Valuable lessons for today’s young investors
Michael Price is a well-known value investor who specializes in distressed and special situation investing. Mr. Price began his career in 1973 when he joined Max Heine at Mutual Series. In 2001, he left the firm to begin his own fund, MFP Investor, LLC, managing approximately $1.6 billion, most of which is his own money.
Following is a summary of Michael Price’s thoughts published in the spring 2011 issue of Graham and Doddsville investment newsletter from the students of Columbia business school. His remarks on how he constructed his portfolio, how he thinks about intrinsic value, other information sources beyond the traditional data sources, and how young analyst should bring into picture superior judgment skills in addition to the Excel spreadsheets to become successful investors, were noteworthy.
Investment Strategy and Portfolio
His current portfolio is 60% value, skewed toward small- and mid-cap companies, and 40% cash and special situations (pre- or post-bankruptcy, spin-offs, mergers, liquidations, etc.). Michael likes small-
and mid-cap companies because Wall Street doesn’t follow them well. His portfolio consisting of special situations and value stocks bought at a discount to the intrinsic value should be able to weather any bad market very well, as special situations do not move with the market (they move with the situation). In addition, high quality value stocks bought at discount generally decline less than the market. The key in the business is weathering the bear markets, not outperforming the bull markets.
Activism
Activism is good for the money management business, but activism is not a business strategy. The business is really about buying companies cheaply, and letting the management and board run it. If they do something really against your interests, you get active. But you don’t buy a position just to get active.
Information Availability and Information Overload
The internet is a huge source of information about products, companies, markets and consumer preferences, but Michael does a lot of his original information gathering on the phone. You get that sort of information (outside traditional media) from competitors, customers, former executives not privy to inside information, and other people who know the company. This also leads to information overload, but then it comes to your judgment as to what to do with the information. Back in 1975 and today in 2011, you still need the judgment.
Advice for Young Analysts and Investors
The younger generation is so reliant on all these modern tools, like Excel. Valuation is more than just the spreadsheet. It is the back-of-the-envelope judgment that gets one started and makes you work harder on the position. You can’t rely on the projections that you put in the spreadsheets alone. You have to do both. When looking at a stock, reduce it to a question, and then, without the noise of Wall Street, answer
the question. That means doing segment analysis, sum of the parts analysis, a judgment on the integrity of management, and a judgment on the overall economy, etc. Think about what really matters for each company, e.g., economy matters to JC Penney (JCP). If you are working really hard on a J.C. Penney spreadsheet and you don’t think about GDP, you are missing a big piece.
Correctable Mistakes Analysts Make
Staying away from debt, buying B shares with no voting rights, depending too much on the Excel spreadsheet and forecast of discounted cash flows are all mistakes analysts make. DCF should not be the only approach you have to look at many valuation approaches. Pick the one that makes the most sense — there is no one valuation approach that works for all companies and industries.
When evaluating a stock, think about the business, without any input from Wall Street; think about how you are going to understand that company, the business values and the management. You need to understand where the company is in the world and what the competition is for the products, whether the products are any good, and whether or not the company has any pricing power or barriers to entry. Call
around to people who use their products, to competitors, to trade associations. Make your own phone calls and do primary research.
For Anyone Trying to Enter the Field of Investing
Foot in the door is the most important thing. It doesn’t matter what the pay is. Get your foot in the door in a shop, big or small, that does things in the areas you are interested in. There is nothing like the real-world experience. Getting your foot in the door is key to figuring out whether you really have the fire and the ability for the business.
Intrinsic Value
The key question in investing is, what is it worth, and what one is paying for it? Intrinsic value is what a businessman would pay for total control of the business with full due diligence and a big bank
line. The biggest indicator to us is where the fully controlled position trades, not where the market trades it.
Comparables are interesting, but they are only one data point. Discounted free cash flows or replacement value is other such single data point. But when someone writes a check for the control
of a business, like what happened with Genzyme (Sanofi is acquiring it for $20 billion), that tells you what the business is worth. That to us is intrinsic value. When a private equity firm contracts to buy a company, and they are levering up cash flows, and financing with 25% equity and 75% debt, that is an interesting marker for the back-of-the-envelope calculation for the LBO value of a business. But that is a dangerous marker to use in trying to compute intrinsic value. We would much rather have a strategic buyer multiple for a comparable business to calculate intrinsic value vs. what was paid by a private equity firm.
Current Investments
ITT Corp (ITT, Financial) is his top holding (spin-off opportunity). ITT is divided into three pieces (water business, defense electronics business and industrial business). The stock is trading at roughly $59 ($44.4 on Aug. 24, 2011). The shareholders are going to get 75 cents in dividends and three stocks that will probably be worth between $65 - $72. The upside is quite large as any of these three pieces (all with excellent balance sheets and may pay dividends), should trade at $5-7 billion each, with each having a high probability of getting taken over.
