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VALUE TALK: What’s The Secret? Confidence and Conviction

December 06, 2007 | About:

Charles Mizrahi

19 followers

Over the past few weeks I have been busy giving media interviews and delivering speeches in order to promote my new book,Getting Started inValue Investing. I have to tell you, I did walk into several bookstores last week when I was in NewYork City, just to see my book on the shelf. It really is a thrill,especially after months of writing, researching and rewriting, to finally see the end product sitting prominently in the Investing section at Barnes & Noble.

A few days ago, while delivering a presentation on value investing,a young woman in the audience asked me, "What does it really take to be a successful value investor?" I thought for a few seconds and answered, "Think differently and independently." That was my two-second sound-bite answer; it was perfect for an interview or presentation but didn't really answer the question. Over the past several days, I have thought long and hard on what it takes to be a successful value investor. I wanted to be able to boil it down to a few main traits that I have learned and observed from the "value gurus". Before I start, I want to share with you what you don't necessarily need to be a successful value investor.

In most fields, a high IQ, fancy college degrees and extensive experience are usually the hallmarks of someone who has climbed to the top in his or her profession. While good to have, none of these things will guarantee someone's success as a value investor. After several years of excellent returns, LongTerm Capital Management (LTCM) got into serious trouble. By the summer of 1998, the firm was imploding and threatening to take the financial markets with it. Things were so serious that a rescue effort was orchestrated by the NewYork Federal Reserve to bail the firm out. LTCM had an enormous amount of intellect running the company. The 16 principals included two Nobel Prize winners along with 14 other extremely bright, intelligent people who had decades of experience doing exactly what they were doing at other firms before forming LTCM. Warren Buffett said that "If you take the 16 of them, they have about as high an IQ as any 16 people working together in one business in the country, including Microsoft." But in the end, they lost hundreds of millions of their own and others'money.

I recently read of 69-year-old Earl Crawley, better known as Mr.Earl, who never earned more than $20,000 a year as a parking-lot attendant. But he has amassed a stock portfolio worth more than $500,000.2 When Mr.Earl started working for Mercantile Bank in Baltimore 44 years ago, he was told that his educational background was lacking. He then went on to live on a budget, do odd jobs in addition to his day job and invest his nickels and dimes in stocks. Mr.Earl said his "formula" was to "look for companies with stability that pays dividends." Certainly Mr. Earl did not have a high IQ, college degrees or extensive experience, yet he was a successful value investor.

What's The Secret?

Many people know that Warren Buffett reads a lot of newspapers - perhaps that is the secret? While it is true that Mr.Buffett reads The NewYork Times, TheWall Street Journal, USA Today, the Financial Times, the Omaha World Herald and American Banker every day, reading won't guarantee investment success either. In the mid-1970s the Reichmann family of Toronto bought a package of eight skyscrapers in Manhatn for a fraction of their value. Over the next decade, their development company, Olympia &York, was the greatest property development company in the world. At its peak the company was worth over $10 billion. The genius of the family was Paul Reichmann, an Orthodox Jew who said that his commercial decision making was rooted in Talmudic methodology. It was said that real estate brokers in London and NewYork could be seen leafing through the Talmud in hopes of discovering Reichmann's secret.

You won't find the secret in high IQs, college degrees, experience or reading. Keep in mind that while all these will help you, in and of themselves they are not the secret. Perhaps by looking at training and occupations we can come closer to finding what it takes for success? Looking at the occupations of the investors Warren Buffett showcased in his presentation on "The Super Investors of Graham and Dodgeville"(1984) still offers no clue. Buffett showed the track records of great value investors who came from all walks of life :a lawyer, an IBM salesman, a chemistry major, an advertising executive, a high school graduate. They all shared the same investing principles laid down by Benjamin Graham,but not much else. Without teasing you any longer, the secret boils down to temperament:how strong one's convictions are and how stringently one sticks with them.

Confidence

Value gurus seem to think differently than other people. They get enjoyment from being immersed in the company they are researching, becoming fluent with the financial statements and then forming opinions based on their findings. I can't recall reading about a value guru who offered "my gut" as the thesis for an investment idea. That is far from the way the majority of value investors behave. Instead, a valuation on the security is formed after all the facts are gathered, and not before. These investors are not concerned if they are in the minority; in fact, most of them like to be invested where most investors fear to tread. Those investments most times offer the greatest returns. They understand and completely believe that over the short term stock prices move based on popularity, and over the long term based on the fundamentals of the company.

