1. How and why did you get started investing? What is your background?
I really started investing when our consulting firm was founded. The idea was to grow the book share by at least 25% per year. We created an internal fund that later converted to a charitable trust after the firm was closed.
2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas?
I run a focused fund of roughly 20 to 25 stocks. I focus on high-quality stocks in the small to mid-cap range. I use ROC, ROA, ROC FCF and balance sheet information as the basis for finding opportunities. I get my ideas from a range of sources – GuruFocus screens, Bloomberg, other value investors. I generally read about 10 annual reports a week.
3. What drew you to that specific strategy? If you only had three valuation metrics, which would they be?
I read Graham’s “Security Analysis” when we were starting the company. It made perfect sense to me. I never really focused on any strategy other than value investing. My top three valuation metrics would be return on capital, debt/equity and free cash flow as a percentage of revenue.
4. Which 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?
Certainly Graham and Dodd and Warren Buffett (Trades, Portfolio) had the greatest impact. I would also say Michael Mauboussin and Jack Bogle have been an almost equal influence. The most important things I learned from them are margin of safety, costs matter and to beat the market you need to think simple and different.
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?
Roughly 50% of my holdings at the Nintai Trust I’ve held since 2004. If these companies continue to compound value as I think they can, I will hold them probably until I retire. I would stress I wouldn’t say if I was right or wrong on how the stock price does. I define wrong as admitting the business case is impaired. If that happens, you generally know right away you’ve made a bad decision. You can read more about this in my recent article “Anatomy of a Failed Investment.”
6. How has your investing approach changed over the years?
Probably that I’ve gotten more adamant about the financial strength of the company and the durability of its moat. I migrated much like Buffett from good companies and cheap prices to great companies at fair prices.
7. Name some of the things that you do or believe that other investors do not.
I think the biggest difference is that I rarely look at my holdings stock prices. Daily and weekly changes in the price of my holdings tells me nothing. I mostly focus on what knowledge helps me be a better investor – reading 10-Qs, 10-Ks, market information, competitive offerings, etc. I would say I have warnings set to notify me of significant drops in holdings prices simply because I know – with all things being equal – I will likely buy more.
8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well-run companies? How do you judge the quality of the management?
My favorite companies are those that comprise my longest holdings. These include Fastenal (FAST, Financial), Expeditors International (EXPD, Financial), Novo Nordisk (NVO, Financial) and one I sold last year after holding it for nine years – FactSet Research (FDS, Financial). I use multiple measures to judge management, but two that lead my research are Return on Capital and management compensation.
9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
I utilize one screen at GuruFocus. I wrote about it in an article earlier this year. Otherwise I think the most efficient method is to look at 52-week lows.
10. Name some of the traits that a company must have for you to invest in, 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.
When I look at an investment it has to have exceeded 15% annually over the last 10 years in return on capital, return on equity and return on assets. In addition, I look for (but I don’t insist) companies with no short- or long-term debt. Finally I look for free cash flow as a percent of revenue to exceed 20%. Bad companies are those who fail all of these measures, have high debt and generate little free cash flow. For me, an ideal company compounds value over a 10- to 15-year period through organic growth. An example is FactSet Research during my holding period of 2006-2014.
11. What kind of checklist or homework do you utilize when investing? Do you have a specific approach, structure, process that you use? Or do you have any hard cut rules?
I don’t really use checklists. My research includes reading 10-Qs and 10-Ks for the past 10 years. I will also create a DCF valuation model. I then generate an investment case where I explain how the company makes money, its offerings, competition, market size, market growth, key risks, etc. Finally I spend time trying to break the investment case by lowering revenue, decreasing margins, etc. The entire process takes about two to three months before I’m comfortable that I have the knowledge necessary to make an informed decision.
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?
See above. If the company is small enough and they respond sometimes I talk to management. I remember the former CEO of Fastenal picking up the phone at 6:30 p.m. and talking to me for two hours about the business. That’s pretty rare.
13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock? When is cheap not cheap?
I use a DCF model that employs about 25 tabs. These include allocation of capital, cash return, FCF yield, growth rates, margins, etc. Generally cheap is not cheap when the value is based almost completely on assets on the balance sheet but no free cash flow growth. I find most of these “work out” situations may be cheap, but too risky in my eyes.
14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?
I’m not really finding many bargains in this market. There is occasional individual equity I think is mispriced such as Novo Nordisk, but that is very rare. I generally avoid capital intensive business as well as industries with high debt loads. Of the Standard & Poor's 10 industry groups I have no investments in five of them.
15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
I think the market is fully valued to slightly overvalued. My greatest concern is risk associated with linkages we don’t understand or see. I see derivatives as an example of this. CDS’ and MBS’ created multiple linked pools of risk in 2008-2009. Nobody thought low credit home buyers would almost bring down the entire global financial network, yet they did. I’m still concerned about this type of situation today.
16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?
I find that I re-read many classics that I admire. Right now I’m re-reading “The Manual of Ideas” by John Mihaljevic and Graham/Dodd’s “Security Analysis.” I’m also reading “Consilience” by E.O. Wilson and “The Gene” by Siddhartha Mukherjee. My most important lesson I learned was margin of safety in “The Intelligent Investor.”
17. Any advice to a new value investor? What should they know and what habits should they develop before they start?
Several things. First, develop a process that constrains emotions. Second, build out a process that allows you to create a portfolio where you can sleep at night. Last, read the value investing classics and learn as much as you can from their wisdom.
18. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
Obviously GuruFocus is one. Another is Morningstar’s services. I think people don't spend enough time accessing company financials provided for public access. There is a lot to be learned there about any publicly traded company. One investor’s portfolio I watch is Brown Capital Management. We have a very similar investing process. Of course I follow my friend and co-worker John Dorfman’s selections.
19. Â Describe some of the biggest mistakes you have made value investing. What are your three worst investments that burned you? What did you learn and how do you avoid those mistakes today?
This week I posted about one of my worst stocks in an article titled “Anatomy of a Failed Investment.” Readers can check that out and see how badly I did with one investment. Just a complete disaster.
20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
As I’ve mentioned previously, I generally look at my holdings’ prices about once a month. This cuts down on any emotional responses I might get. If the price drops significantly I will take a long look at my investment case. If it is still valid and the stock is now at a considerable discount to my estimated intrinsic value, I will likely buy more. I only sell when either the business case is broken or the stock is trading far above my estimated value.
21. How does one avoid blowups in value investing?
I think there several key steps. First, know your investment inside out. Fully understand their business model, their financials, their market, their competitors, etc. You should be as knowledgeable about the company as many of the senior management. Second, always demand a significant margin of safety in your purchase. Have the patience to wait until it gets to that price. Last, avoid leverage. Both in your portfolio itself and in your holdings. Nobody ever went bankrupt when they don't owe any money.
22. If you are willing to share, what companies do you currently own and why? How have the last five to 10 years been for you investingwise compared to the indexes?
I used to share my entire portfolio, but working with clients now it would be inappropriate to disclose our holdings. I’ve written many times about my selection criteria. Because it is so focused many of the stocks that meet those standards are likely in my portfolio. I have underperformed on a three- and five-year basis and significantly outperformed on a 10 and since inception basis.
- Here's a fun one – Which stock would Warren Buffett (Trades, Portfolio) or Benjamin Graham buy today if he were you?
That one I have no idea how to answer! They are certainly unique in their abilities.
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