Piggybacking has been a topic that has been discussed frequently these days. Fellow writer the Science of Hitting’s recent article is quite illuminating and definitely worth reading. Inspired by him, I wrote this article to share my observations and thoughts on this subject.
When I first started investing, I piggybacked many gurus and very frequently. I remember the days when I saw David Einhorn (Trades, Portfolio) or Mason Hawkins (Trades, Portfolio) initiating a position in a stock, and within a few hours I became an owner that the same stock. When I saw Exco (XCO, Financial) was bought by Prem Watsa (Trades, Portfolio), Howard Marks (Trades, Portfolio) and Wilbur Ross (Trades, Portfolio), I put a good amount of money in it without even finishing up reading the 10-K.
Boy, did I learn my lessons the hard way after a few disastrous piggybacking fiascoes. Believe me, I believe that piggybacking can be perilous.
Nowadays I piggyback much less but much more effectively. I come up with most of my own ideas by going through the Value Lines, doing scuttlebutt works, reading and screening. Once in a while, perhaps 10% of the time, I still piggyback. It’s been a while since I experienced a loss due to piggybacking. There are a few things that I’ve learned that can make piggybacking more effective.
First of all, I couldn’t agree more with the Science of Hitting when he said this:
My opinion is you shouldn’t own anything unless you’ve personally done the work to make the argument for doing so. This comes with the kicker that it’s quite difficult, at least in my experience, to do so objectively when you already know the opinion of investors you admire.
Nothing to add here. You have to do your homework, period. Many investors either don’t have the time or are not willing to do the homework. I think they should either index or own companies like Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) or Markel (MKL, Financial) using a dollar cost average strategy.
But let’s say you have the time and you are willing to do the homework, then there are things you can do to get better at piggybacking.
1. You need to figure out each guru’s investment style and your own personality and the investment style that fits your personality and experiences. This is extremely important.
For instance, many investors followed Berkshire’s action in IBM (IBM, Financial), Chicago Bridge and Iron (CBI, Financial) and General Motors (GM, Financial). You have to know that IBM is a Buffett idea, CBI is a Todd Combs idea and GM is a Ted Wechsler idea. All three of them have different strategies. Combs is the most active among them and he can trade in and out more frequently. Wechsler, in general, has a longer holding period and a more concentrated portfolio. Buffet will probably hold IBM for a very long time for Berkshire. So let’s put aside philosophical differences and just think about time horizon. If you have a different holding period, then you should really think twice before even doing any work.
Let me make another point. Some people are wired to be Graham-type investors and some are wired to be Buffett-Munger type investors. Both styles work. The Graham style gurus tend to focus more on quantitative factors and have less thorough understanding of business fundamentals. The Buffett-Munger style gurus tend to have a much better understanding and a much more concentrated portfolio. I myself resonate much more with the Buffett-Munger style. Therefore, when Tom Russo (Trades, Portfolio), David Rolfe, or Chuck Akre (Trades, Portfolio) initated a position, I pay a lot of attention. But if Martin Whitman (Trades, Portfolio) or Mason Hawkins (Trades, Portfolio) had a new buy, I ignore them. This doesn’t mean I think less of the Graham-style investors, it just doesn’t fit my personality and experiences.
2. Another thing you need to keep in mind is that most gurus don’t pick all the stocks. In fact, some of them have come to a stage where marketing is more important than actually picking the stocks. Or in other instances, as they develop more strategies, they hire others to run the strategy. For example, at Weitz Fund, Wally Weitz doesn’t usually get involved with technology stocks or retail stocks. When you see a stock pick from Oaktree Capital, it’s very unlikely it’s from Howard Marks (Trades, Portfolio).
3. You need to be careful of copycat gurus. Their edge is often temperamental, not analytical. Based on my observation, they do a lot of in-depth research but may step out of their circle of competency from time to time. I would caution you the same. I think few investors can actually understand energy, financials, commodities and retailers. Stocks in these sectors tend to be very volatile and often appear cheap.
4. I think it’s a good idea to keep a tracking record of the gurus you follow. I pay a lot attention to what they say versus want actually happens. Most of the time it’s time-consuming to verify whether they say is true or not, but we need to look into the reasoning and evidence.
For instance, this is what one guru said on TV during October 2014:
“GM is worth $28 billion in enterprise value. They will do $16 billion in EBITDA value next year. They will do $6 billion in free cash flow. It is much leaner, with capacity utilization in the 90s. At the current stock price, the FCF yield is 20%.”
The conclusion is obvious – GM is cheap.The reason is that at the current price, FCF yield is 20%. The evidence is that GM “will” generate $16 billion in EBITDA and $6 billion in FCF. But when I did my own research, my evidence suggested that GM actually only generates $3.5 billion FCF, instead of the $6 billion he claimed.
Here is a provocative observation: Only a handful of the gurus listed here are truly skilled. Surprisingly and counterintuitively, luck plays a significant role in many gurus’ success. It’s not easy to tell but once your investment skill grows, you will.
Lastly, luck plays a role in piggybacking as well. The guru may get lucky and you may get lucky in copying his best ideas. It’s a good idea to keep track of the ideas you piggybacked and the rationale. Avoid falling into the trap of judging the results solely based on price movements.
