1. How and why did you get started investing? What is your background?
My father was a lifelong value investor and most of my investing habits came from watching him invest and learning from him. He has always been a contrarian, as an investor and otherwise. He spent most of his career as a sell-side analyst for William Blair, a growth shop, despite his natural inclination as a value investor.
When I was in high school, he used to bring home copies of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual letters, and they were always fascinating to read, and of course they remain so. However, I learned far more from watching and learning from my father investing in beaten-down and out-of-favor stocks. I was always amazed to see how patient he was in waiting for a washed-out price; he taught me how important it is to be greedy only when other investors are fearful.
I grew up in Chicago, went to Stanford for my undergraduate and M.B.A. degrees and spent time living in Boulder and, after that, in Boston. During the first 10 years or so of my career, I worked in several operating roles for socially and environmentally friendly companies, including an Iowa-based natural food company and a Boston-based company that helps manufacturers redeploy and re-use surplus manufacturing equipment.
Today I’m the CEO of Pekin Singer Strauss Asset Management, a Chicago-based financial adviser that has been serving wealth management clients for over 25 years, and I am also a portfolio manager of Appleseed Fund, a go-anywhere ESG value fund which we launched more than 10 years ago. Within the last couple of years, we also launched an Appleseed equity long-short strategy, and I am a portfolio manager on that strategy as well.
2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas?
We are value investors who seek to generate market-beating returns by making prudent, disciplined investments. We accomplish this goal by adhering to a core set of investment principles which include protect capital from permanent impairment, be contrarian, use prudence with financial leverage, diversify your asset classes, seek a margin of safety with your capital commitments and invest in companies that demonstrate favorable ESG (environmental, social and governance) practices.
Our portfolio management team includes me and my business partners Bill Pekin and Josh Strauss. In addition, we have three full-time research analysts who are looking around for undervalued, high quality companies around the world. Our approach is very team-oriented; we usually meet as a group at least a couple of times every week to talk about our portfolio holdings and to discuss prospective investment ideas. We try to avoid groupthink and seek to be very hard on each other’s ideas. The scrutiny that we provide to one another is very helpful in refining our investment thinking and in avoiding mistakes.
Many of our ideas are companies we have been watching for years, where we watch and wait for an attractive enough price. Occasionally we find ideas from other investors, but our best ideas are generally ideas which we find where nobody else is paying attention to them. Last quarter, for example, we invested in Okuma Corp. (TSE:6103, Financial), a Japanese machine tool company that most people have never heard of. Okuma shares have performed well in the past few months but only because the share price had really dropped much too far due to lack of investor interest.
3. What drew you to that specific strategy? If you only had three valuation metrics what would they be?
Our favorite valuation ratios are probably EV/Sales, EV/EBIT and price-book (P/B). They reflect our focus on balance sheets, on free cash flow and on return on equity.
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?
I have learned a great deal from many value investors. Some of the great value investors like Ben Graham, Warren Buffett (Trades, Portfolio) and Seth Klarman have had a profound influence on my investment approach, and I’ve already talked about how important my father has been in the way that I think about stocks. The most important lesson I take is the importance of being patient and focusing on the long term. Every professional investor talks about being a long-term investor, but the percentage of self-described value investors who really focus on the long term is easily less than 5%. There’s simply too much career risk for most professional investors to sit on the sidelines in an overvalued market. For that reason, the value investors I’m most impressed by are the ones who are willing to step aside during markets when valuations are ludicrous, such as Jim Grant, Steven Romick (Trades, Portfolio), Bob Rodriguez and Jean-Marie Eveillard. Finally, Tim Smith of Walden Asset Management is a hero of mine. He is the best example I have ever seen of an investor who shows by example that you can make a positive impact in the world through the way that you invest.
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?
At our core, we are long-term investors and invest in companies with a multiyear time horizon. Oftentimes good companies experience temporary setbacks that cause current investors to question the future outlook. In these situations, a long-term investor can often benefit from selling pressure caused by investors with shorter time horizons. During a given stock’s holding period, we re-evaluate our investment thesis regularly. We will sell should our thesis change or be proven incorrect. We have held stocks for as short as several months and for as long as a decade.
6. How has your investing approach changed over the years?
When I look at our biggest mistakes, they generally have involved companies with technology risk or a weak business model where the balance sheet wasn’t strong enough. Our general approach is to be careful and to generate attractive returns by minimizing our mistakes so we work pretty hard to find value stocks where the underlying business and balance sheet is high quality. We also look for responsible management teams who have a long-term outlook on the business and demonstrate alignment with shareholders.
7. Name some of the things that you do or believe that other investors do not.
I do not believe most economists have a clue what they are doing. In past investor letters, we have compared economists and Federal Reserve officials to 19th-century doctors who used to apply leeches as a cure-all, only economists’ remedies are far more dangerous. I think it’s challenging to be a value investor today without understanding the significant macroeconomic risk that exists due to elevated Debt/GDP ratios not just in the U.S. but worldwide. I follow contrarian economists like Michael Hudson and Steven Keen and think that their understanding of the global economy and the global monetary system is far more useful.
