1. How and why did you get started investing? What is your background?
I’ve always loved investing. My father was an engineer but was very active investing his savings in the stock market. By extension I became interested in stocks and investing relatively early on. But I came to the world of investment management unconventionally. I began my career in real estate, doing a variety of brokerage, investment and management activities in both residential and commercial real estate, and I established a few small partnerships with family members and friends to begin buying undervalued income-producing property. We bought residential properties as well as small multifamily properties.
About 12 years ago, I began studying the work of Warren Buffett (Trades, Portfolio). Like many value investors, the simple logic of value investing really resonated with me right from the start. I began studying Buffett’s letters and reading the various Buffett biographies. I set a goal early on to establish a partnership that was similar to the partnership Buffett set up in his early days. After the better part of a decade, I was able to build up enough capital to support my living expenses while also seeding my investment firm. Saber Capital Management was established in 2013 as a way for outside investors to invest alongside me. Saber runs separate managed accounts so clients get the transparency and liquidity of their own brokerage accounts. Our goal is to compound capital over the long run by making concentrated investments in well-managed, high quality businesses at attractive prices.
2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas?
My investment strategy is very simply to make meaningful investments in high-quality businesses at attractive prices. My approach is founded on the principle that a stock is a piece of a business that is owned by you and managed (in most cases) by someone else. I think it is very important to think about stocks the same way a wealthy family would think about the family business. Thinking like a business owner as opposed to a stock investor helps me focus more on the variables that impact the long-term value of the business and less on the variables that impact the short-term fluctuations in the stock price.
As an owner-minded investor, I prefer to make investments in simple, predictable businesses with durable earning power. Since I have no ability to predict the economy or the general stock market, I want a company that has staying power and that can survive a variety of macroeconomic conditions and the business-cycle headwinds that will inevitably occur from time to time. I rest easier knowing that companies I own will not just survive but hopefully take market share during these difficult times. I put an emphasis on consistent profitability and stable free cash flow. Ideally, I want to own companies that have favorable long-term prospects for reinvesting its earnings at high returns. Since durable, high-quality businesses don’t often become significantly undervalued, I tend to have a concentrated portfolio of investments.
While buying good businesses at cheap prices is obviously a well-known formula for success, there are certain character traits and skillsets that are required to implement this approach successfully. I think one of the greatest advantages an investor can have in his or her toolkit is the ability to think and act for the long term. The stock market is an incredible place where market participants on the aggregate assign valuations to each business on a daily basis. Often these valuations make sense, but occasionally they don’t. As Ben Graham talked about, the market is there to serve us (not to be served by us). So I think the key to implementing this approach is to have the right psychological makeup and emotional discipline to be able to think about stocks as pieces of businesses that have real assets that produce cash flow, not as numbers on a screen that hopefully can be sold later to someone else at a higher price.
In terms of portfolio organization, my investments tend to fall into two broad categories: Compounders with long runways and durable mature businesses that are significantly undervalued. Occasionally there will be a special situation that might fall outside of these two categories, but the vast majority of my ideas can generally be described as one of those two types of businesses.
My favorite investment is the first-category business that does the work for you and can compound intrinsic value over time at high rates of return. Owners of these businesses make their returns through the results of the business and its steadily rising intrinsic value per share. These great compounders are extremely rare, but finding just a few can make an entire investment career.
The second category of investments is the high quality, mature businesses that might not have the reinvestment ability of the compounders but still have durable competitive positions and attractive economics. These companies might not be compounding intrinsic value at extremely high rates, but I’ve found that the stock market often allows you to buy stock in these businesses at very attractive prices.
A dollar that is growing at 7% per year will be worth $1.25 in three years. Often this $1 can be purchased at 70 cents in the stock market. There are usually numerous examples of these types of investment opportunities each year, even among the largest companies in the market. Apple’s intrinsic value isn’t $150 billion more now (in December) than it was in May yet the market value has fluctuated by that much in just seven months. Bank of America (BAC, Financial) is growing its book value, earning power and its intrinsic value at around 7% annually, but the market valued the business around $130 billion in June and around $230 billion five months later in November. Even the average large cap stock fluctuates by more than 50% in any given year between the high and low price, and this represents opportunities for the patient investor who can look past the quarterly noise.
