I received this comment on one of my recent posts. The George Soros question got me thinking about how interesting the different philosophies are. Soros had an incredible career, but is it possible to replicate his general strategy?
Here is the basic comment from the reader:
Your posts have given me a great deal of information. What is your opinion on George Soros’ theory of reflexivity? I was reading Seth Klarman’s "Margin of Safety," and it mentioned how in rare times price will actually affect value of the underlying company. This actually made me fearful since then that value investing wouldn’t work. One of his examples was a company in financial distress. If (the market) thinks it’s worthless, the company will go insolvent because no one wants to buy the stock they’re selling or no one wants to give a loan to the company.Even if the company is valuable… if the market doesn’t recognize it, management may take the market’s perception to heart and do actions that will eventually bring the market’s perception to reality.Soros interests me since sometimes price does affect value, and his theory of reflexivity sort of correlates with value investing.What do you think?
I added some thoughts, but here is my basic response:Thanks for the nice words. I appreciate you reading.
Soros built an incredible record. I’ve read his book but find his methods too abstract for my liking. Soros is a philosopher. I get the impression from reading his work that he desires more than anything else to be the smartest man in the room. I’m not trying to disparage him, this is just my opinion I got from reading his writing. I do think he is an incredibly smart guy, and he probably has difficulty explaining his ideas to the everyday person. That’s probably why his writing comes off like that to me (read: I’m not smart enough to keep up with his ideas!).
Reflexivity Goes into the Too-Hard PileI prefer much simpler ideas. Reflexivity is a way to think about the world. It has some merit I think, but it’s very difficult to replicate a method like Soros’. It’s not impossible, but very difficult. It’s an art form.
Plain vanilla value investing has some art as well, but it’s less abstract. It’s far easier to figure out how much a stream of cash flow is worth, or better yet, figure out how much the assets are worth that the company currently has on its balance sheet than trying to figure out the opinions of value that the majority of market participants are going to place on a particular asset class or group of stocks.
Value investing is about figuring out what something is worth and paying a lot less. Soros’ method is more focused on figuring out what other people think, and then trying to predict how they will react.
Keynes Beauty ContestKeynes talked about the market being a beauty contest where the winner was determined not only beauty alone, but by who the majority of voters thought was most beautiful (or even the next derivative after that!).
“It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.” - John Maynard Keynes, General Theory of Employment Interest and Money, 1936This might be true in the short term, but in the long term, the market is not a “voting machine, it’s a weighing machine.” (Graham is easier for me to grasp than Keynes and Soros.)
With No Leverage, the Market’s Opinion Matters NotYour comments about companies caring about the way people think about them has merit when it comes to leveraged institutions such as financials or other companies with lots of balance sheet risk. These companies could go bankrupt if there was a colossal run on the system (like 2008 or worse), but these events are rare and the way to defend against them is to avoid taking on leverage risk. Companies without debt (or low amounts of debt) don’t have to worry about how the market thinks about them.
So I respect Soros’ results. Certainly they are tough to beat, but even tougher to replicate. Buying cheap stocks in the tradition of Schloss or Graham is much easier for an investor like me to replicate. I have the discipline and the emotional mindset to do so, and it does not take a genius to do it.
I usually ask myself these questions when considering a new idea:
- Do I understand how the business makes money?
- Is it cheap?
- What are the insiders doing? Any catalysts?
- What are the risks?
- What’s the upside?
Thanks again for your thoughts. Always fun to consider different ideas.
About the author:
By using separate accounts, Saber offers its clients complete transparency and liquidity (the funds are held in the name of the client and cannot be accessed by the investment manager). Saber looks to partner with like-minded clients who are interested in a patient, long-term approach to investing that is rooted in the principles of value investing.
I also write at the blog www.basehitinvesting.com.
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