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The Science of Hitting
The Science of Hitting
Articles (686) 

Kill the Company

April 05, 2012 | About:

Bruce Berkowitz is famously known among value investors for his "kill the company" strategy, which is part of his investment process; here is what he has said in the past on the topic:

"…We try to kill the company. We think of all the ways the company can die, whether it's stupid management or overleveraged balance sheets. If we can't figure out a way to kill the company, and its generating good cash even in difficult times, then you have the beginning of a good investment."

This is similar to what Alice Schroeder noted about Warren Buffett (NYSE:BRK.A)(BRK.B) at the Value Investing Congress in 2008; when discussing a potential investment that Warren had brought to him by some friends in the 1950s, here is what she had to say about his analysis:

"He said no because he went through the first step in his process, and this is where I think what he does that is very automatic [to him] but isn't very well understood: he acted like a horse handicapper. And the first step in Warren's investing process is always to say, 'What are the odds that this business could be subject to any kind of catastrophe risk that could make it just fail?' – and if there is any chance that any significant amount of his capital could be subject to catastrophe risk, he just stops... he won't go there."

As Alice notes, this is backwards from the way that most individuals approach their investments. For many people, the process starts with an interesting idea, whether itcomes from a GuruFocus article, Jim Cramer, or a friend at a cocktail party. At that point, the investor will likely look at the financials and the valuation, and attempt to estimate some range of intrinsic value (I'm probably giving the average CNBC viewer WAY to much credit…); only at the end will the individual likely stop to think about the potential risks that are hiding around the corner.

There are a couple of problems with this. First, Warren Buffett disciples (likely many of the people reading this article) believe a wonderful business at a fair price is preferred over a fair business at a wonderful price; with that as a condition, the sequence discussed above appears backwards, and will result in a significant amount of wasted time and effort if the "wonderful business" aspect is an imperative for potential investment. By flipping the approach, we can zero in on the most fundamental condition for the preservation of capital: a sustainable competitive advantage.

Another issue is the perverse effect of human emotions, which may cause us to act irrationally. As many readers have likely experienced, finding an undervalued security ignites a fire in the belly, and begs for immediate action (with the justification being that the opportunity may be gone tomorrow). While it's easy to say that we won't let this excitement affect our objectivity, my personal opinion is that this is a recipe for trouble; suddenly, your definition of a "competitive advantage" becomes a bit more lenient, such that your hours of hard spent research don't go to waste…

But flipping the order on its head is a much more attractive (and logical) approach. With thousands of securities to choose from, you have the luxury of simply following those that fall into your circle of competence, and choosing from that shortened list the few that hold a truly sustainable competitive advantage. From that point, you can estimate each securities intrinsic value, and then twiddle your thumbs until the market price on any individual stock hits a level that offers an adequate (estimated ex-ante) return.

This seems like common sense, and is ideal for individual investors who don't have clients to report to; if you sit in cash for a year and don't make one trade, no one will have any idea (if you must, you can lie to your friends and neighbors about your recent investments in the high-flying tech stocks of the day). By focusing on catastrophe risk and attempting to "kill the company", you kind generate a list of stock's worthy of your precious capital; with a bit of patience, this is a strategy that all but guarantees attractive long term returns.

About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.7/5 (35 votes)

Comments

onthefringe
Onthefringe - 8 years ago    Report SPAM
Nice.
BEL-AIR
BEL-AIR - 8 years ago    Report SPAM
Science of hitting, you pretty much hit it right on the head.

Perhaps I should say you hit it right out of the ball park with this article.

I would go farther on saying that this simple short article of yours is perhaps in the top 10 articles I have ever read on investing in my entire life.

It is the individual investors biggest single advantage to have patience and to wait for the big fat pitch.

I find most value investors or value investor want a Be's are fully invested at all times, and are trying to find the cheapest stock during a fully priced bull market like we have today as I am writing this. They will buy anything as long as it is cheap, (Or a little cheaper than most) even if it is not a good business or they do not fully understand it, (They might think they do though) But by not being patient and not planning ahead by having watch lists etc 99.9% of private individual investors turn their single biggest advantage to their single single biggest disadvantage...

You will also eliminate alot of the value traps out there as well by using this method.

I hope you will write more articles about this basic theme in the future, as they are most inspirational to my investing style.

Anyways good stuff I loved this simple article of yours and keep it up...

5 Stars from me all around.....
Cornelius Chan
Cornelius Chan - 8 years ago    Report SPAM
Since we have moved into a general conversation loosely revolving around the good qualities of The Science of Hitting's writing, allow me some leeway for some positive input.

First, I also love this type of article. I consider this fine-tuning for my general investing knowledge and know-how. These types of fine-tuning pieces of investment strategy are like drops of life-giving water falling onto the parched desert of my general ignorance.

Then, I was just reflecting on Science of Hitting's name. I really like the analogy of baseball to investing. You have got singles, doubles and triples. You can hit one out of the park; a home-run. I came up with the idea to benchmark the bases analogy to gains in stocks. 1st base is a 30% rise. 2nd base is a 60% rise. 3rd base is a 90% gain. A home run is of course a 100%+ rise in price within a calendar year.

In other words, if you buy shares that double within a calendar year, you have hit a home-run in investing.

Cheers!

The Science of Hitting
The Science of Hitting - 8 years ago    Report SPAM
Everybody,

Thanks for the extremely generous comments! I'll continue to write articles about these basic themes, the tenants of value investing that in my opinion are the source of extraordinary long term returns and can be attained by nearly anyone who is willing to dedicate themselves to a life of continuous learning mixed with a healthy dose of patience and humility.

THANKS AGAIN!
jayb718
Jayb718 - 8 years ago    Report SPAM
Really useful article. Thanks!
becomingbuffett
Becomingbuffett - 8 years ago    Report SPAM
Good stuff! Thanks!

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