So while I prefer investing in great compounding machines, the majority of opportunities tend to come from this second category of investments, simply because they present themselves more frequently.
3. What drew you to that specific strategy?
I became drawn to this approach simply because I love the idea of owning a quality company that can do the heavy lifting for me. I am a value junkie, and I love finding hidden gems and bargain basement “classic value stocks” as much as anyone else, but I believe most of the big returns come from latching onto high-quality companies when they are undervalued. These investments work well because returns can come from two main sources: the intrinsic value growth of the business and the increase in the valuation that the market eventually assigns to the business.
So while cigar butts and other more traditional value stocks can be great investments, I think these types of stocks have to be sold more quickly if the underlying business isn’t compounding its intrinsic value. The other issue with these types of stocks is that they are higher maintenance and require a steady flow of new ideas (cheap stocks that get sold have to be constantly replaced with new cheap stocks). I much prefer to make fewer investments in better businesses when they are available cheaply and then patiently own them as they grow their intrinsic value, knowing that as time goes on these companies are becoming more valuable, meaning that any initial margin of safety (or gap between price and value) grows wider as time goes on.
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?
"The Big Short" is probably one of my favorite books, and the financial crisis is one of my favorite general topics to read about and study. My investment approach was generally in place when that book was published, but certainly reading about the independent thinking of Michael Burry or Jamie Mae was very meaningful. It’s also a helpful reminder that truly great investment ideas are very rare, and when they present themselves they should be capitalized on in a big way. The book also demonstrates a few other key factors that are really crucial for investment managers such as the importance of being patient and letting investment ideas develop and also – from the view of an investment manager –Â the importance of having like-minded clients who understand your strategy. Michael Burry was brilliant and had an incredible investment idea but struggled communicating this to his investor base, which largely became impatient with him and his short-term poor performance despite the high merit of the investment idea and the incredible results that were right around the corner.
There are many other books that are great so it’s hard to list just a few. But obviously Buffett is someone worth studying intensely, and "Snowball" is by far the best book to study if you want an honest depiction of his investment approach and his evolution as an investor. The book also indirectly stresses the importance of thinking independently as evidenced by how Buffett at a very early age departed from the diversified approach of his mentor Ben Graham. Despite having one of the greatest teachers one could imagine when it comes to value investing, Buffett still –Â even in his early 20s –Â had his own unique views on what makes a great investment, and he managed his own portfolio very differently than did the Graham-Newman partnership where Buffett worked.
Buffett did special situations, but he understood very early on that there is incredible power of latching onto the great businesses. By studying his early investments, you will notice a lot of special situations but also a number of investments in high quality companies like American Express (AXP, Financial), Geico and Disney (DIS, Financial). And one thing I noticed from studying the "Snowball" book is that Buffett, while certainly a diligent detective when it came to many of his investments, tended to focus on just a few key variables for some of his largest investments.
For example, there were just two simple variables that were key to convincing Buffett to buy Geico in the early 1950s: the low-cost distribution model (Geico sold its policies direct to consumer, cutting out the “middleman” agent) and the huge addressable market (everyone needs car insurance, people tend to choose based on price, and Geico had just a tiny portion of the market). Buffett wrote an investment article on Geico around this time, and what’s striking is that he barely mentions the valuation, giving it just one sentence at the end of the write-up, almost as an afterthought. It clearly was undervalued, and there is no doubt that the price was a significant factor, but the emphasis was on the quality of the company and specifically those two key variables that gave Geico its advantage. The lesson here is that understanding the business model and keeping the big picture as the primary focal point is very important.
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?
