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, Financial), Countrywide Financial Corp. (CFC, Financial) and USG Corp. (USG, Financial). 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.
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, Financial), Countrywide Financial Corp. (CFC, Financial) and USG Corp. (USG, Financial). 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.
