How long did it take you to develop your own style?
I’m an odd case. It happened almost instantly. And here’s why.
I got started investing when I was 14. I didn’t actually read anything about investing for a couple years. So, there’s no way I could have been simply a value investor or a growth investor or whatever – because I didn’t know what those things were.
I first learned about value investing when my dad brought home an article about Ben Graham. Before then, I didn’t know there was such a thing as value investing.
There is a reason why I talk about things like comfort with a stock and Warren Buffett’s 20 punches.
It’s not that I abstractly believe that investing like you get to make only 20 investment decisions for the rest of your life will work well. It’s that I lived that approach to investing when I was very young.
I was born in 1985. I got started investing in the late 1990s. I had money. And no idea where to put it. I didn’t know anything about stocks – except for the part every kid knows: “A stock is a piece of a business”.
So, it’s not like I learned about stocks first and businesses second.
When I was growing up, my mom was basically the second officer at a family-controlled company. She was the only executive with no ties to the family. They had a board. They had a chairman. They had a president. They had auditors. When I looked at stocks, I saw they too had CEOs and boards and auditors and all that. I figured they were the same. I mean I would look in the glossy annual report and see a picture of somebody and under that person’s name was my mom’s job title. In that situation, why would it ever occur to me to think of the stock market as a place where I bought a piece of paper instead of a business?
I never thought about buying a stock purely because of its P/E ratio or tangible book value or PEG ratio or earnings growth or whatever because I hadn’t read any investing books and I hadn’t heard the only person I knew in business – my mom – ever use words like that.
What did I know?
My mom’s company had moved from New Jersey to Florida when I was about 6. She was offered the CEO job. But she didn’t want to move our family. So, they split the CEO role into three parts. She took one part – sales and marketing – and set up a home office. Every month she flew down to Florida for a few days of meetings.
My mom’s home office actually doubled as my bedroom (I slept on a pull out couch). Whenever I got home from school my mom was always on the phone with someone inside her company – usually a sales engineer – or with a customer.
The company my mom worked for made dust control systems. Dust control systems are used in the tissue paper and pharmaceutical industries. So their customers were mostly huge public companies like: Procter & Gamble (PG), Kimberly Clark (KMB),Georgia Pacific, Scott, Pfizer (PFE), Merck (MRK), Upjohn, Pharmacia, etc.
If you don’t recognize some of those names, it’s not because they were small or private. It’s because somebody bigger bought them. These were all big public companies when I was growing up. And they were my mom’s customers.
So it was not unusual to come home from school and have a snack while hearing about why Procter & Gamble was suing my Mom’s company or why they weren’t going to bid on the Georgia Pacific job or something like that.
Since my mom’s company was an engineering company, I also heard about all the little problems those companies were having in their plants.
I heard about how one company had a plant in Southeast Asia where the defective diapers they dumped were being scavenged by the local poor. The diapers were only cosmetically defective. They were being rejected because of misaligned tape that still held the diaper fine. Perfecting the tape alignment would cost too much. Selling the defective diapers would obviously ruin the brand. Even though diapers worked you couldn’t put a product like that on store shelves. But dumping them was creating a brand problem too. The people scavenging the diapers were very poor and the rich folks in this country had only recently started adopting disposable diapers. Disposable diapers were a bit of a status symbol. And this company did not want its target customers – the rising middle class – seeing this very premium foreign luxury good on the butts of the country’s very poorest babies. So they wanted some way to cheaply and efficiently shred the diapers – or at least render them more than just cosmetically defective before dumping them.
That was a lesson in brands I would never forget.
It was not the only one I got.
I was at a fast food restaurant with my mom one time when she pointed over to a napkin and told me a story. People take too many napkins at fast food restaurants. Some people stuff extra ones in their glove compartment, in fear that one day the person at the drive through window will forget to drop napkins in the bag. It’s a high volume low cost sort of business – supplying a fast food chain with its paper napkins. Well, if that’s all there was to the business it would be a pretty simple task to just make the lowest cost napkin possible. But it’s not quite a total commodity. Because the fast food restaurants want their logo on the napkin. And they want their signature colors used. So they always have this trade off between lowering the cost of napkins and doing a nice job with the logo. For most companies, it’s easy enough to find some paper mill that will competently execute the logo and still give you a super low price. For one fast food company it was not. This company had a particularly difficult logo – let’s say it was a girl with red hair and red freckles. The little red dots will bleed like inkblots and make the corporate mascot look awful. And for awhile solving this problem was an absolute obsession at one particular paper mill. All they wanted to know was whether you could fix that problem.
