My previous notes on Michael Mauboussin's talk at Google (GOOG, Financial)(GOOGL, Financial) was well received so I decided to do another article on an equally fantastic talk from a well-respected investor – Tom Gayner from Markel. As a side note, I personally found that by forcing myself to take notes, I am learning a little more than I would have had I just listened to the talk passively. Therefore, I encourage the readers to try it.
Here is the link to the video.
https://www.youtube.com/watch?v=2sG91e1Wh4I
Here are my notes:
- He had a very strong quantitative bias in selecting investments when he started.One of the tendencies for us when we start out is to have quantitative metrics that we can really rely on. This is a good way to start but this is only a partial step along the journey of becoming an accomplished investor. It worked spectacularly well for Ben Graham, but back then there were a lot of stock that were statistically and quantitatively cheap.
- He evolved from spotting value to spotting the creation of value. Spotting value means you see a price gap between what the security is trading and what you have in mind what the security is worth based on some quantitative methods. A good analogy is picture versus movie. Value spotters only a picture but value creators seen the whole movie and how’s the reel going to unfurl over time. So instead of asking what this company is worth today, he started to ask what this company is going to worth next year, the year after that and the year after that. And decades after that. This has applications not only in investing but in leadership and relationship too.
- This evolution from value spotter to value creator led him to the four-pronged approach to investing.
- The first thing is a profitable business with good return on capital without excess leverage (demonstrated record of profitability). The best business creates value for customers and the mark of value creation is profitability. Also generally speaking high quality great character people don’t use a lot of debt so you want to be careful with financial leverage. Crooks don’t steal their own money, they steal other people’s money.
- The second thing is the management team running the business. He looks for integrity and ability.
- The third bit is what the reinvestment dynamics of the business are. This is the most important one. What’s the compounding feature? Let’s take the restaurant business for example. If you have a 5-star restaurant, typically the owners are there every day. They are not chains of the best restaurant in the world. So it is a good restaurant but the model can’t be replicated anywhere else. Some businesses are like that, like boutiques. So you want a restaurant model that’s replicable over and over again. So McDonald’s (MCD, Financial) is a great example. You should think of things as binary. A perfect business is that one that earns high return on capital and has the ability to keep compounding at the same sort of a rate a year. The second-best businesses are the ones that the owners know that they can’t compound the current business at a satisfactory rate, but through intelligent capital allocation, they can create enormous value. Berkshire Hathaway is a perfect example.
- And the fourth and final lens is price, valuation. Valuations ratios go into the thought process, but there are two types of mistakes you can make when you’re doing your valuation work. One is you pay too much for something. This is not the worst thing. You can still recover from that. The second and harder error is mistake of omission and especially missing out on compounding machines because the valuation level didn’t fall into your predefined range. It’s very easy not to talk about it because human beings only have very vivid memories of things that we did and things that happened to us. We tend to not have vivid memories of things that didn’t happen to us or that we didn’t do. That money you didn’t make will end up being a far bigger subtraction from your theoretical end net worth, than the things that you did buy and perhaps did not work.
Q&A Summary:
1. You mentioned that you evaluate a management team based on integrity and ability. But for us who don’t have access to a management team, how do we actually go about figuring that out?
Answers: How do you decide who you are going to marry? You dated. The point of dating is to spend time with somebody to see if their values overlap enough with yours so that you’ll be able to get along for a long period of time. With management teams and people running the business, what I’m doing is analogous to the idea of dating. You suggested that I can get an appointment and see people who run a business and interact with them whereas you face severe limitations in doing so. That may be true but at the same time, I spent more time reading about people using the exact same resources that you would have access to as well as annual reports, proxy statements and magazine articles. And I try to think and just look and get a gut feeling and make some judgment and discernment whether these people are acting in a way that’s reasonable. I encourage you to think about things in that dimension. You will make a judgment and your judgment will not be perfect, but by virtue of the times you get it wrong, when you make an error, you’ll learn something. And that will be a marker to you that the next time you see it, you will be sensitized to it and it will help you make better judgments. You don’t need to personally know the CEO to know whether he will be able to run the business well or not. There’s a good paper trail and a good set of evidence out there for you to think about and draw judgment upon.