Wall Street will give it better PEs due to the elimination of the conglomerate discount. They will all have a much better definition of their business, so Wall Street analysts will be able to cover and understand each of the businesses better.
Pfizer is another company he owns. All of a sudden, the board threw out the CEO. The board would
not throw out the CEO of a major pharmaceutical company without a backup plan. By throwing the CEO out, the board signaled that they were willing to look out for the shareholders. Company has yield of 5% at $16. It had some terrific businesses that could be spun out at very high multiples, and you would be left with the worry over this patent cliff, but you also had the pipeline that you were paying next to nothing for. They have already sold one division for almost 3x sales. They have four or five businesses that they could get big realizations of value for. The balance sheet is fine, and they have interesting products. The Street consensus is that there is $24- 25 of value in this company, and they are going to realize that, and maybe they will also get lucky in the pipeline.
Another stock he likes is Cache (CACH, Financial). This company has almost $3 in cash, and the stock trades at $4,
so I am paying a dollar per share or $13 million for $250 million in sales. He prefers the small-caps stocks that no one is working on.
Today’s investing environment
It has changed for the worse. The last worst change has been high-speed trading. Today, you can’t
show any size of your purchase or order, else the high-speed traders run in front of your order. Trading large orders has really become very difficult to execute. On the other hand, the technology has brought big improvements to buy side trading, like Liquidnet, which is an electronic marketplace for buy-side
to buy-side trading, where there is no broker involved. That is very efficient and it has been the best innovation in the last 10-15 years. SEC and the regulations have been bad. By and large, the media has not been helpful.
View on Dividends vs. Share buybacks
He would rather own a company not paying dividends. Dividend tends to keep that stock close to its
intrinsic value. We don’t own Bristol Myers. Why? It pays a big dividend. But Pfizer had both a 4% dividend and at $16, it was trading at a third less than its intrinsic value. That was a beautiful thing. A lot of managements want to pay dividends, and the tax on dividends right now is not bad, but still it is
double taxation, and it does not make sense. I would tell management not to pay a dividend, and since their stock would be cheaper because of the lack of dividend, buy the stock back, and
shrink the capitalization.
For the full text of the interview, please click on the link below: http://www4.gsb.columbia.edu/null/download?&exclusive=filemgr.download&file_id=7218158
Michael Price is a well-known value investor who specializes in distressed and special situation investing. Mr. Price began his career in 1973 when he joined Max Heine at Mutual Series. In 2001, he left the firm to begin his own fund, MFP Investor, LLC, managing approximately $1.6 billion, most of which is his own money.
Following is a summary of Michael Price’s thoughts published in the spring 2011 issue of Graham and Doddsville investment newsletter from the students of Columbia business school. His remarks on how he constructed his portfolio, how he thinks about intrinsic value, other information sources beyond the traditional data sources, and how young analyst should bring into picture superior judgment skills in addition to the Excel spreadsheets to become successful investors, were noteworthy.
Investment Strategy and Portfolio
His current portfolio is 60% value, skewed toward small- and mid-cap companies, and 40% cash and special situations (pre- or post-bankruptcy, spin-offs, mergers, liquidations, etc.). Michael likes small-
and mid-cap companies because Wall Street doesn’t follow them well. His portfolio consisting of special situations and value stocks bought at a discount to the intrinsic value should be able to weather any bad market very well, as special situations do not move with the market (they move with the situation). In addition, high quality value stocks bought at discount generally decline less than the market. The key in the business is weathering the bear markets, not outperforming the bull markets.
Activism
Activism is good for the money management business, but activism is not a business strategy. The business is really about buying companies cheaply, and letting the management and board run it. If they do something really against your interests, you get active. But you don’t buy a position just to get active.
Information Availability and Information Overload
The internet is a huge source of information about products, companies, markets and consumer preferences, but Michael does a lot of his original information gathering on the phone. You get that sort of information (outside traditional media) from competitors, customers, former executives not privy to inside information, and other people who know the company. This also leads to information overload, but then it comes to your judgment as to what to do with the information. Back in 1975 and today in 2011, you still need the judgment.
Advice for Young Analysts and Investors
The younger generation is so reliant on all these modern tools, like Excel. Valuation is more than just the spreadsheet. It is the back-of-the-envelope judgment that gets one started and makes you work harder on the position. You can’t rely on the projections that you put in the spreadsheets alone. You have to do both. When looking at a stock, reduce it to a question, and then, without the noise of Wall Street, answer
the question. That means doing segment analysis, sum of the parts analysis, a judgment on the integrity of management, and a judgment on the overall economy, etc. Think about what really matters for each company, e.g., economy matters to JC Penney (JCP). If you are working really hard on a J.C. Penney spreadsheet and you don’t think about GDP, you are missing a big piece.
