*This is an interview I did recently with Gurufocus. It gives a pretty good idea of how I think about investing and my background
How and why did you get started investing? What is your background?
First off, let me say that I’m not quite sure I belong or deserve to be included with the other investors in this Q&A series. In fact, I’m quite certain I don’t. But when I was asked to do this I thought it could help me clarify my investment process and be somewhat interesting to a few people out there.
I work for a government contractor specializing in asset forfeiture investigations. In some ways it is quite similar to the process of investing. I investigate companies and look for financial crimes, transactions and large assets for seizure. I have a Bachelor of Science in economics and will be obtaining my master’s in financial management next semester. I’ve thought about going for a CFA, but have a two year old with another on the way and a wife who might kill me if I tried.
I became interested in investing while I was in college, but at the time thought I was more interested in running/owning a business. Once I graduated I had the opportunity to work with a family member in starting a franchisee business. This experience was invaluable to me in both life and investing. I was given immense responsibility right out of college and was basically at the ground floor of starting and operating a business. I was involved in store development/location plans, construction, hiring/firing, purchasing, labor and just about every aspect of the business. I was managing three stores and around 75 or so employees, which taught me a lot about leadership. I was lucky to be given the freedom to pursue my ideas for the business, which were generally focused on improving profitability and efficiency.
I learned a ton in that short two-year period. We opened three stores within almost a year, which is sort of insane when looking back. It was a whirlwind, but it taught me about hard work and what goes into running a successful operation. Our stores were extremely successful due to our combination of intense focus on customer service, cleanliness and efficiency. It was the perfect example of how management can make a huge difference in the success of a business. I say that in respect to my boss who hammered home the importance of customer service, which was hands down the biggest factor in our success.
When we opened our stores there were two other stores (no owned by us) in the same general area. Same franchise, same product, same marketing, similar buildings, equipment, location, just about everything was identical. Despite that, those two stores were struggling and we were thriving. The main difference was our customers loved us; our stores were cleaner, our product fresher and our employees better trained. It sounds easy, but these factors don’t really show any tangible return or benefit and cost more money on the front end. We had some pushback from others in the business about cutting more labor or reducing waste by keeping the product out longer. It’s hard to show the tangible benefit of a larger staff or fresher product, but if done right it can really make a difference.
I always go back to this when I’m researching companies. It’s made me much more aware of management and how easily they can improve or damage a business.
After two years of the 24/7 grind I realized that (like Buffett) I didn’t particularly enjoy the nitty gritty of operating a business. I preferred the strategy/capital allocation aspect, but it was obvious to me that I could never fully step back from the operations side.
Around this time is when I began investing in stocks. I actually bought my first stock (Dick’s Sporting Goods (NYSE:DKS) at ~$15) right in the midst of the financial crisis. I knew nothing about it except that I’ve been to the stores and liked them. A typical “buy what you know” Peter Lynch style investment with just about no research. The stock dropped 15% the day after I bought it. I bought more. I also bought Costco (NASDAQ:COST), American Express (NYSE:AXP), Nike (NYSE:NKE) and a few others. I knew next to nothing, but like Klarman says you either have the value gene or you don’t and I’ve been hooked ever since.
Describe your investing strategy and portfolio organization. Where do you get your investing ideas from?
My strategy is a concentrated value based approach. Typically I own around 10 to 15 companies, with a large concentration in the top 3 to 5 holdings. Currently I have only 8 holdings. That is probably the lowest number of stocks I’ve ever held, but that can change quickly. I can afford to do nothing for long periods of time since I’m not managing clients’ money and only my families (which thankfully can’t withdraw). There are times when I could own closer to 20-25 if I found a basket type investment or if there was just a ton of cheap ideas available. Generally I’d like to keep it in the 10-15 range.
Value is a very generic term. I’d put myself more on the Buffett side of the spectrum rather than the Graham side, but I find those descriptions sometimes too simplistic. I look for (like everyone else) great companies that can compound at high rates of return for a long time. Obviously these companies don’t grow on trees and/or don’t come cheap. I also like to find good maybe even just average companies at cheap prices. These tend to be contrarian type investments selling at double digit FCF yields where I think the market is overly punishing the company. I will occasionally look at a net-net type investment if there is something that appeals to me beyond cheapness. Also, I keep an eye out for special situations. It could be a spinoff, a company with underappreciated assets or maybe a profitable business obscured by a money losing one.
What ties these strategies together is my focus on simplicity and downside. I like to find companies no matter what type, that even in a bear case scenario I see very little downside. I also want situations where I can see just a few variables at play. If the situation is too complicated I generally pass. Simplicity doesn’t mean it’s easy or that I’ll be right, but having clarity into the factors and possible outcomes. That’s easier said than done. I also tend to be attracted to great management teams that I feel I can trust, which comes from what I talked to about earlier.
I get my ideas from everywhere and anywhere. Newspapers, internet articles, Twitter, Value Investors Club, newsletters, my wife, my kids, going out to eat, friends, the person that cuts my hair, wherever. I’m always thinking about investing and looking for new investment ideas.
What drew you to that specific strategy?
I think it’s just in my nature to look at downside risk first. And as I mentioned earlier, my previous job left an indelible impression on me regarding the importance of good management.