These are the sorts of problems my mom’s company would be asked to solve. It might sound like complex and technical enough work that there should be some competitive advantages in it. But I didn’t know any theories on what makes for competitive advantages.
What I did know was that my mom’s company was in a lousy business.
That was made clear to me every day. There was never any doubt that their customers all had better businesses than my mom’s company. That selling branded, disposable products to the masses was much better than selling some engineering solution to a paper mill.
I went to a couple trade shows with my mom. Miami and Nice, France were the big shows back then. But I never went to those. Brazil was growing in importance. We were the only house on the street with a subscription to a Portuguese language paper magazine.
But obviously I went to the trade shows at the Javits Center in New York. There was a big drug industry trade show where I remember setting up the products my mom’s company was showing and asking which way was up. I really couldn’t tell which was the top of the thing and which was the bottom. Everything my mom’s company made looked an awful lot like an airplane toilet. I walked around the floor and looked at a lot of other companies’ products that also looked suspiciously like airplane toilets. Everything in the place was stainless steel.
What I was struck by then – walking the floor looking at products I didn’t know the use of sold by companies I didn’t know the name of – was the huge chasm between the sellers and their customers.
These little companies were selling big, heavy products that did not conjure up a single thought in your mind to big companies that were selling tiny little products that weighed about as much as a feather and yet had all this mental baggage.
So when anyone asks why I have this prejudice against capital goods companies – it’s from that trade floor. It’s from growing up around a company that installed things in other people’s factories. And from the memory that while my mom’s company always submitted a quote for a job, the system they were selling was going to be used to produce a little pill or some tissue that someone was going to buy at a convenience store the second they needed it – and they probably weren’t even going to check the price. A business where your customer has a meeting about your price is a bad business. A business where your customer is in pain until they take your product is a good business.
My mom’s company was in trouble for a very long time. I remember going to the bank with her when they were borrowing against their New Jersey real estate. And I remember the first time I heard about a “factor” was when my mom’s company needed cash and had to use their receivables to get it.
Eventually, a European company offered to buy my Mom’s company. They served the same customers – installing different systems in the same paper mills. There were supposed to be revenue synergies. Really, I think they just wanted the North American sales engineers. And they couldn’t systematically poach them all at once.
The negotiations dragged on. My mom flew to Spain a lot that year. They ended up only selling part of the company.
My mom’s company filed for Chapter 7 bankruptcy soon after.
There’s a net-net lesson in there too. Another company wanted to buy this thing almost up until the very second it went under. Baffling but true. People will pay a lot for what they feel is their missing puzzle piece. If you have distribution or technology or a brand they covet – they might just overlook the fact you are within spitting distance of bankruptcy.
And while that may be a very boring story having very little to do with the way most people invest – it’s the only thing I had to go on when I started investing. To me, all businesses were like that.
I learned a few things from that experience. My extreme hatred of capital goods companies. My love for businesses with pricing power. The idea that bankruptcy is not – as most investors seem to think – some sign of management failure, or misalignment of interests, or lack of effort to keep up with the times. Bankruptcy comes from insolvency. Insolvency comes from having too many bills and too little cash. Businesses do not fail on purpose. They fail because despite their best efforts because they can’t keep the cash coming in faster than it goes out.
Usually, this is preceded by years and years of poor profitability.
This poor profitability is rarely due to laziness.
I watched for 10 years as my mom’s company tried to grow sales and cut costs. They went from selling in the U.S. to selling all over the world. They moved their factory, their office, and the families of all their people halfway across the country. And they still failed.
So any business with insufficient cash, insufficient profits and excessive liabilities can go under. I know that. And I can assess that situation with bringing morality in to it the way most investors do.
These were the things I brought to investing when I was just starting out at 14. I knew a lot more about businesses than I did about stocks. Mostly because I knew nothing about stocks. So the only thing I had to go on was whether I liked the business, felt comfortable with the business, and knew I wasn’t paying more than it was worth.
The first three stocks I bought were:
· Activision (NASDAQ:ATVI)
· Village Supermarket (NASDAQ:VLGEA)
· J&J Snack Foods (NASDAQ:JJSF)
Check out the performance numbers on those three stocks over the last 10-13 years (I bought them at different times). You’ll notice that if I just never sold those stocks I wouldn’t need to do anything else. Those three stocks would’ve made a fine portfolio for the next decade or so.
Well, I did sell those stocks. And I did a lot else. And some of it worked very well and some of it worked very badly. But, almost without fail, the net result was never better than what would have happened if I’d kept those three stocks.
That’s not an accident. It took me a very, very long time to buy stocks when I was a kid. I bought six stocks in my first five years as an investor. That’s not quite a 20 punches approach – but it’s pretty close.
