Learning from the successes of great investors is one way to improve your own process. Though you will likely never find an identical situation to the one they found themselves in, you can still learn a lot from the thought process of the investor in question. But there is an even better way to learn from the greats, and that is by looking at their mistakes.
It is difficult to replicate exactly what someone else has done - it is far easier to simply avoid falling into the same trap. In a (possibly apocryphal) story, the sculptor Michelangelo was asked how he managed to carve David, his masterpiece. He replied: “It is easy. You just chip away at the stone that isn’t David.” Remove all that is not necessary, and you will be left with what is.
The lesson
Joel Greenblatt (Trades, Portfolio) invested in a company that owned a very big Las Vegas computer trade show. The rate of turnover in the computer industry is quite high: he observed that of the 2,400 exhibitors that presented at the show every year, about 400 would be out of business every year. However, those 400 would be replaced by a new 400, and so he surmised that so long as the computer industry as a whole was doing well, the trade show would continue doing well.
Greenblatt refers to this experience as his "lesson in operating leverage." The company could rent any amount of convention space for $2 a square foot, and got $62 per square foot from the exhibiting companies - not a bad margin! So in other words, the company was making large amounts of profit on relatively low fixed costs. Now, this is all well and good when your business is growing; however, if it starts to shrink, every lost source of revenue goes right back to the company’s bottom line.
In Greenblatt’s case, his company bought another trade show just a few days before 9/11, which caused a sharp decline in the number of companies willing to travel to trade shows. The fixed costs started to add up and he ended up with a pretty painful situation.
“Everyone knows financial leverage from 2008 - you put up $1 and borrow $9, then buy something worth $10 - that’s a risky thing. But companies with big operating leverage - people aren’t as knowledgeable about. So leverage works both ways - when the business is going well, it was great, when it turned badly, it turned badly quickly.”
So what is Greenblatt’s attitude to this story? With characteristic good cheer, he pointed out that making mistakes is ultimately a good thing. He likes to say to his students at Columbia Business School that he has made a lot of mistakes in his career, that he’s not "that great an analyst" and that if he still managed to do quite well, then so can anyone else. And while this may be excessive modesty on his part, I think that’s an emboldening idea for any investor to hold in their mind.
Read more here:
- Warren Buffett: Complex Accounting Is a Warning Sign
- The Value Investor's Handbook: Dividend Investing
- Warren Buffett and Charlie Munger on Discount Rates
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