I Liked to Sell the World a Coke (Part 1): Neville Isdell – Bloomberg

Bruce Berkowitz on the Keys to Success for the Fairholme Fund

100 Ways to Beat the Market #15: Become a master

Some years ago, George Leonard wrote a wonderful book called Mastery which gives wise advise on how to become highly skilled at something.  The book has helped many people in numerous endeavors and continues to be widely read today.  I contend that consistently beating the market requires a high level of skill and that one would be well served by paying attention to what Leonard has to say on the subject of mastery.

Leonard teaches that true mastery requires an understanding that learning a new skill comprises brief periods of progress punctuated by long, successively higher plateaus, and even this does not always happen in regular clockwork fashion.  During these plateaus further progress seems elusive.  Yet, even without being conscious of it, learning continues.  Lessons are being assimilated and the mind and body are preparing for the progress necessary for reaching the next plateau.

The key is recognizing and accepting that this is the nature of pursuing mastery.  And that learning to love the plateau is an essential requisite for getting where you want to go.

Leonard further explains that there are three opposing and deficient character types which thwart the pursuit of mastery and short-circuit its attainment: the dabbler, the obsessive and the hacker. The dabbler begins the pursuit of mastery and initially makes good progress. However, once the dabbler hits the first inevitable plateau, he loses interest and moves on to something else. The obsessive thrives on getting better and settles for nothing less than continual progress. To fuel this progress, he throws himself into the task at hand and presses hard – too hard. Eventually he becomes burnt out and moves on to something else. Finally, there is the hacker. After some initial progress, the hacker hits a plateau where he is content to stay, never spending the time or effort to grow and move on to greater levels of skill.

To beat the markets requires mastery.  Learn to love the plateau by finding joy in doing the necessary work, confident that real progress will follow and true skill will develop in time.

100 Ways to Beat the Market #14: Don’t dabble

When an average person goes to an accountant, they expect, and usually receive, value in exchange for payment. Likewise, when hiring a plumber, electrician, attorney or any number of other specialists, the average layperson receives reasonable value in the exchange.

When it comes to money managers, though, this may not be the case. There is a lot of data that shows that, as a group, money managers’ performance equals that of the general market minus the frictional costs they incur in the form of fees, commissions, slippage, and taxes. How could it be otherwise? Many savvy investors such Bogel, Buffett and Greenblatt advise that average investors simply invest in an index fund and pocket these frictional costs. This is certainly a rational approach, and, as long as expectations are kept in check, it is likely to generate a reasonable return over the long term. Also, it has the added benefit of minimizing, if not eliminating, self inflicted wounds.

What about going it alone as an active investor? I think Buffett is correct that a person who spends an hour or two a week on investing has the potential to get a significantly worse result than simply buying and holding an index fund, particularly if he is doing focused value investing. Being able to value a company is sine qua non for successful value investing and this requires time and experience. Without good valuations grounded in independent work, you will lack the necessary conviction to buy meaningful positions and hold them through the inevitable ups and downs of the market. You could also get seriously burned if you buy something that looks “cheap” that really is a lousy, deteriorating business.

So why do many investors – even those who call themselves value investors – continue to dabble?

First, speculating can be very exciting and enticing. People can go to great lengths to speculate, even if it means dressing it up as value investing. Second, because investing outcomes are a result of both luck and skill, it is easy to draw the wrong lessons from one time successes or bull markets that generate good results for everyone, even know-nothings. These misguided lessons can lead to the conclusion that it is easy to make money in the markets. This is closely related to over-confidence bias which continues to draw patsies into the markets even when they bring nothing to the table and can offer no sound reason why they should generate a sound return when trading against well informed, sophisticated counter-parties.

Therefore, if you want to beat the market, don’t dabble. Dedicate yourself to it in a serious fashion or find a professional with the right investing framework and psychological makeup who will. Short of that, you’re better off investing in an index fund.

Links of Interest – October 14, 2011

Signals from Berkshire Hathaway’s Buyback Announcement « Gator Capital Blog

Gator Capital Management’s Investment Process – Disciplined and Repeatable – Good example of a strong investment process.

Ruane Cunniff’s Success Formula

Bill Ruane’s “Meek Lamb” Mentality for Value Investing

Longleaf Partners Q3, 2011 Letter

Oakmark Fund Letter to Shareholders – 9/30/2011

100 Ways to Beat the Market #13: Use a good filter with your search strategy

When Bill Ackman was recently interviewed on Bloomberg Television, he was asked if he was interested in Hewlett Packard given its recent large sell-off.  Ackman commented, “One of the things I learned a lot earlier in my career is to do a calculation which I call return on invested brain damage, which is before I make an investment which requires brain damage, or a lot of work and energy, I figure out how much money I can make.  The higher the brain damage, the higher the profit has to be to justify it.”

Ackman does not want to spend time on an idea if the payoff isn’t large, particularly if it is a complex idea requiring extensive analysis. Ackman also said, “I have the fairly quaint notion that the value of anything is the present value of the cash you can take out of the business over its life.” So, if a business is not predictable, he will take a pass and look for something that is.

Buffett has similar filters before he will get interested in an idea.