I think the average stock in my portfolio will probably be held for two to three years. As I mentioned earlier, my ideal investment is one where I might be able to own it for five to 10 years or longer, but finding compounders is very difficult, the great ones are very rare, and the stock market tends to provide enough opportunity to locate two or three ideas a year that can be taken advantage of so I tend to have low turnover, but I do have some turnover, which is sometimes a necessary aspect of trying to generate above average returns over time.
While I strive for a “punch card” approach because I am a big believer that there just aren’t too many truly great investment ideas, I also believe there are usually at least a few ideas that can be found in any given year. When it comes to the math of portfolio management, just as asset turnover is a component in a company’s return on assets (ROA), portfolio turnover is a component in an investor’s returns over time. A company that has low asset turnover needs to have high profit margins in order to produce high returns on capital, and a portfolio manager who has very low turnover has to ensure that he or she has some really big winners in order to produce high returns as well.
The key is balancing these potential big winners (the “high profit margins”) with the undervalued stocks that should be sold at fair value (which tend to be the durable, high-quality mature companies that might only be growing at 7% to 8% or so but can sometimes be bought very cheaply). Both investments can represent very attractive risk/reward opportunities, and both categories can consist of really high-quality companies. The portfolio manager needs to be able to determine when he or she might have the potential 10-bagger and when it might be wise to own that company over the very long term (this means understanding that the business is compounding its intrinsic value at above average rates).
So low-turnover tends to be blanketed with a negative connotation, but it is neither good nor bad by itself. But generally speaking, I tend to find myself leaning more toward lower turnover simply because I think great ideas are rare, activity in the investment business tends to be a net negative, and taxes are generally reduced as turnover is reduced.
When it comes to realizing when I’m wrong, there is no set time frame. I have made lots of mistakes and will make many more in the future. And when I realize I’ve made a mistake (regardless of how long this takes me to realize), I am very willing to change my mind and sell the stock. As Keynes wisely said: “When the facts change, I change my mind.” I would add to Keynes by saying “When I realize I was wrong about the facts, I change my mind.”
6. How has your investing approach changed over the years?
I have really tried to focus more and more on the high-quality businesses. I’ve noticed that most of my past investment mistakes tend to come from investment situations where I was much more attracted to the security and/or the valuation than I was to the business. So I try to focus first on evaluating the business and seeking out companies I’d like to own and then waiting for the valuation to enter a range where I believe my returns will be high enough to meet my general hurdle rate going forward.
7. Name some of the things that you do or believe that other investors do not.
That’s a good question. I’m not sure if I can speak for other investors, but one thing I believe that I think many do not is that there is often incredible value even in some of the largest companies in the market. I look at both large caps and small caps, and I think many individual investors and many smaller professional investors feel that they’ll only have an “edge” in small caps. I certainly think that small caps offer more significant gaps between price and value at times, but there can also be very attractive value in some of the largest stocks in the market. I did a talk and mentioned this concept in a post recently.
8. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
I don’t tend to use screens that often. I do find GuruFocus (a plug for you guys) to be a very good screener. And I also have used Morningstar’s screen in the past. Some of the more expensive professional options like Bloomberg and Capital IQ have some really great features, but I don’t tend to use screens for investment ideas. I occasionally look at them for fun or just to see what groups of stocks are down or occasionally to seek out a list of companies that meet some quality metric like return on capital or historical free cash flow growth or something along those lines. But generally, I’ve found that screens create a built-in bias where if I’m looking at a low (price-earnings) P/E screen for example, I find myself trying to work hard to justify why the stock should be bought. Often this creates a hurdle for me to think independently about the business or sometimes prevents me from properly weighting potential pitfalls that the business has.