I consider passive investing to be a foolish endeavor. Fees are lower, to be sure, but passive investing also leads investors to own an overweight position in the most egregiously overvalued and risky securities at the worst possible time in the market cycle. Passive investors were overweight Japanese stocks in 1989, tech stocks in 2000 and energy debt in 2014. I expect passive investors today, and they are growing more numerous by the day, are going to get burned by chasing the recent strong performance of passive indexes.
Finally, I believe value investors do themselves a disservice to ignore environmental, social and governance issues when evaluating an investment. Value investors were piled into Valeant (VRX, Financial), even after it was clear that the company suffered from governance issues that, at best, provided poor oversight to a CEO and management team that was likely engaged in criminal behavior. To remain invested after these issues surfaced is not smart investing or prudent investing or sound value investing. We look at ESG performance as a risk mitigation tool, and I think it gives us a perspective and an edge that many value investors lack.
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 company in the world, by far, is Frontier Natural Products Co-op. I was fortunate enough to serve on the company’s board of directors for 12 years. It’s a model company in about 20 different ways, and the CEO and management team are absolutely top-notch. Unfortunately, Frontier is also a private company.
The only way to judge the quality of management is by its track record, in my view. That said, I generally try not to fall in love with management teams. My favorite management teams are generally founding teams who continue to have a large personal stake in the business. They tend to be the most long term in their management orientation and the least likely to bet the company on a large and ill-considered acquisition. We owned John B. Sanfilippo (JBSS, Financial) for about 10 years due in part to the fact that insiders owned half the company, and we knew they wouldn’t do anything dramatically stupid that would cause irrevocable value destruction.
When we meet with management teams, it’s usually not to identify great management teams because, in my view, that’s nearly impossible to figure out in a few meetings. However, it is possible to identify horrible management teams in a meeting. Sometimes all it takes is an hour before it becomes clear that the person sitting across the table from us is obviously an untrustworthy manager. There is more than a little rot at the top of many publicly traded companies today.
9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
We use stock screeners, among other methods, as an initial way to find potential investments. While screeners are a good way to get a high-level view of a company, they are ultimately of limited use without looking deeper into company fundamentals. Beyond screens, we maintain a list of companies that we would like to own at given prices and revisit each company if and when their stock price breaks below such levels. We have also historically found ideas from interviews with other investors and by attending conferences and meeting with company management teams.
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.
On the highest level, we like to invest in undervalued companies with durable competitive advantages. From a business perspective, we like companies that have a strong ESG track record, employ a prudent amount of leverage and are run by management teams that have historically proven to be good capital allocators. Typically, a company that fits all of these characteristics will fall into the category of a high quality company. Failure to meet these characteristics oftentimes results in subpar investment outcomes. We come across many companies that appear undervalued at first but upon further examination are actually fairly valued or too risky because of one or more unattractive characteristics.
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?
We begin by looking for companies that fit the criteria that I discussed above. After we perform a detailed fundamental analysis of a specific company and its industry, we put together a comprehensive report to share with other members of the investment team. We meet as a team to debate the merits of the given proposal and stress test assumptions to understand our downside protection. The portfolio managers then come together to vote on the specific stock proposal. A unanimous vote among the portfolio managers must be reached before we purchase a given stock.
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?
Prior to making an investment, we do a deep dive into various aspects of a company. We utilize historical financials to understand the fundamentals of the business and build a valuation model. Further, we examine the industry outlook for the company to assess whether or not any competitive advantage exists and whether the company’s moat is shrinking or growing. Finally, we test the reasonability of our initial analysis by speaking with company and competitor management teams and industry experts.
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?
We use multiple valuation methods when we estimate the intrinsic value of a stock. We examine whether the stock is cheap versus its own history, versus its peers and on an absolute basis as compared to the entire stock market. Most importantly, we look at free cash flow and value a prospective investment based on our own conservative view of where cash flows are going to trend over the next 10 years. During our research, we often find characteristics of a company that make it appear cheap at first but upon further examination fairly valued. Examples of these traits include hidden liabilities, poor historical allocation of free cash flow and/or industry risks that make the company’s growth outlook highly uncertain.
14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?
We particularly like certain countries where we are finding bargains, such as Japan and South Korea. We particularly like wireless telecommunications companies. We also particularly like financials although not as much as we liked them a few months ago.
We are generally finding much more attractive value investment opportunities outside the U.S. In Appleseed Fund, about half of our equity portfolio is outside the U.S. Our U.S. exposure is very limited and selective and concentrated. I wouldn’t touch a Standard & Poor's 500 Index Fund right now with a 10-foot pole.
15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
If “the market” is U.S. stocks, I’m not feeling particularly warm and fuzzy about it. What concerns me the most is the damage that will be unleashed on the global economy, on pensioners and on the middle class when interest rates finally go up and equity valuations revert to the mean. One of the reasons we launched a long-short strategy recently is because in many cases we think there’s more money to be made by betting on a decline in the share price.
16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?
