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PJ Pahygiannis
PJ Pahygiannis
Articles (149) 

21 Questions With Ugo Ume

'I was 14 in 2008 and had no clue what was going on'

October 05, 2016 | About:

1. How and why did you get started investing? What is your background?

About 5 years ago I enrolled at the University of Arizona. As a freshman, I was worked at a deli on campus. One of my colleagues told me he ‘invests’ $100 thousand of his money. A month later, he had more than ‘tripled it’ $360 thousand. My jaw dropped. I had saved $4,000 by negotiating cell phone prices down on craigslist and then subsequently selling them market price on eBay both in high school and also my freshman year of college – a strategy I later learned to be a term in finance called Arbitrage. I said to myself, I have $4,000 today, if I conservatively double my money every month until I graduate, I can retire without ever working a post-college job. Most inexperienced investors would believe these ego-stroking stories, but as I read more about finance, I realized that there is absolutely no way he turned $100 thousand into $360 thousand in a few weeks. Also, why would someone be working for $7.65 per hour if they were doing so well? I applied for a Scottrade account about a month after on my 18th birthday. So my interest in investing was effectively by chance.

2. Describe your investing strategy and portfolio organization. Where do you get your investing ideas from?

I prefer to generate my own ideas. My level of comfort with certain stocks or sectors eliminates the majority of companies in the Universe. There are very few people that practice my level of ‘value’. Most people drift to ‘quality’, though very subjective, rather than sheer value while accepting a premium price for the securities. The fortunate truth about investing is that asset prices inevitably revert to the mean. Quality is subjective, cheapness is objective and hence outperforms over the long run.

I look for companies with proven and consistent cash flows. A company that is able to generate and maintain consistent cash flow likely has some sort of competitive advantage. Only after a company passes the quantitative valuation and the consistent cash test will I even consider reading the company’s 10-K. I make no attempt to forecast the operating or net margins of companies that do not make money.

If I come across net-nets, the fundamental questions are: do they pay dividends? Or is there an activist situation to unlock the supposed value? If neither of the aforementioned exist, I usually skip them. If there is a situation where the stock doesn’t return cash to shareholders, but has taken a sharp drop, then there are likely investors still following the stock. That itself could be a catalyst. If it has been cheap for over a few years, I’ll likely skip over.

3. What drew you to that specific strategy?

Dr. Michael Burry. I studied some of his older investment theses and realized that he stuck to cheap companies with proven and consistent cash flows at very cheap valuations. In his 2001 fourth quarter letter to investors, one of the stocks he owned fell to ¾ TTM FCF right after the Sept. 11 selling rout. He bought more of it and the company was bought out by a competitor at a 700% premium from its Sept. 30 lows in the fourth quarter of 2001 - less than three months later. Although value of that sort is nearly impossible to find in today’s market, it is quite obvious that buying cheap works.

4. What books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? What investors do you follow today?

I already mentioned Michael Burry so I’d say Tobias Carlisle. Reading his book "Deep Value" in 2014 was eye opening for me. It was the first book I read that detailed backtests on various investing strategies. After reading the book, I re-read Michael Burry’s letter to investors as well as his older investment theses and finally understood what he was doing. "The Art of Short Selling," and "Financial Shenanigans" by Kathryn Staley and Howard Schilit are also two of my other favorites. I’ve avoided an innumerable amount of investing landmines because of those two books. There’s also Professor Damodaran of New York University, Howard Marks (Trades, Portfolio) memos and many more.

I learned that the amount of safety embedded within an investment is not derived from the quality of the asset, but on the price paid for it. The average person would agree that a Mercedes-Benz S65 AMG has a higher quality build than a Honda Accord. If one purchases a brand new 2017 Honda Accord Touring today for $20 thousand, they could sell it next week for $30 thousand. If the person purchases a brand new 2017 Mercedes S65 AMG for $400 thousand, it doesn’t matter how great the car is, not one is going to pay $400 thousand for it next week. So the price paid for the ‘quality’ asset is more important than the ‘amount of quality’ embedded within it – these are mistakes I see all over the investing world and I strive to avoid it.