9. 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 tend not to use checklists as I feel that investing is much more art than science, and I think each individual business and investment situation is completely unique. There are certainly similarities, and pattern recognition is a good skill to have, but I’ve never found that going through an extensive checklist is a useful activity for me personally. I understand why some investors use them, and I certainly don’t think it’s a bad idea for everyone, but I prefer to think independently about each individual investment without a standardized list of items to think about. I think every investment is going to have certain items that “don’t pass” an extensive checklist and like the bias that I feel susceptible to when I am using screens, I feel a similar bias when using checklists, and I think that certain standardized items on checklists can sometimes take your eye off the ball on what might really be important for this particular investment (as well as what might not be important).
If Buffett used a 100-point checklist when he analyzed Geico in 1951, he might have erroneously decided not to buy it because it may have failed in 20 or 30 different categories. So if one does use a checklist, I think you have to somehow consciously weight some categories more than others depending on the type of business you’re analyzing. This might be possible, but for me it creates too much unnecessary noise so I prefer to keep a clean slate and try and focus on which variables matter most and if the company “passes or fails” on those few key variables.
10. 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 rarely talk to management teams, although I have at times. I do tend to find a lot of value in what Phil Fisher would call “scuttlebutt” (talking with other people who know more about the business than I do – these might be customers, former employees, suppliers, etc., or sometimes visiting the place of business, which is a really valuable way to gain some insight into consumer-based businesses such as restaurants, retail, brand companies, etc.). Most of my research tends to be done in my office by reading about companies. I obviously find a lot of value in reading the annual reports and the SEC filings.
I also read a lot of books, and I’ve found that one of the best ways to learn about a business is to read a book about that particular business (if it’s available). I always feel that my learning curve seems to really accelerate when reading books about companies that I might not have studied previously, and they help provide a solid foundation for other research activities going forward.
There are also countless sources of information on the web when it comes to reading about businesses. Trade publications are valuable and are often cited as great sources, but I’ve also found that there are lots of great blogs and other similar websites that are freely accessible that contain great information on businesses (I’m not referring to investment blogs, but I’m talking about blogs or sites that are written by people who are discussing the business or the industry, not necessarily from an investment standpoint).
11. 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?
The value of any company is simply the present value of all of the cash that you’ll be able to pull out of the business over time. So this would imply the DCF valuation model is best. I tend to be investing in operating businesses as opposed to cigar butts or asset-heavy liquidations so I tend to think in terms of earning power. I don’t use spreadsheets, and I don’t really do traditional DCF calculations, but indirectly that’s really how I think about value. I tend to simplify it by thinking about the current earning power and then trying to think about what the company might be earning five years or so from now. I then just decide approximately what that would be worth to me or some other private buyer. Once I have that estimate, I simply try to wait for a large gap between the stock price and that estimate of value.
The best ideas can be done on the back of an envelope. With Bank of America, if the bank is earning somewhere around 10% returns on equity and there is around $190 billion of equity and 11 billion shares outstanding, this is around $1.70 per share of earnings. If the bank will grow its tangible book value per share by 7% or so just through a combination of retained earnings and share buybacks, then the bank will be earning around $2 per share in three years, even with no improvement to the current level of modest profitability (10% ROE). A reasonable valuation level might be somewhere around 10 to 12 times earnings, giving the stock a value of somewhere between $20 and $24 in three years or so. If the stock was trading at $12, that’s a pretty good value. If the stock is at $22, it’s much more fairly priced.
Obviously, much more deep thinking about the bank must be done, including the cost and the stickiness of the deposits, the leverage and the capitalization levels, the credit quality of the loan book, etc. But assuming the business is determined to be a stable, high-quality firm, then I tend to stick to really simple, back-of-the-envelope valuation methods that allow me to be off quite a bit in my precise estimate and still make a nice return. As Joel Greenblatt (Trades, Portfolio) once said, “We’re looking for spreads that we can drive a truck through.”
In terms of “cheap not being cheap,” I think that whenever a security is more attractive than the underlying business, it’s a red flag. I don’t really believe in the term “value traps” (because a stock either is undervalued or it isn’t, regardless of what the P/E multiple might be), but I think value traps occur most often when investors get overly focused on some valuation metric and don’t think critically enough about the economics and the competitive position (or lack thereof) of the business.
