Over the past few years, I've had the fortune to learn from a legendary value investor - Jean-Marie Eveillard (Trades, Portfolio). Below are the notes from my various meetings with him.
On value investing - Value investing either clicks with you or not and perhaps only 5% of the market participants are genuine value investors.The important thing to remember is that value investing works, over the long run. He gave an example of a Japanese stock that was flat for 4 years before tripling in price. Non-value investors may say too bad it was flat for four years before it worked out. Genuine value investors would say if you think the stock will worth three times 5 years from now, it does not matter whether it triples during the last year or progressively throughout the 5 year period. This way of thinking cannot be taught.
Genuine value investors can also tolerate short term under-performance in order to achieve better long term results. First Eagle Fund lagged badly for 3 years in a row and the the fund’s AUM went from $6 billion to $2.5 billion by early 2000. He did what was right for the shareholders and eventually he was proven right. He admitted that it was an extremely difficult time because there were times he thought he was guilty of not understanding the internet companies and how to value them. He thought he was an idiot.
On sell-side research- Sell-side research is often targeted to the 90% non-value investor clients. Value investors often find sell-side research ludicrous but we have to understand that they have to conduct the business that way because the dominating majority of their clients share the short-term bias.
On how he spends his day - He spends half of his day just reading books. He recalled that Buffett mentioned many years ago that he is a voracious reader and reading voraciously is an advantage developed in the long run. You may not be able to reap the benefits of reading in the beginning but over time you will feel the benefit.
He spends the other half of his day talking to First Eagle’s analysts. The analysts have three duties: keeping track of the current holdings; researching potential ideas from portfolio managers; researching their own ideas. He respects his analysts’ ideas and he would gave them the green light to research their ideas most of the time. He said some of the analysts have the preference to analyze complicated ideas and he told them there is nothing wrong to analyze simple ideas. In fact, Buffett’s best ideas were all simple ideas. But again, it is probably human nature to think that you are more likely to gain an edge in complicated situations.
On the most important things - He told his students in Columbia’s value investing program that you don’t have to know everything about a business when making an investment decision. Instead, he instructed the students to figure out the five or six major advantages and disadvantages about the business and ignore the trivial. An inevitable risk with this approach involves missing a key advantage or disadvantage. However, if you get most of them right, the results will likely to be fine. Most of the students found it hard to believe because they think the more they know about the business, the better they can value the business. His experiences have proved otherwise. For instance, in the 80s (or 70s) when they bought a timber company that had two businesses prior to the spin-off of the bad business, the only thing that mattered was that they were getting rid of the money-losing paper-making business and retaining the profitable and better timber business. Market was unaware of this dramatic change. David Swensen (Trades, Portfolio) of Yale Endowment bought the timber land outright because the value was better. His fund bought the timber company due to restrictions. But they still made a lot of money.
On international market – It’s almost stupid not to have international exposure. Japan is still cheap even after the recent run up. A lot of good companies trading at low single-digit EV-EBITDA, which is his preferred multiple to use as it takes into account balance sheet. Japanese companies tend to do less stupid acquisitions, unlike their American counterparts but their cash holdings are not generating good returns and they are very reluctant to buy back shares. It’s hard to unlock shareholder value in Japan but values are still abundant in Japan. American companies are doing stupid acquisitions and buying back shares at the wrong prices using leverage. He is concerned with the consequences.
On Graham approach and the Buffett approach- Graham’s approach takes less time and involves less judgment, but at the same time less profitable than Buffett’s approach. Buffett’a approach takes much more time and involves more judgment on the qualitative side. However, the biggest advantage of Buffett’s approach is the upside potential created by a marvelous business’s ability to compound returns indefinitely. The best ideas tend to be a Buffett’s business trading at Graham’s price. But at the same time, it’s more likely to make an mistake using the Buffett approach and if you are very wrong about the quality of the business, you can lose a lot of money.
Each approach requires a different skill set. The Graham approach requires a substantial understanding of financial accounting and especially the balance sheet accounts because your intrinsic value calculation is heavily dependent upon the net assets value of the business.
The Buffett approach, on the other hand, depends less on balance sheet analysis. This doesn’t mean you don’t have to understand financial accounting. You still need to understand the basic accounting rules so you can figure out the real earnings power of a business. The difficult part of the Buffett approach is that it involves a great deal of judgment and the intrinsic value is nothing more than an educated guess – unlike a hard number from the Graham approach. It takes a lot more time to analyze the qualitative factors of the business than the quantitative side of the business However, if you are right, your reward can be much more substantial than the reward you would have reaped with the Graham approach. And unlike the Graham approach, you should concentrate on your best ideas if you want to significantly outperform.
On Gold – He views gold as money or currency. Gold does well in both deflation and inflation. The idea that gold does well in a deflationary environment is counterintuitive but if you look back the period of late 1920s and 1930s and the recent short deflationary period during the crisis, gold held up really well.