Why did I only buy one stock a year?
Because I didn’t know anything about stocks. And I didn’t think I knew anything about stocks.
My investment style was formed from a combination of extreme ignorance and extreme confidence. I was totally ignorant about stocks. And I was totally confident that I could learn all I needed to know about the stocks I needed to know about.
That combination led to focusing on a few very specific stocks. Stocks I was comfortable with.
When I was 14, there were only two places my money went. Into my brokerage account. Or into video games. So it’s not a surprise I bought Activision. At the time the video game industry had a much clearer future than it does today. And there was no better CEO of a video game company than Bobby Kotick. The balance sheet was pristine. When you backed out cash, the stock was cheap relative to sales. I looked at everything I could about video game companies and I decided sales were pretty profitable and pretty cash generative in this industry. All you needed was sensible capital allocation. All you needed was management that was going to run the place like a business. And I thought you had that.
I worked as a cashier at Village Supermarket when I was 14. Nobody could work at one of those stores and not be impressed by the business side of things. Outsiders can get a glimpse of this in the sales per square foot number. But folks who have actually been in the stores have an unfair advantage. It is hard to imagine a bigger store with lower prices and longer checkout lines than the store I worked in. Anyone who had the misfortune of trying to find a space in that parking lot wouldn’t believe you if you told them the stock went for something like 8 times earnings.
And I bought J&J Snack Foods. It had a good record. It was cheap. I liked the CEO. And I figured soft pretzels weren’t rocket science.
Since then my style has changed. And not for the better. I read all sorts of value investing books. A couple were worthwhile. But most were not.
About seven years ago, I started a blog. And shortly after that I started writing articles as well. That’s been a lot of fun. And I’ve learned a lot about investing.
But I’m not sure it’s made me a better investor.
I still think that the thing that makes you a better investor is sitting down alone and reading about a single company.
I think that’s an under-appreciated art. And I really do think that’s all there is – or at least that’s all there needs to be – about investing.
You don’t need to make it more complicated than that.
All you need to do is find a company you:
· Are comfortable with
· See a clear future for
· And can buy at a good price
When I started investing, I never calculated intrinsic values. And if you’ve read my articles, you may know I’m still pretty prejudiced against this. I mean, intrinsic value estimates are the bread and butter of folks like me who write about value investing. And yet I hate ever putting one down.
It’s better to think in terms of owning a business.
And owning a certain amount of assets.
Most people focus on book value. But financing an asset doesn’t mean the lender has any right to the production of that asset. At a bank, the depositors don’t get paid based on the bank’s earnings. Only the shareholders do. At Village Supermarket, if they had a mortgage they paid the going rate for a mortgage. It depended on interest rates. It didn’t depend on whether they were having a good year or a bad year. So, if they were going to have a long string of good years in the future – their shareholders were going to benefit, not their bankers.
So I like to think about the assets the company controls. That’s the stuff I can earn a return on. And then I try to figure out what kind of return the company will earn. And then I just look at my investment in those terms. What assets am I buying and what kind of return will those assets produce.
Basically: ROA * Assets/Market Cap = Investor Return.
Now, it’s a little bit more complicated than that. Growth matters.
For companies like Village Supermarket and J&J Snack Foods it’s pretty much that simple. They can grow, but they won’t grow in a way that adds much value to my investment beyond their return on assets. Neither of them was going to start earning 20% a year on assets – so I had no reason to believe the returns they earned on their assets would grow faster if left in their hands than if paid out to me in dividends. As a result, I never really considered growth except insofar as I made sure that they were earning enough on their assets that if they grew those assets I’d still get a decent return.
But there are some companies like Fair Isaac (FICO) where it’s different. FICO can actually grow earnings faster than assets. As a result, you are probably getting something like a 3% annual kicker beyond ROA * Assets/Market Cap when you invest in Fair Isaac. They throw in a little “free” growth.
Most companies don’t. You have to earn a really high return on your assets to make growth valuable for investors if you are simultaneously growing your assets very quickly.
The easiest way to make growth pay for shareholders is by achieving it with very little investment in asset growth.
Anyway, that’s my investing style. I look at the business as something that has to earn a return on its assets. If I like the business I’ll buy it when I think the combination of my expectations for future ROA times the ratio of assets to market cap is enough to earn me the kind of returns I want to make over time.
What companies fit that profile today?
Two of the best examples are in the same industry:
· Carnival (NYSE:CCL)
· Royal Caribbean (NYSE:RCL)
Someone asked me a question about how I could consider Carnival attractive. So I’ll connect those two stocks to my investing style when I answer that question.
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