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?

If a stock hits my price target within 3 weeks of buying it, I’ll sell it. If I realize that there is even a sniff of a mistake in my thesis, I’ll sell it. I don’t buy the Buffett ‘forever’ holding period that most value investors love. Buffett’s best years were during his partnership days, which coincided with high portfolio turnover.

6. How has your investing approach changed over the years?

Well, I started out trading penny stocks, then speculating on larger cap stocks and then 100% value approach after learning some hard speculative lessons. I’m still evolving and finding various risks within my process. For example, I purchased shares of a company that provides shelter services to the employees of crude oil (to take advantage of the depressed crude oil-linked stocks) companies in Canada but decided to sell it because I no longer wanted my portfolio to be tied directly to a commodity. So that’s one thing that has changed this year. I’ll buy the stock of a company that provodes services partially to a commodity, but also has another unrelated segment that will provide cash to the company while the commodity price is depressed. I cannot predict the price of any given commodity, so stocks that are fully dependent on commodity prices do not meet my value criteria.

7. Name some of the things that you do or believe that other investors do not.

I no longer use financial models. If something is not undervalued without a model, it's not worth my time. Financial models provide a false sense of security. It’s easy to toggle assumptions to justify a desired price. Just because you fantasize about the price or your model says so does not mean it will materialize – reality is unforgiving.

8. What are some of your favorite companies, brands, or even CEOs? What do you think are some of the most well run companies?

I don’t have a favorite CEO, but I like shareholder friendly management teams. So I’d go with Monica Iancu of Mind C.T.I. Ltd. (NASDAQ:MNDO), David and Darcy Will of Gamehost (TSX:GH).

9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?

I use GuruFocus – it’s the best price per dollar spent out there. I screen with EV/EBITDA and Price/FCF. What makes this extremely efficient for me is that it shows you a 15-year financial history of the company. I can generally tell within 10 seconds if I’m interested in looking further or not. I read a lot of theses on SeekingAlpha and GuruFocus, but I haven't bought a stock based on someone else’s research just yet, but I think it’s a great way to find ideas. It's also a great way to learn from other people's mistakes.

10. Name some of the traits that a company must have for you to invest in, 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.

I like companies that exhibit some sort of shareholder return – be it paying down debt, paying dividends or repurchasing shares. I avoid shareholder hostile management teams. I see a lot of Graham type net-nets/NCAVs on my screens and they look enticing, but without returning cash to shareholders or without an activist, there is no catalyst and they will likely remain cheap for the foreseeable future.

11. What kind of checklist do you use when investing? Do you have a specific approach, structure, process that you use?

I first look for companies that have proven and consistent cash flows and a history of profitability. I make exceptions for losses caused by non-cash expenses. If they have been profitable for so long, then they must have some sort of competitive advantage – the goal is to figure out what that is. I usually wait to buy them when their cycles have turned and the price is depressed relative to their normalized earnings power.

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?

I just read the SEC public filings and figure out what the company does and how they make money. I have no access to management, as I’m usually not a majority shareholder.

13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock?

A stock has to be both absolutely and relatively undervalued for me to buy it. If the company is cyclical, I’ll usually try to figure out how cyclical it is and then figure out an appropriate multiple to pay for it. It has to be the cheapest of its competitors and also trade at a reasonable valuation absent of competitor comparison.

14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?

I avoid for profit education – there is something so immoral about degree mills that irk me. Also, immoral investments eventually catch up to investors in the form of Government interventions.

I also generally avoid banks and insurance companies – valuing them, in my opinion, is quite difficult. Distributors and supply chain servicing companies look fairly reasonable, you can get a 10% earnings yield on some of them absent of growth.

15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?

It does feel overstretched, 25x is certainly a deviation from the norm. Government bonds concern me the most. People have accepted negative rates in Europe and Japan and it is absolutely nuts. To get the same yield on the DOW today with, you have to buy 30-year U.S. Treasuries, which is ridiculous. Fixed-Income investors bear both currency and interest rate risks, I wouldn’t touch government debt with a 50-ft pole.

