An Exclusive GuruFocus Interview With Value Investor Wally Weitz

Value investor Wally Weitz founded Wallace R. Weitz Company in 1983 where he currently manages the Partners III Opportunity Fund, and co-manages the Value, Partners Value, and Hickory funds.

Over the past 10 years, the Partners III Opportunity Fund returned an annualized 8.76%, while the annualized return since inception is 13.4%. The fund’s top five holdings as of the first quarter are Berkshire Hathaway (BRK.B, Financial), Liberty Global PLC (LBTYK, Financial), TransDigm Group (TDG, Financial), Liberty Media Corp (LMCK, Financial), and Valeant Pharmaceuticals International (VRX, Financial).

Weitz recently answered a few questions from GuruFocus readers about his investing philosophy, his experience over the years, and also shared a few of his favorite investing books.

1. Can you tell us about your background and how you became interested in investing?

As a 12-year-old, I sat in on a lunch with my grandparents’ stockbroker and was interested in his pitch for investing in stocks. I bought “How to Buy Stocks” by Louis Engel on the way home. It explained why business would need capital, what it meant to sell stocks, etc. It was very rudimentary, but I was excited about the idea of building a business and profiting from investing in stocks. I then bought odd lots of blue chips with earnings from jobs. In high school, I heard about technical analysis and went through a several-year charting phase where I traded based on charts…unsuccessfully. In retrospect, it was cheap tuition. While at Carleton College, I discovered Ben Graham’s “Security Analysis.” His concepts of (1) understanding business value vs. stock price and (2) buying only when the facts indicated that the stock was cheap enough that one had a “margin of safety” sounded very sensible to me.

2. Which investors had the most influence on your investment philosophy?

Warren Buffett (Trades, Portfolio) by a very wide margin. John Templeton, Henry Singleton, Marty Whitman and others contributed ideas and cautions. However, Buffett’s letters, speeches, Q&A sessions, and actions in both stock investing and building Berkshire are the basis for how I think about investing.

3. If you had to invest all your money in five stocks, what would they be if the long term goal was (i) growth and (ii) growth with capital protection?

Lists of favorite stocks tend to get out of date pretty quickly and can look pretty dumb in retrospect. However, if I had to buy a small number of stocks and keep them 10 years or more, I would like holding companies managed by smart, disciplined, good capital allocators. The holding companies should own good, net cash generating businesses but the managers should be unsentimental about evolving the portfolio of companies to maintain a strong overall company that can survive any financial disaster and can “make its own breaks” even in tough times. Warren’s Berkshire Hathaway (BRK.A)(BRK.B, Financial) is the prototype, but John Malone and others have good track records, too.

4. Do you meet with management? If so, what qualities do you look for?

We like to meet with management, but evaluating them is tricky. Ideally, we’d like to confirm that they have a clear vision and are likely to execute it well. We’d like to confirm that they feel that shareholders are partners and that they truly believe that their job is to build per share business value over a period of decades (and that their compensation encourages that behavior).

5. How do you determine a stock’s margin of safety?

This question defies a simple answer. We try to estimate a company’s business value based on the cash flows it will generate for owners over the years, and to buy the stock at such a big discount to that value that we can be way off in our estimates and still win. That is art, not just doing present value calculations.

6. Interest rates are going up; what investments would perform well in this climate and should we continue to add/hold onto REIT positions?

It’s hard to generalize about the impact of rate increases. Conventional wisdom says “rising interest rates are bad for stocks, especially ‘interest rate sensitive’ stocks.” Conventional wisdom is always dangerously over-simplified, but that doesn’t mean people won’t sell enough stocks to cause a correction or even a bear market. The key for an investor is how each company is positioned going into a rising rate environment. If they have debt maturing near-term, they will be hurt. If they have long-term, fixed rate debt, they will be somewhat insulated. Banks and other “spread lenders” are both borrowers and lenders, and an investor needs to understand the maturity structure of both their assets and liabilities. If they will be hurt by X%, but their stock is so depressed by the fear of rising rates that its price reflects 3X amount of damage, the stock might be a buy in spite of the company’s vulnerability. As usual, it’s about business value, calculated with reasonably accurate expectations about key variables and stock price.

7. Can you tell us of an investment mistake you’ve made, and what you learned from the experience?

For decades we bought banks and thrifts whenever the Fed raised interest rates (yes, they used to do that!) and sold them when the Fed reversed course. It worked beautifully in the 1980’s and 1990’s. It didn’t work in the recent mortgage crisis because loan losses were many times higher than ever before and caused permanent damage to the lenders. The mistake over the decades was failing to recognize that the banks were “over-earning” and escaping punishment for over-borrowing and sloppy underwriting because home prices always rose enough that they could sell foreclosed property at good prices. It turned out that we were engaging in a bad investment idea that we “got away with”…until we didn’t. We still earned great profits on balance over the years, in spite of giving some back, but it was a good lesson in a version of the old quip, “Never confuse brains with a bull market.”

8. What books would you recommend to a beginning value investor?

Benjamin Graham: “Intelligent Investor”

William Thorndike: “The Outsiders”

Howard Marks: “The Most Important Thing”

Roger Lowenstein: “Warren Buffett (Trades, Portfolio)” and “When Genius Failed”

Lawrence Cunningham: “The Essays of Warren Buffett (Trades, Portfolio)”

Carol Loomis: “Tap Dancing to Work”

Note: Though more reader questions were submitted, Weitz answered only those where he felt he could add value.