“Value investing, the way I define it, is finding a good business run by smart people, at a reasonably good price relative to its values today and five or more years from now.” --Mario Gabelli
Asked to describe his investing style in 25 words or less, Mario Gabelli (Trades, Portfolio) responded, “Graham and Dodd plus Warren Buffett (Trades, Portfolio).”
Overheard conversations on the golf course first triggered Gabelli’s interest in stock picking, but he went on to become anything but an armchair expert. Since founding his own company in 1976, he has become an outstanding fund and money manager, as well as a media favorite on stocks.
The essence of that strategy is what he calls “Private Market Value (or PMV) with a Catalyst.”
Who is Gabelli?
Gabelli was born to immigrant Italian parents in 1942 in the Bronx, a borough of New York City. He bought his first stock at the age of 13; during his teen years he caddied at a golf course where he overhead conversations about investing. Fordham University awarded him his first degree in 1965, which was followed by an MBA from Columbia Business School.
Among his teachers at Columbia was Roger Murray, co-author of the fifth edition of "Security Analysis," the Graham and Dodd value investing bible.
After university, he worked at Loeb, Rhoades & Co. as a security analyst. In 1976, he went out on his own by forming Gabelli & Co., an institutional brokerage house. Starting capital came from his savings and borrowed funds. That was followed by the formation of Gabelli Investors (which later became GAMCO Investors) to manage money for clients.
Institutional Investor named Gabelli Money Manager of the Year for 2011; in 2014, he received the Irving Kahn Lifetime Achievement Award from the New York Society of Security Analysts; and in 2000, he was named to Barron's All-Star Century Team.
Although we do not get any specifics about the golf course conversations that stimulated his interest in stocks, it is clear he did make the most of what he learned in Murray’s classes.
What is GAMCO?
It began as an institutional research firm, but has since evolved into what the company’s website calls "a diversified global financial services company."
The company also says the key to its success has been its research-driven culture, with a focus on fundamental bottom-up research, a consistent investment process and committing itself to superior risk-adjusted returns.
GAMCO Investors Inc. (GBL) is a publicly traded company, trading on the New York Stock Exchange under the symbol GBL. GuruFocus gives GAMCO a mediocre 5 out of 10 for financial strength and a strong 8 out of 10 for profitability and growth:
This table, from the 10Q for the first quarter of 2017, shows the company managing more than $41 billion in assets, mainly mutual funds and institutional accounts:
Its more than three dozen mutual funds include value, growth, contrarian and several other approaches. Although the markets they cover are diverse, they all start with the same approach.
GAMCO is a relatively large firm, serving institutions and individuals, with a wide range of investment products that all depend on intensive, bottom-up research. It is also a public company, which provides a glimpse into a company that exists to evaluate other companies.
Gabelli’s investment philosophy, strategy and process
In outlining their research, the guru and his colleagues lay out this manifesto on their website:
Their investment philosophy is “Private Market Value (or PMV) with a Catalyst.”
They define private market value as“The price an informed industrialist would pay for the entire company,” and a catalyst as an event that has the potential to surface more value.
Within that broad context, they do intensive fundamental analyses focusing on:
- Free cash flow.
- Earnings per share.
- Private market value, which includes on- and off-balance sheet assets and liabilities.
This analysis generates candidate companies; analysts follow their industries on a global basis, develop an operational understanding of the companies and generally become experts on them. This expertise is maintained by meeting company managers, suppliers, competitors and customers.
This familiarization process narrows the field to those companies trading at a significant discount to their private market value.
The remaining candidates are the subject of more research, through industry dynamics, to find potential events or catalysts that might unlock value. Based on this knowledge of companies—the relationship among private market value, public market value and catalysts—the firm makes its buy and sell recommendations. They add this research usually takes a long-term perspective, much like a strategic or financial buyer.