Correctable Mistakes Analysts Make
Staying away from debt, buying B shares with no voting rights, depending too much on the Excel spreadsheet and forecast of discounted cash flows are all mistakes analysts make. DCF should not be the only approach you have to look at many valuation approaches. Pick the one that makes the most sense — there is no one valuation approach that works for all companies and industries.
When evaluating a stock, think about the business, without any input from Wall Street; think about how you are going to understand that company, the business values and the management. You need to understand where the company is in the world and what the competition is for the products, whether the products are any good, and whether or not the company has any pricing power or barriers to entry. Call
around to people who use their products, to competitors, to trade associations. Make your own phone calls and do primary research.
For Anyone Trying to Enter the Field of Investing
Foot in the door is the most important thing. It doesn’t matter what the pay is. Get your foot in the door in a shop, big or small, that does things in the areas you are interested in. There is nothing like the real-world experience. Getting your foot in the door is key to figuring out whether you really have the fire and the ability for the business.
Intrinsic Value
The key question in investing is, what is it worth, and what one is paying for it? Intrinsic value is what a businessman would pay for total control of the business with full due diligence and a big bank
line. The biggest indicator to us is where the fully controlled position trades, not where the market trades it.
Comparables are interesting, but they are only one data point. Discounted free cash flows or replacement value is other such single data point. But when someone writes a check for the control
of a business, like what happened with Genzyme (Sanofi is acquiring it for $20 billion), that tells you what the business is worth. That to us is intrinsic value. When a private equity firm contracts to buy a company, and they are levering up cash flows, and financing with 25% equity and 75% debt, that is an interesting marker for the back-of-the-envelope calculation for the LBO value of a business. But that is a dangerous marker to use in trying to compute intrinsic value. We would much rather have a strategic buyer multiple for a comparable business to calculate intrinsic value vs. what was paid by a private equity firm.
Current Investments
ITT Corp (ITT, Financial) is his top holding (spin-off opportunity). ITT is divided into three pieces (water business, defense electronics business and industrial business). The stock is trading at roughly $59 ($44.4 on Aug. 24, 2011). The shareholders are going to get 75 cents in dividends and three stocks that will probably be worth between $65 - $72. The upside is quite large as any of these three pieces (all with excellent balance sheets and may pay dividends), should trade at $5-7 billion each, with each having a high probability of getting taken over.
Wall Street will give it better PEs due to the elimination of the conglomerate discount. They will all have a much better definition of their business, so Wall Street analysts will be able to cover and understand each of the businesses better.
Pfizer is another company he owns. All of a sudden, the board threw out the CEO. The board would
not throw out the CEO of a major pharmaceutical company without a backup plan. By throwing the CEO out, the board signaled that they were willing to look out for the shareholders. Company has yield of 5% at $16. It had some terrific businesses that could be spun out at very high multiples, and you would be left with the worry over this patent cliff, but you also had the pipeline that you were paying next to nothing for. They have already sold one division for almost 3x sales. They have four or five businesses that they could get big realizations of value for. The balance sheet is fine, and they have interesting products. The Street consensus is that there is $24- 25 of value in this company, and they are going to realize that, and maybe they will also get lucky in the pipeline.
Another stock he likes is Cache (CACH, Financial). This company has almost $3 in cash, and the stock trades at $4,
so I am paying a dollar per share or $13 million for $250 million in sales. He prefers the small-caps stocks that no one is working on.
Today’s investing environment
It has changed for the worse. The last worst change has been high-speed trading. Today, you can’t
show any size of your purchase or order, else the high-speed traders run in front of your order. Trading large orders has really become very difficult to execute. On the other hand, the technology has brought big improvements to buy side trading, like Liquidnet, which is an electronic marketplace for buy-side
to buy-side trading, where there is no broker involved. That is very efficient and it has been the best innovation in the last 10-15 years. SEC and the regulations have been bad. By and large, the media has not been helpful.
View on Dividends vs. Share buybacks
He would rather own a company not paying dividends. Dividend tends to keep that stock close to its
intrinsic value. We don’t own Bristol Myers. Why? It pays a big dividend. But Pfizer had both a 4% dividend and at $16, it was trading at a third less than its intrinsic value. That was a beautiful thing. A lot of managements want to pay dividends, and the tax on dividends right now is not bad, but still it is
double taxation, and it does not make sense. I would tell management not to pay a dividend, and since their stock would be cheaper because of the lack of dividend, buy the stock back, and
shrink the capitalization.
For the full text of the interview, please click on the link below: http://www4.gsb.columbia.edu/null/download?&exclusive=filemgr.download&file_id=7218158
