How did you get started investing? What is your background?
My father was a businessman actively involved in some listed companies, and had always invested family money in shares. This gave me an awareness of business and the stock market from a fairly young age. There were a few books about investing around our house, which I devoured – as I did with books on a wide variety of other topics.
The passion for investing that I have today only really blossomed later in my high school and university years though. The enjoyment I got from debate and challenging ideas initially drew me into studying law. But the prospect of compounding capital at high rates grew stronger in appeal as time passed, which led me to obtaining finance degrees and studying the great investors and how they go about things.
First and foremost of course, was Warren Buffett (Trades, Portfolio). As he was (and still is) widely regarded as the greatest investor ever, it made intuitive sense to me to study him and his views on investing. Had I known then what I know now about survivorship bias and halo effects and the like, I may have gone about choosing role models to study a bit differently! But be that as it may, Buffett and value investing really resonated with me, and set me on the course to where I am today.
Describe your investing strategy.
We are value investors. But today, that statement can mean just about anything – we have seen some interesting strategies being labelled ‘value investing’ in recent years. To us, value investing means buying assets for less than what they are worth. Which is of course what everyone in the market wants to do, and by definition therefore very few people can do. So we attempt to focus on areas of the market where prices are more likely to be irrational. Typically, this irrational pricing is driven by market myopia and the fear of readily apparent near term risks. Investors willing to take a longer term view who can stomach the emotional discomfort of standing apart from the crowd can find opportunities in such times.
What drew you to that specific strategy?
Buffett. His missives about markets and crowd psychology really made sense to me. To deliver better returns than the market you cannot do the same thing as everyone else in the market. There has to be some aspect to delivering those excess returns which makes it difficult for most people to follow a strategy that will outperform, otherwise the excess returns will of course be arbitraged away in short order. It made sense to me that the emotional difficulty of staying disciplined in value investing tilts the odds in favour of those who can stay the course.
What books or other investors influenced you?
Besides Buffett and the obviously related authors/investors (Graham, Fisher), I have tried to learn as much as possible from as many great investors as possible – the list is really too long to repeat. Behavioral finance also really caught my attention quite early in my investing career, and I have found the works of most of the renowned students of the field very interesting.
In recent years, my interest in the academic side of investing has grown, and I have found the work of some researchers (Cliff Asness, for instance) very illuminating. Having viewed the world through a very ‘Buffett-esque’ lens for many years, some of these academic authors have really helped me to expand my thinking about the field of investing.
How has your investing changed over the years?
After initially being of the firm opinion that one should only invest in great businesses (a la Buffett), my thinking around this has definitely developed over the years. A great business is just another cash flow producing asset. It is only worth the present value of those cash flows. Yes, those cash flows are likely to endure for longer and potentially grow faster than for a lower quality business, but that stream of cash flows can be as mispriced as any other stream of cash flows emanating from any other business. As one can only deliver excess risk-adjusted returns by buying mispriced assets, there is at first glance no rational reason to favor high quality businesses over other businesses as investments.
In practice of course, things have been a bit different, as it does appear that the market has historically under-priced high quality businesses. Whether this is because of market participants’ preference for lottery-like payoffs (which results in speculative assets being priced too highly relative to ‘boring’ assets) is seemingly not quite clear yet. But buying and holding high quality businesses has been a very good investment strategy for the better part of the past fifty years – which probably partly accounts for Berkshire Hathaway’s (BRK.A, Financial)(BRK.B, Financial) success. But there are some compelling indications today that the price of high quality assets has been bid up to very high levels relative to history, and the future for high quality assets as investments may hence not be a perfect replica of the past.
Name some of the things that you do that other investors do not.
The primary differentiator between us and other investors is probably that we are willing to invest in situations with more near term uncertainty than what most investors are willing to do. Many investors want the storm clouds to dissipate before making an investment. That is not a prerequisite for us, as long as we can understand the long-term economics of a business and can be comfortable that the business is likely to see through a protracted difficult period.
Where do you get your investing ideas from?
Anywhere and everywhere, really. Reading widely, screening the market, stealing ideas from other investors we respect – all of these have been sources of ideas for us. But our attention is typically attracted to areas of the market where the circumstantial evidence suggests there is likely to be short term irrationality in asset prices. This is typically where the newspaper headlines are fairly scary at the moment. Being aware of second order impacts of readily apparent market or industry dynamics can be very valuable, as can an awareness of the unintended consequences of regulation.
Do you use any stock screeners?
We do run some internal screens for stocks with characteristics that we like to narrow the focus of our research efforts. This can be particularly valuable when initiating research efforts in a country we have not invested in before, for instance.
Name some of the traits that a company must have for you to invest in.
The only trait that a company has to have is that its shares must be mispriced. Obviously, we apply very different discount rates or multiples to valuing different kinds of businesses, but fundamentally we are in the business of buying mispriced assets without fear or favor.
What kind of checklist do you use when investing?