It really boils down to having an information edge over Mr. Market and a way to determine the value of the company. If you don't know, you'll have to take the last price the stock traded at in order to determine the value of the company. By rolling up your sleeves and diving into the annual reports and financial statements, you've begun to develop an edge by discerning if the company is efficiently priced by Mr.Market or not. Just by reading the past five years' annual reports and the current annual reports of its competitors, you will have gained more insight into the company and its industry than most people who buy and sell the stock on a daily basis.

Assume the house next door to you is being sold by the county at a public auction. Since you have lived in your house for the past 30 years, you have a very good idea of its value and that of the one next door. The auction draws a nice crowd of locals as well as out-of-towners. Since you know the neighborhood, the condition of the house, how it was maintained, etc., you have clear edge over most of the other bidders. The bidding starts at $100,000 and quickly goes up to $225,000 before stalling out. The auctioneer says,"Going once, going twice...," and before he is about to bang the gavel, you raise your hand and bid $250,000... and win the auction. Why did you bid more than everyone else and win? Simply because you knew that homes on your block are selling for over $500,000. In fact, your next-door neighbor on the other side just rented his home for $25,000 a year to two college professors while he went on a year-long cruise. In other words, the price wasn't as important to you as it was to most of the bargain hunters; you saw an opportunity to buy $1 worth of assets for 50 cents.Your downside risk was minimal and you did not let the lack of other bids scare you into thinking, "How come I'm the only one left bidding?" Instead, you had confidence in making that bid because you were informed, had a very good idea of the value and were able to buy it at a significant discount to your valuation.That's the type of confidence I'm talking about.

Conviction

Why is it so important to do your own research and have a high level of confidence in the value of a company? Sometimes Mr.Market is erratic, in that he will offer a stock price that is down 20 percent or more from the previous day's closing price because of an analyst downgrade or perhaps the company missed their earnings target by a penny. An owner of the stock who bought it because of a tip from a friend will be shaken and sell into the downdraft. But since you know the value of the company, you view times like these as opportunities and take advantage of them. In hindsight, these purchases will make all the sense in the world and will become so obvious to so many. However, during the panic very few investors are willing to step up to the plate, because they lack conviction. Watching their stock account drop 40 percent or more over a short period of time is a very painful experience for most investors. In order to stop the pain, they sell at any price. Value gurus fight this instinct of fear and let the confidence of their research and the conviction of their thesis win the day. This is not as easy as it sounds. It is very hard to keep your head when everyone around you is losing theirs, but that is what separates the great investors from the mediocre ones. Since the early part of this year, three industries have been getting hammered by Mr.Market: financial, retail and housing. Most investors have sworn off these industries because of the sharp losses. What do you think value gurus have been doing? If you said buying, you are correct. Talking the talk is one thing, but how many people do you know have been able to walk the walk and buy when stocks are falling sharply? To sharpen this point just a bit, I took a look at three stocks that have been making headlines over the past several months and have seen sharp price declines: Home Depot, Inc. (HD), Countrywide Financial Corp. (CFC) and USG Corp. (USG). They are all in industries that Wall Street is avoiding like the plague: retail home improvement, mortgage investments and general building materials. Each value guru below has an excellent long-term track record and invests by following the principles of value investing.

The Last Word: Paid for Failure

When I was a kid, I used to daydream about playing centerfield (instead of Tommie Agee) for the NewYork Mets. There were more days than I can remember that I sat in my fourth-grade class seeing myself running to the warning track and leaping up to rob a home run off the visiting team. Now I know I really wasted my time. I should have been dreaming about running Merrill Lynch instead.

For the life of me, I just can't figure out why certain companies pay their board of directors. Imagine losing $7.9 billion on mortgage-backed securities and not getting fired! Instead you are allowed to retire as chairman and CEO so you can receive an annual $1.3 million pension, $5.4 million in deferred earnings and $131.4 million worth of unvested stock awards and units you can now sell.Your total exit package comes to $160 million. If you were fired, you wouldn't be able to keep all that money. Oh,and for doing such an outstanding job, by piling up risk so your balance sheet now looks like crap, you get to keep your executive assistant for three years and have your former company pick up the tab for the office space. Boy, I should have been dreaming about being Stan O'Neal, former chairman and CEO of Merrill Lynch, instead of TommieAgee.

