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Eric Houssels
Eric Houssels
Articles (5983)  | Author's Website |

Know Your Intrinsic Values

April 29, 2009

We have lived in an era of unprecedented volatility, and there really is no telling if this volatility will continue, lessen, or, dare I say, increase. Looking backwards, what I can say (or confess) is that I was not as prepared mentally for the volatility that transpired starting in the latter half of 2008 as I should have been. The rest of this piece details the basic lesson, as revealed in the title, that I have taken from this era.

Traders love volatility, as it increases the margins of their game (assuming they are right more often than they are wrong, in weighted magnitude terms). I personally think that volatility spooks a great many buy-and-holders into making poor decisions (i.e. selling low), for it painfully disrupts their major aim of slow and steady progress. Institutionals just cannot handle losing, and, if the volatility comes in a bear market (i.e. is downwardly biased), they will seek refuges of safety. But what about we fundamental investors? What should our attitude towards volatility be?

As stated at the outset, I was ill-prepared mentally for the 2008-09 volatility. I screwed up in not harvesting its benefits to the extent that I reasonably could have and should have; my thoughts, therefore, originate from the “wish I had done it differently” perspective. Disclaimer communicated, I contend that we fundamental investors, with regards to volatility of asset prices, need focus on and stick to the discipline of the fundamentals. The two basic fundamentals of most fundamentalists, especially those in the Buffett camp are:

Buy the right businessessBuy them at the right prices
Volatility does not affect the first fundamental, at all. We know what the right businesses are: they are the ones in your circle of competence, that are reasonably predictable to you, run by people who are looking out for the shareholder owners. We all vary in what is actually in our circle of competence or how much downside risk, induced by either financial leverage or business-specific risk, we are comfortable with; but the commonality remains that we understand what we are getting into and accept it. How does volatility affect the second fundamental? This is simple…it is its friend! Volatility increases the likelihood that a “right” price will come along.

If you believe in your estimate of what a business is worth (and, for the record, you will be wrong your fair share), you can and should pull the trigger when an adequate margin of safety cushions your reasonably accurate estimation. And this must be the focus of your efforts. Estimate the values of your circle, update your estimates routinely, and always be learning more about or strengthening your circle by delving into a deeper understanding of your companies, by expanding it with new names, and by culling it when appropriate.

I erred by falling in love with Buffett’s “buy and holdness.” First off, to “hold forever” is a different game – it works only for those superior ROIC companies which are so, so rare and, even then, you have to be on the lookout for their superior ROIC to normalize over long periods of time (either through competition or the IC base just getting too big). Second, there are times even still when the “hold forever” should be sold – the KO’s and GE’s of 1998-99, for example, during the large cap, household name bubble.

There have been several occasions during the bear market when, due to rampant short covering, many of my good (not superior ROIC) businesses reached their reasonable approximations of full value, and I stared at the screen, allowing “hold forever” to be my prison.

In the end, high volatility is a net positive for us fundamentalists, as it presents us with bargains for purchase as well as opportunities to realize our reasonable approximations of full value. When we stick to what we know how to do - price cash flows and/or assets, we will make out just fine in the high volatility world. We will win when we know our intrinsic values.

Eric Houssels

Houssels Capital Management, LLC

About the author:

Eric Houssels
Eric Houssels is the co-founder and managing member of Houssels Capital Management, LLC, a money management firm based in Las Vegas, NV. The firm focuses on investments in the stocks of publicly-traded companies of all capitalizations that possess, preferably, significant earnings power or, alternatively, assets that can be (re)deployed to achieve significant earnings power and are trading at reasonable valuations. Houssels Capital Management was founded in 2000.

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