2. How do you think about investing in rapidly changing companies?
Answer: It’s harder. There’s no right or wrong. It’s just harder. Graham and Dodd’s Security Analysis has a few editions, but I suggest you read the first edition. Ben Graham in the first edition says that growth, which is your point about rapid technological change, is extremely important. It's just harder to calculate and evaluate. Graham went on in the Intelligent Investor made the point that he made more money in GEICO than every other investment he made combined. He struggled with that investment because it wasn’t the classic sort of investment that he was used to. The rapid technological change is something that didn’t exist not that long ago. All you need to do is to get it right once in your lifetime and it will change your investing career forever. But it’s hard to do that.
3. Seth Klarman (Trades, Portfolio) mentioned it’s important to have the right structure in the investment business, the right clients. And Markel has both of those. Can you share how you came about Markel from your previous career? How was the transition?
Answer: I started out as an accountant with PwC. I was more interested in dollars than numbers. By accident I found a broker in Richmont, Virginia called Davenport. He was an analyst and a broker at the same time. We got along and after some time, he offered a job to me. So I went there in 1984. In 1984 that’s the year I read the article about Buffett. Every word was just dripping common sense. I looked at the price, and it was almost $380. That was my biggest investment regret. So in 1986, Markel went public. There was an insurance business. Steve Markel was interested in investing the underwriting profits in equities. So the light went off on me since I missed the first part of Berkshire, but at least I was given a second chance. I bought what Markel was covering from 1986 to 1990 at Davenport. And in 1990 Steve Markel offered me a job and I took it. I’ve been there ever since. Half of Markel’s compounding comes from underwriting profit and the other half comes from the investment portfolio. The good thing about being an individual investor is that it has basically the same structure as being an investment manager at the right organization. But you have to spend less than you make. If you are living on less than what you are making, you are rich. If you keep doing that positive cash flow begins to compound just like Markel. You have every advantage that Berkshire has and Markel has. On the other hand, catching lightning in a jar is very hard to do and it’s harder to repeat that process consistently year after year.
4. Are you worried about missing out on private companies such as Uber and AirBnb, which could be huge compounding machines?
Answer: I remember I saw the private value for Uber appraised at $50 billion roughly and FedEx at that particular time was about $51 billion. I’m not sure which one is a better investment. FedEx is a harder documentable number. The Uber valuation is within the context of private market value. But there will be other things to do. You don’t need to catch a Uber to (be successful in investing). FedEx started in the '60s or '70s, any time during that period you bought FedEx you’ll do fine. I would be willing to bet you a beer anyway that 10 years from now, FedEx is still an important and profitable business. Again, there’s no right or wrong. It’s just knowing who you are and how you do things and things that resonate with you. I’m very happy to compound my money at a reasonable rate with FedEx as opposed to getting upset for missing out on Uber.
5. Do you keep track of your mistakes of omissions?
Answer: Yes, not as formally as what you might think. I started out in the business every day I look at the new low list. Now I look at the new high list first then the new low list. If I don’t own it and I see a company making new highs all the time, I started to get curious.
6. How does Google do according to your investment criteria?
Answer: I own some Google (GOOG, Financial)(GOOGL, Financial). It’s one of the things that I feel like I’ve missed and I feel stupid about that. I’m on Google 20 times a day how do I miss it. The things that remain challenging for me are how the compensation at senior level works and how the company intends to accomplish the same thing for the shareholders at the same time they are trying to accomplish these things in the world. I don’t know how to assess that. It’s not within my current skill set, but I’m trying to learn more about it. So I put a little money in Google so that I can keep track of it and get me to read the reports.
7. As Markel grows, when would size eventually become a factor?
Answer: I will try very hard to make that a problem for us.