Investors also have a tendency to play the greater fool game with bad business, meaning there is always an idea that the stock of a declining business will be able to be sold to someone else before the real problems of the business come to fruition.
12. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
I don’t think the market is overvalued. But nor do I think it is cheap. However, the nice thing about running a concentrated portfolio is that I don’t need to find that many ideas to fill my portfolio, and there are almost always a few undervalued stocks of good businesses around. There might be times when the overall stock market is in a bubble, and almost all stocks reach valuation levels that would be categorized as risky, but this is not one of those times. This doesn’t mean the market can’t or won’t go down (it certainly can and certainly will at some point enter another bear market, maybe in the very near future).
I just don’t think that overall valuations should scare investors from looking for attractive opportunities in stocks. I tend not to focus on the general market and simply look for individual opportunities. There might be pros and cons to this type of mindset, but I have firmly come to the conclusion that I have absolutely no idea where the stock market or where the economy is going to go in the next year or two, and so I choose to focus on things I think I can evaluate, which is trying to locate and value good businesses.
13. What are some books that you are reading now?
Right now I’m just finishing a book called "East-Commerce," which is a decent book "summarizing the online retail market in China. I’ve just started "Shoe Dog," which so far is really a great book about Nike (NKE, Financial). I’m also reading another book on the financial crisis called "All the Devils Are Here" by Bethany McLean (who wrote the excellent book about Enron called "The Smartest Guys in the Room"). And in my on-deck circle is "America’s Bank," a book about the founding of the Federal Reserve.
14. Any advice to new value investors? What should they know and what habits should they develop before they start?
I think the best advice I’ve received is the advice I’d probably give which is to really focus on the companies that you can understand and then really be patient and wait for the rare opportunities to capitalize on the obvious ideas, which generally don’t come around very often.
In terms of habits, I think everyone is probably different when it comes to their own specific process so that’s hard to generalize, but it certainly helps to get into the habit of reading a lot. Read the papers, read The Economist, read books that you find interesting and then spend time talking to people who know a lot more about certain businesses than you do. That’s the general approach I use which I think is a process that can help you get better each day.
15. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
I don’t use a lot of resources, but I do like Value Line, Morningstar, and GuruFocus’ 15-year financials. All of those three sources help provide a nice quick snapshot for what a company has been doing over the past decade or so. Other than those data sources, I rely on the SEC website for all the filings, the various newspapers that I read each day and then a few blogs that I like to read occasionally on the weekends. I don’t do a lot of coattailing or 13-F “cloning.”
I know that is a popular tool now, but for the same reason I try not to rely on screens to give me investment ideas, I find that 13-Fs have a way of creating a built-in bias (i.e., “Seth Klarman (Trades, Portfolio) bought this stock so I need to figure out why he likes it”). I find it hard to be completely objective if my starting point is that someone who I really respect bought the stock. So admittedly, I still glance at 13-Fs because it is interesting, but I try not to let it be a major factor in driving my research process.
16. Describe some of the biggest mistakes you have made value investing.
As I mentioned earlier, I have made (unfortunately) many mistakes, and many more will (even more unfortunately) be in my future. This is part of the game. The good news is that investing is a game where many mistakes can be made and the overall long-term result can still be very good. Peter Lynch once said that if you bat “.600” (or get six out of 10 right), you’ll be in the “investing hall of fame.” I’m not sure what batting average is ideal, but I know that there will be lots of mistakes.
The key is making sure that no mistake (or no one single decision) poses an existential risk to your portfolio or business. Another key is identifying when a mistake has been made and quickly correcting it (by selling the stock and trying to learn from the mistake). Probably my biggest mistake of commission would be buying Weight Watchers (WTW, Financial) after the stock fell a significant amount and appeared to be very cheap. I liked certain aspects of the company’s business model, including the recurring revenue nature of subscription business, the high returns on capital and the sizable free cash flow the firm generated over the previous decade. The economics of the business are very attractive as meetings were held in very low-cost (or sometimes no-cost) locations that could generate a relatively sizable amount of revenue through product sales and more importantly, provided rapport, encouragement and feedback for members who paid monthly fees for access to this “club.”