First, he’s looking for “seven footers”. Making an analogy to putting together a basketball team, Buffett wants ideas with obvious big upside potential. Only after finding a seven footer would he invest the time to check his skills, character, grades, etc. He also wants ideas where, if he could, he would put his entire net worth in the idea. He is not interested in taking a flyer on something.

The lesson here is obvious. Time is short. Don’t squander it on ideas that don’t offer large asymmetrical payoffs, especially if its something you could literally spend a year on and end up with a lot of superficial knowledge but no real insights into its future prospects.

Teledyne: Possible archetype for Berkshire Hathaway’s future?

Henry Singleton, Teledyne’s legendary chief executive, was a gifted capital allocator who created enormous shareholder value. Warren Buffett is a great admirer of Singleton and believes, “Singleton of Teledyne has the best operating and capital deployment record in American business.”

Singleton’s repurchases at Teledyne shed light, I believe, on what Buffett is doing at Berkshire. Financial journalists writing about Berkshire’s recently announced share repurchase policy – now actively underway – are often ill-informed and sometimes clueless.

The following article provides a good overview of Singleton’s record of capital allocation and will give you insight on how to think about and value Berkshire Hathaway’s stock, particularly as it regards the addition of share repurchases to Buffett’s capital allocation toolbox.

Teledyne and Henry Singleton a CS of a Great Capital Allocator

See previous blog post: Henry Singleton: A Master of Capital Allocation

Links of Interest – October 7, 2011

Bill Ackman Interview With Bloomberg

Warren Buffett at Fortune’s Most Powerful Women Summit – Fortune Management

Investors Sing a New Tune—’Won’t Get Fooled Again’ – WSJ.com – Investors sidestep current market to wait for a cheery consensus. Some things never change.

Charlie Rose – Warren Buffett, Investor, Philanthropist

Diageo CEO Financial Times Interview

Prem Watsa – Highlights from “Fair and Friendly : The First 25 Years of Fairfax”

Mental Models : Farnam Street

100 Ways to Beat the Market #12: Swear Off Market Forecasts

When John Griffin started Blue Ridge Capital in 1996, it was a very difficult period because he did not have a long-term track record, and everyone was fixated on his short-term record, i.e. what he had done in the prior week, month, year, etc.

When Griffin started, he had a large amount of cash to deploy.  It was very stressful to go from the comfort of holding cash to putting it at risk.  At the time, he wrote on the board in his office, “The future is uncertain; it is always a difficult time to invest.”  He constantly reminds himself and his staff of this.

Today the markets feel particularly uncertain. Hardly a day passes when I don’t see an article about retail equity investors dumping their stocks because they can’t bear the high level of volatility. They often claim that they’ll return to the equity markets when things calm down and prospects become clearer.

The problem with this is that the future is never clear. There may be times when people think the future is clear – typically good times or in the latter stages of a bull market – but this is generally self-delusion based on over confidence. Yet, most people continue to be lured by the siren song of market forecasters, and opportunists are happy to oblige as evidenced by cable financial networks ever readiness to put on an endless stream of market prognosticators.

So, what’s the answer? After all, investing inherently involves making judgments about the future. One rational answer lies in focusing on individual companies where you can occasionally – if you work hard enough at it – gain a powerful insight into one of their future prospects that can fuel the level of commitment and certainty necessary to invest a meaningful amount of your capital.

Great companies with important economic advantages have provided satisfactory returns – or better – in spite of the many vicissitudes the markets have faced over the past century. When you find such a company and Mr. Market makes it available at a good price, you commit a costly sin of omission if you sit on your hands because of an uncertain macro environment, provided – again – that you really know what you’re doing. Worse yet would be to sell such a great holding after a sharp decline in its quotational value because you couldn’t stomach the volatility.

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100 Ways to Beat the Market #11: Seek a margin of safety in certainty

Having a margin of safety is the cornerstone of intelligent investing. Buffett has said that chapter 20 of Benjamin Graham’s The Intelligent Investor which deals with the concept of having a margin of safety is one of the most important things ever written about investing. That Seth Klarman named his book Margin of Safety tells you something about the centrality of this concept.

Most often, a margin of safety is thought to reside in the gap between the price you pay and the value you receive, and rightly so. In addition, though, a margin of safety can be found in the certainty with which you believe a company will be worth far more in ten years than it is worth today. This is particularly true if you run a focused portfolio.

Buffett has said that he would sell a stock of a business that he was 90% certain would be worth more in the future if he could replace it with a stock of a business whose prospects were 100% certain. Moreover, he has said that he is not in favor of compensating for uncertainty by using a higher discount rate, which he views as nonsense. This notion of finding a margin of safety in certainty is essentially a positive embodiment of the famed first rule of investment, namely don’t lose money.

Commenting on when he was on Coke’s board, Buffett once said that, although he understood why it was done, he didn’t see much point in doing an ROI analysis on Coke’s prospective investments in growing the business because of his supreme confidence that the returns would be more than satisfactory.

If you want to beat the market, spend time looking for companies that you are virtually certain will be worth far more in ten years than they are today and then patiently look for an opportunity to buy shares at a reasonable price. Be patient and don’t commit your capital at prices that will lock you into mediocre returns. On the other hand, be reasonable. Businesses of this caliber rarely sell at deeply distressed prices.

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