I’m currently reading “The Sovereign Individual.” Without subscribing to the author’s primary thesis that the nation-state is in secular decline, there’s a lot of interesting and insightful historical analysis that goes back, in some cases, thousands of years. Also, the author, writing in the late 1990s, correctly anticipated the development of crypto-currencies like bitcoin, which is pretty stunning prediction when you think about it.
My favorite book of 2016 was “The Boys in the Boat.” If you enjoy rowing or history or philosophy or fantastic writing, you should drop everything and read this book.
I don’t really have a favorite book of all time, but I’ve been thinking a lot recently about “The Good Life” by Helen and Scott Nearing. There are a lot of great lessons in "The Good Life" and in books like it which provide ideas on how to live life more simply and become a happier person in the process.
17. Any advice to new value investors? What should they know and what habits should they develop before they start?
Focus on learning as much as you can through mentors, through reading and through internships. Don’t be afraid to give away your services cheaply in return for the opportunity to learn important skills.
18. What are some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
We follow the portfolio changes of other investors who we like and respect, but we generally have not found that to be a useful technique for finding new ideas.
19. 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?
I talked about where we have made mistakes in my answer to question 6 above. Our three worst investments over the past 10 years were our investments in Powerwave, KSP Shipping and Rentech (RTK, Financial). In all three cases, we made the mistake of investing in a business model that turned out to be weaker than we thought combined with a balance sheet that was too levered. With KSP, we were saved by an acquisition, but with Powerwave and Rentech, we realized losses.
We try to avoid repeating similar mistakes by constantly asking ourselves an important question that should be asked before we ever invest a dime of our investor’s capital – if management misses guidance in the future, and the stock declines by 60% within the course of a year, are you going to be overjoyed at the opportunity to buy more shares, or are you going to be scared out of your wits? If the answer is the latter, it means that you are probably thinking about investing in a poor quality business, or in a company with a poor quality balance sheet, or quite possibly both.
20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
Weather permitting, I try to ride my bike to and from work every day. The exercise helps me reduce and manage stress. I also find that riding along Lake Michigan as the sun is rising along the horizon helps me to keep some perspective. It also helps to seek out investors who understand how you invest and are seeking out what you have to offer.
21. How does one avoid blowups in value investing?
A key to outperforming the overall stock market over the long term comes down to not just picking winners but, as importantly, avoiding losers. One of our key investment criteria that must be present before we make an investment is downside protection. To avoid blowups, we like to invest in businesses that are easy to understand. Complicated business organizations and accounting practices can be a sign of shareholder unfriendly management teams. We also get comfortable with our potential downside by understanding the value of the assets on the balance sheet of the companies in which we invest. Additionally, we like to invest in companies that have favorable ESG (environmental, social and governance) practices. We believe that companies that compare favorably to their peers from an ESG perspective are less likely to stray into questionable business practices that may increase the probability of permanent capital impairment from the investment.
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 investing wise compared to the indexes?
Some of our favorite portfolio investments today include Oaktree Capital (OAK, Financial), Hyundai Home Shopping (XKRX:057050, Financial), Herbalife (HLF), Aggreko PLCÂ (LSE:AGK)Â and Syntel (SYNT). Most of these companies have not performed well, and your readers either will hate them or will have never heard of them. But that’s also why their share prices are so inexpensive.
Appleseed Fund just passed its 10-year anniversary in December 2016. We are in the top 5% of our category, which is the World Allocation category, over the past 10 years, and we have beaten the MSCI World Index by more than 2% per annum on average since the Fund’s inception, despite being only 60% invested in stocks for much of that time.
23. Here's a fun one – Which stock would Buffett or Graham buy today if he were you?
Hyundai Home Shopping, which is a small cap stock in South Korea. HHS has a combination of characteristics that is so difficult to find in today’s overvalued market environment – a great balance sheet, a great business and a fantastic price relative to both. Hyundai Home Shopping is a leading Korean home shopping company that sells a variety of consumer products over the television and Internet in Asia with a business model similar to that of QVC and Home Shopping Network here in the U.S., except that home shopping has far more penetration in South Korea than it does in the U.S. Because the company does not take legal ownership of the goods its sells, it generates revenue through commissions and produces a sizable amount of free cash flow each year. In fact, the company has generated positive free cash flow every year back to 2007.
We believe the stock is undervalued because the growth outlook for the company is somewhat uncertain and investors appear to be waiting on the sidelines for it to become clearer. However, Hyundai Home Shopping’s current cash and investments balances together account for almost 100% of the company’s stock price which should serve to protect our downside risk. After subtracting the cash and investments, Hyundai Home Shopping is trading at an EV/EBIT multiple close to 0x. You just do not see those sorts of valuations here in the United States. HHS is trading at a substantial discount to its more well-known U.S. counterparts, QVC and Home Shopping Network, which are trading at 19x and 8x EV/EBIT ratios, respectively. With intrinsic value rising every quarter as the company grows revenues and generates additional cash flow, we find the risk-reward potential of Hyundai Home Shopping to be very attractive.
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