 

About the author:

Charles Mizrahi
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.1/5 (29 votes)

Comments

Alex Garcia
Alex Garcia premium member - 6 years ago
I would have to disagree with you and agree with Warren E. Buffett. In the preface to the 4th edition of "The Intelligent Investor", Mr. Buffett answers this question for you. Speaking from personal experience, I found this short paragraph to be more truthful.

"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights,or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.this book precisely and clearly prescribes the proper framework. You must supply the emotional discipline."
Gangstarr
Gangstarr - 6 years ago
Isn't that more or less what Mr. Mizrahi said?
valuemodel
Valuemodel - 6 years ago
As someone who has tracked Buffet since 1989, I have come to the conclusion that he does indeed use something like "gut sense" or intuition to make decisions. He seems to be able to spot good management quickly. Also, understanding the durability of a franchise is more of a "soft" skill.* I would submit most of us have trouble applying a numerical value to the great global brands. Even the venerable Billy T., who correctly taunts others to come up with a scenario where JNJ and BUD are earning less 20 years from now than today, is making a judgement (which I agree is sound) that is not purely grounded in looking at numbers and ratios alone.

Adding my two cents worth to what makes a successful value investor, it is extreme focus and being able to tune out "noise": the daily deluge of non-news, masquerading as vital information, and applying the same criteria to each investment opportunity.

*N.B.: it is precisely because WEB's skills are so unique, that I think BRK will need to be re-evaluated once he departs.

(Full disclosure, I own BRK.)



billytickets
Billytickets - 6 years ago
Valuemodel WELL said. Investing is mostly Science and partially Art and instinct.After making 20000 decisions and whether or not you eat if you are wrong I can say that Iam better suited to most to do it.Many like CCYORK who obviously doesnt make his living allocating capital just would not know

See its real simple show me a scenario where JNJ 's EPS is less in 20 years? No one cc york included has been able to do it.

Now show me a scenario where a financial could be selling for less in 10 years? I dont own WFC and USB like WEB because NO ONE knows how bad the credit crunch will be But for over 100 years JNJ and BUD have DESTROYED their competitiors. Great posts guys
itznuthin1
Itznuthin1 - 6 years ago
leave stan o'neal out of this
iammatt
Iammatt - 6 years ago
billytickets Wrote:

-------------------------------------------------------

>

> Now show me a scenario where a financial could be

> selling for less in 10 years? I dont own WFC and

> USB like WEB because NO ONE knows how bad the

> credit crunch will be But for over 100 years JNJ

> and BUD have DESTROYED their competitiors. Great

> posts guys


As you know, WEB talks about some industries being a tax on the profitability of America. You may hate financial stocks and think they are un-understandable and impossible to predict, but there is no industry that is better described as a tax than the financial industry. That doesn't mean that every company will survive, but if you really think that earnings in the financial sector will be a lower percentage of GDP ten or twenty years from now than today, I think you are insane (no offense intended).

Every transaction in the United States goes through the financial system. Every stock and bond offering, every home sale, every purchase. Unless you believe that GDP, not adjusted for inflation, will be lower ten years from now, then you are plainly wrong. I can see being bearish on some companies or on some sectors, but not on the financial industry as a whole, and not on its biggest, best run companies.
billytickets
Billytickets - 6 years ago
Matt Ima not saying it at all. I just don't understand who the winners are going to be in financials. I "trust WEB about WFC but I just dont understand WFC's moat "yet". ( im NOTdoubting WEB I just don't see it) but I KNOW BUD Mo KFT BRK and BNI will be doing MORE business 20 years from now. Whyjump over a 5 foot bar when You can step over a one inch bar
iammatt
Iammatt - 6 years ago
billytickets Wrote:

-------------------------------------------------------

> Matt Ima not saying it at all. I just don't

> understand who the winners are going to be in

> financials. I "trust WEB about WFC but I just dont

> understand WFC's moat "yet". ( im NOTdoubting WEB

> I just don't see it) but I KNOW BUD Mo KFT BRK

> and BNI will be doing MORE business 20 years from

> now. Whyjump over a 5 foot bar when You can step

> over a one inch bar


I understand what you are saying, but feel differently. I do not think that determining the fate of well run banks is all that difficult, and I would rather buy a very good to great business at a cheap price then a great on at full price. With the ones you mention, you get no valuation return, that is to say that they are all fully priced... at least. I don't believe that their growth will be any greater than that of BAC over ten years, and with BAC you get the added advantage of a good price. Just my .02.

