Chad Brand is president of Seattle-based Peridot Capital Management.
1. How and why did you get started investing? What is your background?
I discovered the stock tables in my local newspaper at age 12 and was pretty hooked right away after my dad explained to me how the stock market worked. The idea that I could make money as a passive investor while others did the heavy lifting seemed both odd and intriguing. Add in a competitive personality, being good with numbers and an interest in business, and I quickly knew that I wanted to study finance in college and work in the investment industry after graduation. I did just that, attending Washington University in St. Louis and starting Peridot after a stint working in the corporate finance department at Express Scripts (ESRX, Financial) in St. Louis.
2. Describe your investing strategy and portfolio organization. Where do you get your investing ideas?
I am a value investor who focuses exclusively on U.S. securities. Portfolios typically contain one or two dozen names, enough to be diversified but not overly so. Most sectors are represented, and I get investing ideas simply from paying attention to market action and trying to find companies that may be oversold in the short term.
3. What drew you to that specific strategy?
The historical data showing a direct inverse correlation between equity valuation and future stock price performance is very strong. Tipping the odds in your favor by following the data does not ensure success, but I liken it to a casino floor. If the house has an edge, even if slight, over the long term your results are going to be pretty impressive.
4. What books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? Which investors do you follow today?
There are too many to name, but suffice it to say that whenever someone puts valuation in the forefront of their security analysis that earns my respect. The holy grail is finding great companies at great prices so I tend to follow those value investors who are willing to take a position in a name where the headlines are quite bearish, but longer term we are all likely to forget about whatever short-term issue was dogging the company.
5. How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?
Upon initial investment I have every intention of having a multiyear holding period. My underlying assumption is that any contrarian investment is unlikely to turn around right away so I have to be prepared to average down in the short term and wait for sentiment to shift. Sometimes that takes a quarter or two and I look like a genius. Other times it takes a few years and I have to be patient. I’m fine with either scenario. As long as my thesis is not disproven along the way, I’ll hang on. Usually my fair value targets are based on an assumed multiple on a certain level of profits, so if either one of those inputs proves to be wrong, it is imperative to reassess the situation. Most times the profits fall short, as opposed to the multiple not improving. After all, contrarian investments tend to come with low multiples to begin with.
6. How has your investing approach changed over the years?
It seems that with each passing day the markets become more and more short-term focused. Investors extrapolate the latest quarter in perpetuity in both bullish and bearish scenarios. Computerized algorithms also have elevated the reactions stocks have to near-term events. As a result, I definitely find more opportunities nowadays due to a single poor earnings report than I ever have before.
7. Name some of the things that you do or believe that other investors do not.
I guess one saying goes that if you are early that just means you are wrong. I firmly disagree with that. Just because the market disagrees with your evaluation of a company’s value in the short term, it does not mean that you are inaccurate in your valuation. The market is very inefficient in valuing companies over the short term. That is quite evident considering that values can vary greatly one day to the next despite no underlying business changes. Along the same lines, I hate the idea of using stop loss orders. Giving up on your thesis just because the market disagrees with you is not a very strong argument for throwing in the towel. There needs to be actual fundamental business evidence.
8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well-run companies?
Amazon (AMZN, Financial). Starbucks (SBUX, Financial). Costco (COST, Financial). AutoZone (AZO, Financial). Different reasons for each, but they all have great managements and are able to put all stakeholders at the forefront. People like Howard Schultz and Jeff Bezos are tremendous CEOs.
9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
Sometimes, but usually I have no shortage of ideas. When I do screen I will look for unusually high cash balances relative to market value, as well as low multiples of EV/EBITDA, price-book and price-free cash flow.
10. Name some of the traits that a company must have for you to invest in it, such as dividends. What does a high-quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.
I think great investments can take on many different looks. I would never use strict criteria like a minimum dividend yield or something like that. The biggest thing is to have confidence in your assumptions. That is very much helped by having management teams that are forthcoming and tend to do what they say they are going to do. That may sound obvious, but it is not always easy to find. Conference calls are a great way to do that. You can hear how management answers questions (if they do at all), and you can track their predictions with future results to see if they seem to come through and put shareholders' interests high on their list of priorities. Combine that with a good business and an attractive valuation, and I will be happy to invest even if the market is disinterested at the moment.