Writing for StreetAuthority, David Goodboy said Gabelli begins with principles set out in "Security Analysis" by Graham and Dodd. To that, he adds Buffett’s ideas about business valuations and taking a major ownership position in portfolio companies.
Goodboy says PMV is “the value an informed entrepreneur would pay to purchase an asset with similar characteristics.” He also says the researchers and analysts are looking for companies that have the potential to deliver a 50% return in 24 months, and that Gabelli sells a stock once it reaches its PMV or if the catalyst fails to materialize.
The Novel Investor blog parses an interview with Gabelli to identify three keys to his performance:
- Good businesses.
- Longer time period (16 years according to Novel Investor).
- Deferred taxes (a positive consequence of selling as infrequently as possible).
Finally, a few words from Gabelli himself, as collected by Quoteswise.com:
- “We believe free cash flow, defined as earnings before interest, taxes and depreciation (EBITD), or a slight variation, EBITDA, both minus the capital expenditures necessary to grow the business, is the best barometer of a company’s value.”
- “When the informed industrialist is evaluating a business for purchase, he or she is not going to put a lot of weight on stated book value… What that informed industrialist wants to know is: How much cash is this business throwing off today and how much is he going to have to invest in this business to sustain or grow this stream of cash in the future.”
- “What we like to do is to buy, buy, buy when everyone doesn’t want it.”
Gabelli the value investor has more than just bargains in mind when he buys; he looks for businesses that are selling at or below what a prudent business owner would pay, and he must see a catalyst that should drive the market price up in the future.
Current holdings
Industrials and consumer cyclicals dominate holdings in the Gabelli Asset Fund Class AAA (net assets $2.6 billion):
Of the more than 800 stocks in this fund, these are the top10, along with their proportion of the portfolio:
- Bank of New York Mellon Corp. (BK, Financial) 1.69%
- Ryman Hospitality Properties Inc. (RHP, Financial) 1.6%
- Time Warner Inc. (TWX, Financial) 1.69%
- Honeywell International Inc. (HON, Financial) 1.29%
- Crane Co. (CR, Financial) 1.27%
- American Express Co. (AXP, Financial) 1.24%
- Sony Corp. (SNE, Financial) 1.16%
- The E. W. Scripps Co. (SSP, Financial) 1.16%
- National Fuel Gas Co. (NFG, Financial) 1.14%
- Dish Network Corp. (DISH, Financial) 1.14%
Interestingly, this value portfolio holds more than 800 stocks, which is very large compared with the funds of other gurus. Gabelli is on a path of his own with an emphasis on industrials and consumer cyclicals. Most gurus have gained their high rankings with technology and health care, but his holdings for those sectors are in the mid-single-digits.
Performance
Goodboy argues Gabelli’s approach yields long-term consistency of returns, yet this GuruFocus table, showing results for the Gabelli Asset Fund Class AAA, suggests significant variation from year to year:
Longer-term cumulatives look strong, with all of them beating the S&P 500 (overperformance shown in brackets):
- 15-year: 8.0% (1.3%)
- 20-year: 9.7% (2.0%)
- 25-year: 10.6% (1.5%)
- 30-year: 11.6% (1.4%)
Over the lifetime of the fund, this chart from GAMCO shows an investment of $10,000 would have generated more gains than an investment in the S&P 500:
In the chart immediately above, note how the Asset Fund closely tracks the S&P 500 from 1986 until 2000 (the year of the dot-com crash); good active management meant smaller losses, which has contributed to the fund’s ongoing outperformance since 2000.
Conclusion
There is another important conclusion to be drawn from the chart: the long-term matters. While Gabelli’s fund bobs up and down from year to year, it clearly outperforms for the patient investor.
The guru can afford to be patient because his combination of valuation and catalyst identification gives him robust raw material to work with. He has quality companies with some corked potential that should emerge given sufficient time.
Gabelli has made the most of combining private market valuations with the spark of catalysts.
Disclosure: I do not own shares in any of the companies listed, nor do I expect to buy any in the next 72 hours.