For full disclosure, I own MO in the low 40s and BNI in the mid 50s, so they are not stocks or companies I hate. I do not like KFT and have been a seller of it this year. I do own BAC among other financials, but not WFC.
billytickets
Billytickets - 6 years ago
Matt we can agree to disagree I bought all my stocks when they were"chepa'.My basis in MO is 19 and holding period about 9 years KFT is 8 and holding period is 9 years BrkB is 2730 and holding period is 2 years BUD is 42 holding period of 2 years JNJ is 61 holding period is about 5 months and BNI is 81.18 and holding period about 2 weeks.

If you can do better than that then Iam very impressed. I have no way of knowing how well my stocks compare to others and My only barometer is 15% annual return over a 3 and 5 and 10 year period which I have been able to achieve

My goal is buying the GREATEST companies in the world when they are priced significantly below intrinsic value. I am thankful you and others feel they are Fullyvalued. If you all didn't then I would have to get ajob instead of being able to allocate capital. Good luck in your quest to achieve financial security through your opinion. peace


vooch
Vooch - 6 years ago
Couple counterpoints:

> I can’t recall reading about a value guru who offered “my gut” as the thesis

> for an investment idea.

I can recall either reading or watching a Mohnish Pabrai video where he stated that after the analysis, if the stock doesn't come out and scream "BUY ME!" (or something similiar to that [ie. "gut" feeling]), then he doesn't invest in it. I think "gut" feeling is probably one of the best things I've seen for entering or exiting a stock. Of course, you need the foundation of knowledge to rely on the gut.

> It really boils down to having an information edge over Mr. Market

I'm not sure what this means. It seems you are implying "inside information". If that's what you meant, you are wrong.

> The auctioneer says,“Going once, going twice...,” and before he is about to bang the

> gavel, you raise your hand and bid $250,000... and win the auction. Why did you bid

> more than everyone else and win? Simply because you knew that

> homes on your block are selling for over $500,000. In fact, your next-door neighbor on

> the other side just rented his home for $25,000 a year to two college professors while

> he went on a year-long cruise. In other words, the price wasn’t as important to you as

> it was to most of the bargain hunters; you saw an opportunity to buy $1 worth of

> assets for 50 cents.

The numbers don't work here, for me, and for several reasons. You, the highest bidder, paid $250,000. Your next-door neighbor rented his home for $25k per year, so at the best, you make 10% a year.

Throw in inflation, and you're out another 4%.

Then, throw in the fact these professors are late on their payments. Afterall, they learned the most efficient way to live is screwing over the landlord. Getting someone evicted costs a fortune in time and money for the landlord, so you're out another at least 5% for the year.

Normal wear-and-tear on your property (ie. maintenance costs) throw you back another 2%.

- Vooch

iammatt
Iammatt - 6 years ago
billytickets Wrote:

-------------------------------------------------------

>

> If you can do better than that then Iam very

> impressed. I have no way of knowing how well my

> stocks compare to others and My only barometer is

> 15% annual return over a 3 and 5 and 10 year

> period which I have been able to achieve

>

> My goal is buying the GREATEST companies in the

> world when they are priced significantly below

> intrinsic value. I am thankful you and others feel

> they are Fullyvalued. If you all didn't then I

> would have to get ajob instead of being able to

> allocate capital. Good luck in your quest to

> achieve financial security through your opinion.

> peace

>

>

>

I've done alright, and thank you for the good wishes.

janbil1
Janbil1 premium member - 6 years ago
Comment to Vooch

Gut- buying without doing research. One buys based on instinct and gut feel rather than the facts.

Information edge on the market- not inside information but knowing something about the value of the company that the market is overlooking.

House example- you looked at the income side of the house example only. What about the fact you bought a $500,000 house for $250,000...and can rent it out and get some kind of return (dividend)? You totally overlooked the fact that the example showed buying a $1 for 50 cents. Can't see how someone buys a $500,000 asset for $250,000 and gets screwed. Look at the article again "Why did you bid more than everyone else and win? Simply because you knew that homes on your block are selling for over $500,000".

kfh227
Kfh227 premium member - 6 years ago
-------------------------------------

"look for companies with stability that pays dividends."

This is the cornerstone to my investment philosophy.

------------------------------------

"You won’t find the secret in high IQs, college degrees, experience or reading."