11. What kind of checklist do you use when investing? Do you have a specific approach, structure, process that you use?
I don’t use a checklist. Although I have yet to perfect the idea, I really try and wait for a situation where I can honestly say to myself, “This is a no-brainer. The market price makes absolutely no sense.” Most of the time, those situations turn into wonderful investment opportunities.
12. Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
I don’t talk to management. Their job is to paint a rosy picture so they will just tell you how great their company is most of the time. I build my own financial model and value companies using historical filings, conference call transcripts, corporate press releases and presentations, etc. And I just try to find companies where the values I come up with are materially above the current market price and the risks to those models is minimal.
13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock?
The metrics I use will depend on the sector. I might use price-to-tangible book for a bank, EV/EBITDA for a media company, price to FFO for a REIT and price to free cash flow for a blue chip.
14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas and why?
Health care and retail are two sectors that have been popping up a lot lately for me. Over the years I have learned to avoid sectors where I don’t have a deep understanding. So I am a lot less invested in things like energy, commodities and industrials than I was earlier in my career. And when I do invest in those sectors, I go with more conservative plays (energy pipelines instead of E&P firms, for instance).
15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
Generally speaking the market is overvalued. Trailing Standard & Poor's 500 earnings are about $100 on the numbers I use. So the market’s P/E (price-earnings ratio) is over 20x. With corporate profits having stagnated and valuation ratios being as high as they really typically go, it is hard to see how the U.S. stock market goes much higher from here. The market could drop 20% tomorrow and still not be particularly cheap (17x earnings) even with low interest rates. So the risk-reward is not favorable. I worry about what could trigger something like that happening, but I don’t think anyone is really able to predict that ahead of time, especially with any timing precision.
16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?
Looking forward to Ed Thorp’s book that is coming out in a few months. I am currently going through the fictional Vanessa Michael Munroe series by Taylor Stevens. James Cameron has optioned one of the books for a movie, but that project will not get under way until the Avatar series is finished so I’ll have to wait awhile for that.
17. Any advice to new value investors? What should they know and what habits should they develop before they start?
It’s great to find stocks with excellent growth prospects, and it’s great to find cheap stocks, but the real money is made when you find both at the same time. It is rare, and you should be selective, but when you can get profit growth and multiple expansion together, those will be your best investments.
18. What are some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
I really stick to businesses I know and understand and then focus on the numbers so there aren’t any real value investing-only resources that I use. Interestingly, I have found that the few times I have tried to ride coattails I tend to make mistakes. I suspect I let the value investors’ reputation justify investing in something that probably would not have met my full criteria without it. Never compromise!
19. Describe some of the biggest mistakes you have made value investing. What are your three worst investments? What did you learn and how do you avoid those mistakes today?
The biggest mistakes probably come from being enamored with the rock bottom valuation and letting that result in an investment in a poor business. If your view on the underlying profits don’t come to fruition, most times valuation alone won’t save you. Worst investments were in the energy sector where I really did not have an edge from an industry standpoint. Lost money on both Chesapeake Energy (CHK, Financial) and Halcon Resources (HK, Financial) equity as well as Alpha Natural Resources (LFA, Financial) bonds.
20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
I am lucky that I was born with the right temperament for investing. The highs and lows really don’t bother me that much. I have no problem averaging down if I am early or selling when things go right. One of my favorite sayings is “You don’t get nervous if you know what you are doing.” It’s not completely true, of course, but there is some truth to the fact that if you have a strategy that you believe in and you are an expert in a particular field, you can probably better deal with the ups and down of any task or profession.
21. If you'd like to share, how have the last five to 10 years been for you investingwise?
Like all of them really. More winners than losers and always trying to learn from the mistakes to improve. I think the key is not to avoid mistakes (we are human after all), but to avoid repeating the same ones over and over again.
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