It’s a classic tale.
An individual from one culture walks into another culture and experiences culture shock. It permeates stories — a country boy going to the big city, a city girl going to the country, a rich individual trading places with a poor one. It’s not difficult to think of other examples.
The reason I mention these is because I have recently had that experience — a clash of cultures — and the clash illustrates a fundamental differentiator of value investing. In order to make my point, I’m going to give you a brief background of where I’m coming from. My goal is not to talk about me, but to emphasize a critical point about what makes us (as value investors) so different from the crowd (i.e. the financial world at large).
I have been involved with investing for a much shorter time than probably most GuruFocus readers. I first read Graham’s "The Intelligent Investor" in August 2010, making me a student of value investing for slightly over two years now. When I first read "The Intelligent Investor," I was working in China at a job that was a stark contrast to the world of finance, but Graham’s book fundamentally changed how I viewed business, investing and the stock market. Graham made so much sense, and he lit a fire inside of me to learn more!
I read "The Intelligent Investor" again that same month and then began reading as much as I could about value investing, Benjamin Graham, Warren Buffett and Charlie Munger. I read Buffett’s shareholder letters, "Security Analysis," "The Snowball," Lowenstein’s "Buffett," books by Peter Lynch, articles and interviews here on GuruFocus, and whatever else I could get my hands on. This led me to begin investing on my own, as well as studying 10-Ks and 10-Qs, learning about companies, performing crude valuations, examining margins of safety and simply learning as much as I could as fast as I could.
The key takeaway of this “mini-bio” is that value investing was my “home culture” and “home language.” It was everything I knew. I did not know one person in the investment industry. I had never been to New York City, London or Hong Kong. I had never read a finance textbook (other than Graham’s "Security Analysis") or taken any sort of finance, accounting or general business class. My teachers, literally, were Benjamin Graham and Warren Buffett, and I viewed the investing world only through the lens they provided.
When I realized that my career passion was truly for value investing, I decided to come back to the U.S. to enroll in a quality MBA program and learn about business. I knew that an MBA alone would not qualify me for a value investing job, but I did know that I needed to learn as much as I could about competitive advantages, what the best businesses look like, marketing, operations, economics, accounting, etc.
So, I began my MBA program in mid-August (thus the dearth of articles from me lately). The past two months have been busy, but I love being here and learning; my understanding of what makes businesses work has grown significantly over the last few weeks. I have also been learning about the investment management industry through guest speakers on campus, reading the Wall Street Journal, talking to finance professionals, talking with classmates and in general being surrounded by people that make investment decisions.
Now, to the point of my article:
When going from my “home culture” of the Graham/Buffett philosophy into the “foreign culture” of finance/Wall Street, the primary shock to my system was the difference between the long-term orientation of Graham/Buffett and the short-term orientation of the general investment culture.
To many of you, keeping a "long-term orientation" is probably a no-brainer, but it is hugely important to realize consciously and remember. Every day there is an increasingly tremendous pressure from the greater investing culture to focus on the short term, with powerful incentives to do well and not underperform this quarter or year. I think I feel the strength of that pressure more than most because it stands in stark contrast to the long-term philosophy of Graham and Buffett, which is all that I knew before returning to the U.S.
Constantly keeping a long-term mindset is one of the key, fundamental advantages that we as value investors have. Yes, understanding businesses, finance, accounting, etc., are all important, but there happen to be thousands of finance professionals (our competition) who also know the basics of business. My competitive advantage does not lie there. Were I to compete against the dozens of highly intelligent analysts covering an IBM or PepsiCo, and try to predict a more accurate quarterly earnings number, the odds simply are not in my favor.
Why would I compete with the computers, traders and analysts hoping to get a short-term edge? To me, that seems a game with near-impossible odds. Sure, I could maybe have some success, but to me that is not a reliable foundation for long-term success as a professional investor.
(Know that I am not saying studying companies and looking at or making predictions for the next quarter is meaningless. There is definitely some value there. What I am saying is if that is your primary focus, it’s much more difficult to have a competitive advantage over the multitude of your other short-term competitors.)
Since entering the “greater investing culture,” I have realized that my competitive advantage lies, ultimately, in being patient and thinking long term. I must study companies thoroughly, wait for them to become cheap enough to buy with a margin of safety, and then wait for them to reach their intrinsic value after I buy them.
There are other areas where an investor can obtain a competitive advantage as well. A couple of weeks ago I was talking to a research analyst at Diamond Hill Capital Management (a value investing firm followed by GuruFocus), and he mentioned to me that another analyst at Diamond Hill had told him there are three advantages one can utilize to beat the market. Those are:
1. Information arbitrage (knowing more than others, especially with perhaps small-cap stocks that are not widely followed)
2. Time advantage (thinking long term versus short term)
3. Psychological advantage (buying out-of-favor stocks when fundamentals have not changed)
Time is explicitly mentioned in No. 2, but thinking long term and being patient is important to the other two advantages as well.
So, what does all this mean for my personal investing strategy?
I have no short-term pressure on me as I merely manage my personal portfolio, so it’s easy for me to remain long-term oriented and focus on a) large, quality companies that are out of favor due to temporary problems, and b) small-cap stocks of quality companies with minimal analyst coverage. I look for a margin of safety in price of my purchases, trade sparingly, focus every day on being patient and don’t buy a company I wouldn’t hold for years. Every single company in my portfolio met these criteria when I purchased them. Thus far they have all done well, but the true test is not how well they have done up till now, but how well they will do over the next five to ten years.
This week, as earnings cause widespread consternation or widespread joy, focus on the long term, not the short term. That’s what my teachers Graham and Buffett would advise.
It’s a classic tale.