In the report an analyst writes when proposing a new investment, the analyst is expected to consider a comprehensive list of aspects relating to the company and investment idea that is being proposed. This includes things like a discussion of the economics of the industry in general, the company’s relative position in the industry, earnings quality, management quality and incentives, cyclicality of the industry and where the industry finds itself in the cycle currently (both from a business and capital cycle point of view), why the market is mispricing the asset, and how we expect the business and investment idea to develop in years to come by reference to measurable markers. In addition, the analyst is expected to motivate the valuation approach chosen, and to cross-check the base case valuation with best and worst case valuations as well as private market prices paid for similar assets. While we don’t call it a checklist as such, the expected contents of a research report is the functional equivalent of a checklist.
Before making an investment, what kind of research do you do?
It varies depending on the nature of the investment, and also on the individual research style of the analyst. Fundamentally, we have to be in a position to understand an asset well enough to make an informed judgement call about the value of the asset. In some businesses, that can be a fairly simple matter, and in others it can be more complex.
Typically, after an investment idea has hit our radar screens (whether through a process of screening, reading, talking to industry contacts or other investors), our first port of call is to run a set of charts we internally refer to as the ‘pics’. Basically, this is a set of charts covering the past twenty years showing the margins and returns the business has generated, the valuation multiples the share has traded on, and things like earnings, dividends and net asset value per share growth both in absolute terms and relative to the market, as well as share price performance in absolute terms and relative to the market over this period. We find this to be quite a useful tool to get a quick sense of the long term economics and quality of the business, and whether the share price is likely to present long term value at current levels.
If our conclusion above is favorable, the first port of call to understand the business better is the annual report and the latest company presentations and transcripts of conference calls and the like. This usually leaves us with a good number of unanswered questions, which we will attempt to gain insight into by either reading more (the insights gained from reading the last twenty years’ annual reports of some businesses can be fascinating), posing our questions to the company directly, consulting with industry experts, discussions with suppliers, competitors and former employees, et cetera.
While more relevant information is typically a good thing in forming a view on a business, we are also cognizant of the dangers of becoming overconfident due to the amount of information gathered and one’s in-depth knowledge of the business or industry. The crux is to establish what the market’s view of an asset is, what your view is, and to have clarity of thought around why you are right and the market is wrong. Sometimes this is fairly simple to achieve – it is often the emotional aspects that are more challenging to deal with in making the investment decision.
What kind of bargains are you finding in this market?
We are finding that the bargains in the market are by and large in more cyclical industries. Looking back over the past ten years, our sense is that the market has gone from being infatuated with cyclical businesses in the mid- to late 2000’s to being more or less repulsed by cyclical businesses today. While the global economic cycle favored cyclical businesses in the mid- to late 2000’s, investors were willing to believe that the growth would last forever, and were paying prices commensurate with this belief. The Global Financial Crisis of course destroyed this notion, and in the ensuing years investors have come to cherish the stability of earnings and dividends that large blue chip business in mature industries like consumer staples managed to deliver during the 2008 – 2009 period. This sense that these assets are safe and will continue to pay a steady and slowly increasing dividend, combined with the record low interest rate environment of recent years, have driven share prices in these sectors to levels where the long term investment odds look distinctly unfavorable to us.
The areas of the market where we have been finding opportunities in recent years have in many cases been either directly or indirectly involved in the basic materials (mining, oil and gas) sectors. While these sectors are certainly more volatile in the short term than many other areas of the market (and we have a few scars to show for this!), our assessment is that patience and fortitude will be well rewarded in these sectors in years to come.
The luxury goods industry has also been attracting our attention of late. This sector contains some of the best businesses globally, and it is only in cyclically challenging conditions (like the industry is facing today) that one can buy these businesses at large discounts to fair value.
How do you feel about the market today? Do you see it as overvalued?
In general, yes, we see it as overvalued. One can hardly expect to find something different with interest rates where they are! However, we also find a wide divergence in prices relative to intrinsic values in different sectors of the market. The better loved sectors of the market appear very expensive to us, while the less well liked sectors of the market offer very good value. While the sectors are not necessarily the same, we see some similarities to the situation in the market in the late 1990’s, where some sectors were ridiculously expensive, while others offered phenomenal value.
What are some books that you are reading now?
While I typically try to read one book at a time (I find I manage to assimilate the central message better if I don’t have to regroup my thoughts when I start reading again after having been distracted by another book), I am in fact currently busy reading two books. The first is "Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms," by market historian and strategist Russell Napier. This book was published in 2005 (so does not include the 2009 bear market bottom), and studies the circumstances and environment around the four great bear market bottoms the US market had experienced since 1900. It provides some fascinating insights.
The second book is "The Moral Animal: Why We Are the Way We Are," by Robert Wright. This is a very readable work on the subject of evolutionary psychology, which I’m finding very interesting as an explanation for why individuals and societies function in the way that we do.
Any advice to a new investor?
Investing is a field full of uncertainty and ambiguity, and the greatest challenge in an investing career is dealing with the emotional aspects of delivering either very good or very poor investment returns for clients. There are many roads to becoming a great investor. Do not just blindly copy another investor’s style or philosophy. Make sure that the road you choose is one that suits your personality and your emotional makeup. If not, there will likely be a moment in your career where you waver in the face of challenging circumstances, and that can make the difference between a great investment career and a mediocre one.
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