So the business required virtually no capital, the revenue was mostly recurring fee-based revenue, and the free cash flow margins were very high. The problem was that I significantly underestimated how quickly the membership business could deteriorate. I knew the membership was declining, but I erroneously got too attracted to the price of the stock relative to the current free cash flow, which allowed me to convince myself that I had a margin of safety. I compounded the error by thinking the cost structure was much more variable than it was, meaning that as membership and revenue declined, free cash flow declined at a faster pace than I anticipated. The company had a huge amount of debt, and this proved to be very burdensome (and obviously a very large fixed cost, which became, in percentage terms, a bigger and bigger percentage of revenue).
Fortunately, I identified my mistake and was able to sell the stock before suffering a big loss, but that was lucky as the stock now is roughly 50% below the level I originally purchased my shares, and the business is still in a very difficult position. While I’ve had a lot of small losing positions, this was the mistake I viewed as the biggest because it could have resulted in significant permanent capital loss. But also, I cite this mistake because I probably learned more from my experience investing in Weight Watchers than any other investment mistake I’ve made.
The biggest learning lesson with this investment is to be very wary of companies with a lot of debt. In fact, this particular experience really made me want to avoid companies with a lot of debt in almost all cases. Buffett said that great companies don’t need to use much debt, and while I mentioned I don’t use checklists, that is one thing I now keep in the front of my mind when looking at ideas.
There are lots of small takeaways I learned from this investment, but there are two other broad takeaways that can be universally applied to other investment ideas. One that I referenced earlier is that when the valuation (in this case the low price relative to the current free cash flow) is more attractive than the underlying business, then it is wise to walk away.
The other broad takeaway is that investors shouldn’t invest in the rearview mirror. Sometimes the last 10 years can paint a picture of a very stable, durable and profitable business, but some simple common sense thinking and evaluation might tell a different story about the business over the next five years. When I finally woke up and realized that Weight Watchers was having significant issues that weren’t going to be easily solved (or maybe not solved at all), I quickly realized that the business is going to likely be worse off in five years than it is now, which renders moot what the company did in the past. Gretzky was right when he said “Skate to where the puck is going, not where it has been.”
17. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
This is a great question. I’ve always had a long-term view, and I feel one of my strengths is my patience. But one thing I didn’t realize until I started doing this professionally is that managing other people’s money adds a significant element of pressure and sometimes stress. Most people naturally treat other people’s money with more diligence and more care than they would their own, and this can add certain emotional reactions to the mix that wouldn’t be present when managing just your own capital.
Luckily, I have a great group of investors who collectively think very similar to me when it comes to how I view market ups and downs, which is to get excited when stock prices are falling. Even when current portfolio positions are falling, times of panic and fear help create all kinds of incredible bargain opportunities that can be taken advantage of either with cash that might exist in the portfolio or by selling a holding that is more fairly valued to buy one of the much more undervalued ideas that came about as a result of the fear, and so I am always much more interested when stock prices are falling and people are fearful. I think fear and falling asset prices form the foundation from which great fortunes can eventually be built so those are the times to get excited. Other than that, the fluctuations should generally be ignored, and focus should be placed on thinking about the long-term business results, not the short-term fluctuations in the stock prices.
18. How does one avoid blowups in value investing?
I might sound like a broken record, but I think the key is to focus on businesses that are high quality and have durable characteristics that are likely to be making more money in five years than they are now. Whenever a stock of a bad business is getting analyzed because of the apparent attractive valuation, I think there is a higher risk of error. Mistakes will never be completely avoided, but I think focusing on the better businesses helps reduce a lot of unforced errors and dramatically reduces the risk of a portfolio blowup.
Start a free seven-day trial of Premium Membership to GuruFocus.
