The purpose of GuruFocus as spelled out by its founder Charlie Tian is to select the stocks vetted by the best investors. It’s a very simple philosophy. You identify the stocks that investors like Warren Buffett and Seth Klarman buy, the approximate range at which they bought as the exact price isn’t spelled out and then you try to buy below that. This is something that even Warren Buffett followed as he often piggybacked off his mentor Benjamin Graham and indeed one of his greatest investments, GEICO, was a company Benjamin Graham had chaired.
But simply buying with complete abandon is not an ideal strategy, instead determining why it is that investor x bought is equally important and more valuable over the long-run. A company Warren Buffett has continued to invest in is that of Tesco (TSCDY). Over the past year I also established a large stake in the British grocer. But over the same time I devoured every public piece of information about the company I could get my hands on. I’ve read numerous books on the company, and on the supermarket industry in general, financial statements going back years, financials of Tesco’s competitors and then trade journals like The Grocer (certain articles behind a pay wall) and historical articles on magazines like The Economist (historical articles also behind a pay wall).
One of the interesting points I discovered in combing through some long dated articles was that the UK grocery market underwent a similar phenomenon that it is going through today. In the early 90s discount chains such as ALDI had made incursions into the market share of the leading grocers (Sainsbury’s had the greatest market share at the time) by pushing their private label goods during the recession. Shortly thereafter as the British economy and the condition of its citizens improved, consumers began to trade up to products offered in the Tesco’s and Sainsbury’s. As is often quoted, history doesn’t repeat itself, but it rhymes and that may also be the case here.
"We specialize in the highly complex while mostly avoiding the plain vanilla, which is typically more fully priced."
- Seth Klarman
While Warren Buffett may be easier to comprehend, Seth Klarman’s investments are about as difficult to grasp as they come. Klarman’s Baupost Group regularly invests in biotech companies. Recently he had acquired a 20% stake in Idenix Pharmaceutical, a hepatitis C and HIV research company. Unfortunately valuing the company based on historical earnings would yield a valuation closer to $0; the company hasn’t made any money yet. Instead any proper valuation will come from its current pipeline of Hep C drugs.
I followed Klarman into Idenix at prices much lower than he paid. Soon thereafter news broke that the FDA was demanding further data on one of the drugs in Idenix’s pipeline. The stock subsequently tumbled 30% and then some. I didn’t know how to interpret the news. Was Klarman selling? Was this a deal breaker for the company? Was this particular compound more valuable than the rest in the pipeline? Or was the FDA’s request routine? So much uncertainty and so little understanding, I found myself doing what any bad investor would do - panic selling.
What I should’ve done is never to have bought to begin with. I didn’t understand the complexity of the company nor the industry and I was not able interpret seemingly bad news. So what happened after I sold out at a loss? The stock would subsequently go on a tear, up some 55% in a period of 2 months and still a price below what Klarman had paid for some shares.
The lesson here?
Just as Klarman allocates relatively small sums to each of his investments relative to the hedge fund’s assets, it would be instructive to do likewise if you’re going to borrow any of his great ideas. The investments are much more complex and Klarman tends to get much less attached to his stocks than Buffett does making it difficult to replicate his success. If, for example, he buys HP in quarter and sells it the following you may miss the opportunity to scoop shares up at a discount. Buffett on the other hand may hold stocks for a period of years and piggybacking off his picks can much easier as those very stocks he invests in may become very cheap over several years.
Contrast these strategies with that of the managing fund for George Soros or any other of the many hedge funds on Gurufocus. In these funds 100’s if not 1000’s of stocks will be traded in a given year. You have to wonder if these funds can be truly successful spreading out research over such a large base. If Buffett puts 15% of the Berkshire stock portfolio in IBM and another 20% in Wells in recent years, you can safely say these are conviction investments. However, some hedge funds are constrained in how much they can invest in a given stock. I recall T. Boone Pickens saying he was limited to investing less than 3-5% of the funds’ assets in BP 2 years ago even though he wanted to commit a lot more.
Another interesting investment of Seth Klarman’s Baupost Group is that of BP. It currently ranks as his largest equity holding, but like many others the reasons for buying aren’t obvious. While BP is trading right around book value and most of its liability expenses related to the Deepwater Horizon are behind it, there still remains potential litigation by the state of Louisiana for the loss of tax revenues. In spite of these risks BP still generated just under $400 million in revenues this past year. Should BP be able to hit 5% profit margins going forward, a rather conservative one at that, the company could be earning near $20 billion a year yielding a price to earnings of 6.5 if their current market capitalization were to stay the same..
The problem I see with BP, and all oil companies, is that they’re selling on oil prices that are still quite high even though its below the lofty prices of $150 a barrel in 2008. The marginal cost of drilling for oil has gone up, but it is still substantially below $100 a barrel. So the question is, would Klarman insure against this risk by shorting oil? Unfortunately situations like these are the limit to GuruFocus and hedge fund disclosure as we can’t see what’s happening in the debt and derivative side for these “guru” investors.
Klarman has been bearish about the dollar in recent years and even purchased insurance against the dollar via an “out of the money” put option on a treasury bond (see below for an explanation). But he must surely appreciate the risk in falling oil prices even if the dollar must depreciate. The notion that BP is cheaper relative to its peers makes sense. But banking on oil prices sustaining at current levels is harder to justify and some kind of transaction to neutralize this risk might make sense. In either case this stock will be an interesting one to follow.
In summary, the real value of the GuruFocus website is that of a starting point. It is immensely useful in finding good investments for your portfolio, but you must still be able to think for yourself and make judgements accordingly. As encyclopedic as the mind of Warren Buffett may be it is still lacking in a lot of information and perhaps information that could be known to you. At the same time Buffett has seen firsthand the business cycles of the last 60 years so we have some catching up to do.
Disclosure: Long BP, Tesco (TSCDY)
Explanation for an out of the money put option on a treasury bond:Out of the money necessarily means the option would expire worthless at current prices, but will likely sell at a cheap price. A put option becomes more valuable as the underlying security (in this case treasury bond) falls in value. An outstanding treasury bond becomes less valuable when interest rates rise. If inflation rises so do general interest rates and so this complex sequence explains a relatively cheap route to betting on higher interest/inflation rates.
Also check out:
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