16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?

I been so busy that I haven’t had much time to read lately. The first one on my list would be "Billion Dollar Lessons" by Paul Carroll. "Confidence Game" by Christine Richard and "Fooling Some of the People All of the Time" by David Einhorn (Trades, Portfolio) are also great books that essentially tell you to stick to your investment thesis in the face of mass dissent.

17. Any advice to a new value investor? What should they know and what habits should they develop before they start?

I personally started with Michael Burry’s book recommendations and I suggest new investors do the same with a twist some of mine. My recommendation is that you read them in this order:

  1. Take a Financial Accounting course (MIT OpenCourseware)
  2. Take a Macro and Micro Economics class (MIT OpenCourseware)
  3. "Why Stocks Go up and Down" by Bill Pike
  4. "The Intelligent Investor" by Benjamin Graham
  5. "Common Stocks and Uncommon Profits" by Philip Fisher
  6. "Buffettology" by Mary Buffett and David Clark
  7. "Financial Shenanigans" by Howard Schilit
  8. "The Art of Short Selling" by Kathryn Staley
  9. "Competitive Strategies" by Michael Porter

10.) "Deep Value" by Tobias Carlisle

11.) Michael Burry’s Letter to Investors

12.) Warren Buffett (Trades, Portfolio)’s Berkshire and Buffett Partnership Letters

18. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?

GuruFocus and SeekingAlpha are great, I read a lot on those sites and learn from other investors. I also track Mike Burry’s 13F filings, but that’s about it.

19. Describe some of the biggest mistakes you have made value investing. What are your three worst investments? What did you learn and how do you avoid those mistakes today?

Pier 1 Imports (NYSE:PIR) was my biggest so far. Bought at $6.5 and sold at $4.9 – I cut my losses around 24%. I looked at the company and quickly came to the conclusion that it was ridiculously cheap. I took current assets, adjusted inventories down 20% and subtracted all liabilities. I added the derived number back to the market cap to get the enterprise value. Normalized earnings pointed to somewhere near 5x EV. I also assumed inventory levels would normalize in the coming quarters and that margins would revert to the mean. I was dead wrong. I had read in one of Michael Burry’s equity thesis that a stock trading at 8x can fall to 4x and then 2x. I came to the conclusion that the best time to buy these uber-cyclical stocks is during an actual recessionary downturn. Inventory deleveraging for all companies within the industry happen at the same time so you don’t even have to time it. You just buy the cheapest one and play the waiting game. Attempting to ‘buy and hold’ a highly cyclical company would lead to buying and taking an 80% drawdown just to realize a 30% gain over a 2 year span – its not worth it.

20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections, and fluctuations?

First quarter of 2016 is the closest I’ve been to a ‘crash’. I was 14 in 2008 and had no clue what was going on. I run a long/short portfolio with puts to hedge my portfolio as a preparative precaution. There’s a quote from Peter Lynch that goes like this:

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”

And one amusing quote from one of Warren Buffett (Trades, Portfolio)’s partnership letters:

“I resurrect this “market-guessing” section only because after the DOW declined from 995 at the peak in February to about 865 in May, I received a few calls from partners suggesting that they thought stocks were going a lot lower. This always raises two questions in my mind: (1) If they knew in February that the DOW was going to 865 in may, why didn’t they let me in on it then; and, (2) If they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May? There is also a voice or two after any hundred point or so decline suggesting we sell and wait until the future is clearer. Let me again suggest two points: (1) The future has never been clear to me (give us a call when the next few months are obvious to you – or, for that matter, the next few hours); and, (2) no one ever seems to call after the market has gone up 100 points to focus my attention on how unclear everything is, even though the view back in February doesn’t look so clear in retrospect.” -Second Half Buffett Partnership Letter, July 12, 1966

Corrections and crashes are difficult to predict, so I won’t stress myself out attempting to. If it happens, I guess it happens.

21. If you'd like to share, how have the last five to ten years been for you investing wise?

I don’t have much of a track record yet, but I’m in the process of creating one with my website.

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