I think college is great, especially if you go with the goal of being able to learn new things and think for yourself. Thinking for yourself can cause headaches with getting that 4.0, but I'd rather have a 3.5 GPA and a thinking brain in return for my education. I still think a good background in mathematics is important jsut so you can best understand risk, probability, compounding and other concepts. Key word, CONCEPTS. In investing you will not mathematical formulas to do anything. Maybe some addition and multiplication, but it is the concepts of mathematics taught at the collegiate level that i view as very important things to value investors.

I work with some VERY bright people (engineers). Till this day I wonder why some of them want masters degrees in engineering. They are so bright, but don't have a clue on how "easy" investing really is. To them it is a black magic even though I work with people that design complex military systems. The irony is that for all the knowledge and effort engineering requires, investing is more rewarding and much less difficult.

----------------------------------

"Watching their stock account drop 40 percent or more over a short period of time is a very painful experience for most investors. In order to stop the pain, they sell at any price"

I've made two mistakes:

-- CAG and MRK:

Selling CAG and MRK when the stock was down and the dividend was cut. The companies didn't change other than the dividend and I sold. Why? I should have bought more. MRK has doubled in price since I sold it 3 eyars ago. CAG is up about 25% since I sold it 2 years ago.

--- WM

On the other hand, I sold off WM last week and have no regrets about it.

--- PFE

Of all my PFE stock, half is down about 40%. I am not concerned. The other half is down about 10%. Yes, when PFE was down 30% I did the right thing. I bought more.

--- GCI

I have some GCI that is down about 30%. I haven't cost averaged yet, but I think about doing so every day. The last thought on my mind though is selling.

--- HD

HD is down 30%. All I want to do is buy more, ut I am waiting for a 40% loss.

--- BBT

down 20% and I don't care. If it goes down more, I'll eventually add more.

--- MAS

down 20% and I don't care. If it goes down more, I'll eventually add more.

------------------------------------

Conclusion

Point is, my cornerstone rule "look for companies with stability that pays dividends" makes me shrug my shoulders quite easily. In my 7 years of investing my only true regret is WM.
Evan
Evan - 6 years ago
"It really boils down to having an information edge over Mr. Market and a way to determine the value of the company. "

First, how do you expect to have an information advantage over the market? This is (nearly) impossible, and if correct would limit high returns to insiders. All information that is needed to make constantly high yearly returns is available to the public, though it may take some digging. Who would be at a disadvantage when trying to acquire information? This makes no sense.

"However, during the panic very few investors are willing to step up to the plate, because they lack conviction. Watching their stock account drop 40 percent or more over a short period of time is a very painful experience for most investors. In order to stop the pain, they sell at any price. Value gurus fight this instinct of fear and let the confidence of their research and the conviction of their thesis win the day. This is not as easy as it sounds. It is very hard to keep your head when everyone around you is losing theirs, but that is what separates the great investors from the mediocre ones."

psychologists have studied this, and have found that conviction/confidence is not correlated with successful outcomes. If this were so, there would be a disproportionate number of high return portfolios. What investor does not think he is smart money?

But what you seem to be talking about here is more of a control over your emotions. This makes sense, but only if you apply the proper investment strategy. For instance, you can envision the same scenario, but with an extremely over valued tech company. How many tech investors in the late 1990s would have followed the actions in your above quote, and still come out poorly? They certainly can't be said to be "great investors". And what about the case where the fundamentals of the company change from the previous analysis? Hanging on for the drop certainly wouldn't make them a great investor.
edible
Edible - 6 years ago
Afternoon folks, wish I were as smart as some seem to be. My goal is pretty simple...as trustee of a CRT we have to take out 8% a year so, obviously enough, we try to invest such that we have a return of greater than 8% a year. Not rocket science.

Although we are NOT day traders, our "gut feel" is that institutions determine the movement of the market, not individual investors. With this as a given, it then follows that watching the MACD trend becomes important. By the way, we are looking for a site that posts the MACD and Slow Stochastic, displayed as clearly posted by Clearstation.com, but in real-time. The other features [head and shoulders, cup and handle, Bollinger Bands, RS, momentum, and so on--ad infinitum], are interesting but not necessary for real-time considerations (in our humble opinion).

With that said, it is my opinion (after being "in" the market since my first buy of Mobile Oil in 1949), that "buy and hold" is the way brokers cover their misguided recommendations...remember, their goal is commissions.

Last, buying "good" companies is admirable, however not paying attention to their management decisions is often disastrous; think about Rolls Royce, GM, Ford, the major financial lenders, and most of the home builders (who were not watching the financial markets), and others too numerous to mention.

Just remember, the big fish eat the little fish that venture too far from their hidey hole.

edible

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