Bill Nygren: Fundamentals Are the Key to Value Investing

Bill Nygren (Trades, Portfolio) rightly enjoys a formidable reputation as a value investor. His asset management firm, Oakmark, has won the loyalty of many allocators, as can be seen in its whopping $118 billion in assets under management. Oakmark’s mission statement, quoted below, reflects Nygren’s commitment to the principles of Benjamin Graham:

“At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.”

Unsurprisingly, Nygren’s long-term, value-oriented view of stock market investing has won him considerable attention on GuruFocus, and he sat down for an interview with GuruFocus in August. The full transcript is definitely worth reading, but his insights about investor psychology deserve to be discussed in their own right.

Focus on the fundamentals

Value investing is all about business fundamentals. The core premise of the strategy is that the market is usually governed by shorter-term, emotion-driven actors who can drive prices out of alignment with their intrinsic values. In his GuruFocus interview, Nygren offered an interesting take on this subject, arguing that a clear-eyed focus on fundamentals can actually help investors overcome their psychological weaknesses:

"I think the best way to keep emotions under control is to remain focused on business fundamentals rather than stock price. When we buy a stock, we establish a roadmap for how we expect the business fundamentals to progress. If the fundamentals are meeting our expectations but the stock has declined, we often use that as an opportunity to add to our position. On the other hand, if the fundamentals aren’t aligning with our expectations, we will usually consider our thesis broken and move on, regardless of how cheap the stock may look relative to our original expectations.”

This is a critical point. Knowledge is powerful when it is sought out and embraced. Yet, many investors and traders prefer to focus on narratives and other ephemeral factors. This can sometimes lead to confirmation biases and blinkered reasoning, preventing an investor from seeing the picture clearly.

Look beyond the numbers

There is no such thing as perfect information in public markets, but the next best thing is a rigorous commitment to understanding companies’ fundamentals. For most investors, that means looking at financial data. According to Nygren, however, fundamentals are about more than quantitative factors:

“I think the most common tendency of young investment professionals is to rely almost entirely on quantitative skills and ignore qualitative positives or negatives of businesses and their managers. I was no exception. It is really just natural because fresh graduates have better quantitative skills than their bosses. And if you’ve got the biggest hammer, you want everything to look like a nail. But I can’t think of one investment we’ve made at Oakmark where we developed an advantage over other investors by ‘outmodeling’ them.”

It can be easy to reduce companies to their financial statements. Indeed, they are vital sources of information for value investors, but that does not mean they are the only things that matter. The fundamentals of a company extend to factors not so easily measured.

Management is one of the most important aspects of business success, yet its effects are not fully reflected in financial data alone. Yes, excellent managers will produce excellent financial results, but soft-touch elements of their actions must be understood from a qualitative standpoint in order to be fully understood.

Learn from the best

While markets and technologies change, the fundamentals of what makes a good company do not. As a result, many of the lessons learned by others can still be applied to the market of today. According to Nygren, investors are best served when they pay attention to what other talented investors have done in the past, and what they are doing now:

"Some investors suffer from a 'not invented here' syndrome. One of the things I believe we do well is realizing we haven’t cornered the market on good investment thinking. We all read about what our competitors are doing with an eye toward using some of their best ideas."

A good idea is a good idea, yet many value investors can reject ideas that were derived by others. Value investing is a contrarian philosophy by nature, so it tends to attract and breed contrarians, but even the best contrarian can gain from paying attention to what other people are doing. Nygren advised investors to read widely, but he does have his favorites. Perhaps unsurprisingly, he favors Warren Buffett (Trades, Portfolio) most of all. By Nygren’s estimation, if investors could read about the strategies of any one investor, they should pick the CEO of Berkshire Hathaway (NYSE:BRK.A) (BRK.B, Financial) hands down:

“I like reading books about successful investors, especially those who use a different style than we do. I admire Warren Buffett (Trades, Portfolio) and would say if you are going to read about only one investor, pick him.”

Disclosure: No positions.

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