My process has been shaped by my circumstances too. I have a day job that doesn’t allow me to research companies all day, every day. It’s forced me to be selective in the number of companies I follow and focus on simple investments while avoiding complexity. I’m very quick to put something in the too hard pile, because I simply don’t have the time.
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 don’t know where to even start. I can’t say what the most important lesson I’ve learned is, but Buffett and Munger have given so much back to the investment community that has been invaluable to my education. That’s obvious and probably even cliché. Margin of Safety and Mr.Market have to up there in terms of most important lessons/concepts.
I follow a bunch of investors but some of my favorites are Chuck Akre (Trades, Portfolio), Ted Weschler, Joel Greenblatt (Trades, Portfolio), Lou Simpson (Trades, Portfolio), Glenn Greenberg (Trades, Portfolio), Tom Gayner (Trades, Portfolio) and Allan Mecham. Some other investors worth following are Don Yachtman, Bill Nygren (Trades, Portfolio), Mark Massey, David Rolfe (Trades, Portfolio), Paul Lountzis, Jeff Ubben (Trades, Portfolio), Francois Rochon, Brian Bares, Wally Weitz, Tom Russo (Trades, Portfolio) and a bunch more I’m leaving out.
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?
I will hold a stock as long as I think it still offers decent future returns. How long I hold has more to do with the underlying company and the stock price than any predetermined time frame.
I have a longer leash with great companies and a shorter leash with the mediocre/cheap ones. So if one of my compounder type investments gets to fair value or slightly above, I will be more inclined to hold versus with a net-net or special situation I will be more apt to pull the trigger and sell near fair value.
Can an investor know how long it takes to know if you’re right or wrong? You may not know if you were right or wrong even after selling the stock (regardless if you made money or lost it).
How has your investing approach changed over the years?
Like many value investors I started out with a more Ben Graham quantitative approach, buying cheap stocks, low P/B, low P/E, etc. So easy! I learned pretty quickly that cheap does not equal value. I don’t want to make it seem like the Buffett approach is superior, which value guys sometimes do. A quantitative approach with cheap multiples can be a great way to invest if you do your research.
Now I have a much deeper respect for the qualitative side of things. Many of the stocks I own do not screen well based on the typical cheap “value” multiples. I put more weight on management and the underlying business than when I started out. I focus much more on ROIC and FCF; where as, early on being cheap was the most important criteria. That said, I still have a tough time paying up for great companies. And it’s not false modesty; I genuinely have a hard time with paying 25-30x for great companies and am trying to get more comfortable in this area. The Brooklyn Investor did a great post (that I often reread) about Buffett paying 10x pre-tax earnings for some of his biggest investments. Reconciling this hasn’t been easy for me, but some companies are simply great buys at 25x earnings and some companies are terrible buys at 6x earnings.
Name some of the things that you do or believe that other investors do not
I’m not sure I believe anything different than other investors. Maybe I put more emphasis on certain things. I probably put a greater emphasis on simplicity than some. I want very few assumptions made in any investment for the base case. I seek investments where I’m paying virtually nothing for the bull case scenario. But who doesn’t?
What are some of your favorite companies, brands, or even CEOs? What do you think are some of the most well run companies?
Markel (NYSE:MKL) and Berkshire (NYSE:BRK.A) are two of my favorite companies. Obviously Buffett and Gayner are two of my favorite CEO’s. I’m from Baltimore so I’m a big Under Armour fan and I kick myself for not seeing that one early on. Sergio Marchionne is one of the most interesting and entertaining CEO’s out there. No interview or call with him is ever boring. John Malone is a legend, so I like to follow him and the Liberty complex.
Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
Not really. Every once in a while I’ll screen something I’m interested in or look at the Magic Formula screener.
I don’t know about efficient, but if you keep your eyes open and constantly look for bargains you can find some great ideas. Twitter is an incredible resource if used correctly. I have a list of about 200 or so people that share interesting articles, videos, research, commentary, ideas, etc. These are some really smart people that you can follow and converse with daily. It does a great job of filtering through the garbage. I’ve definitely found potential investments or valuable information on an investment through Twitter.
Some great Twitter follows off the top of my head:
@bluegrasscap @BrattleStCap @basehitinvestor @Find_Me_Value @covenantlite @HurriCap
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.
The ideal company to invest in would be Berkshire Hathaway in the early years. A young company with high ROIC, a long runway for growth, the ability to reallocate capital/reinvest at similar rates, a sustainable competitive advantage and if you can get that at a cheap valuation it’s a home run. Unfortunately that is incredibly rare/hard to find.
Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
Once I’m interested in a company, I read everything I can find on it. That includes 10K’s, 10Q’s, any article I can find, research reports, quarterly call transcripts… really anything. I don’t have the option of talking to management. I think you can get a feel for management from listening to calls and reading annual letters to shareholders. Over time it should be evident whether their words are backed up by action.
What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?
I’m not finding much at the moment. I do think some banks are undervalued. I know many will disagree with this, but I believe banks like Bank of America should do well even if rates remain lower over the next few years. At worst, they will grow book value at ~6% or so and payout most of that to shareholders. No you can’t know everything that is in the banks, but they have never been better capitalized or safer. Bank of America is trading less than TBV, around 11x earnings and they’re continuing to cut costs. Of course the upside is rates go up, expenses go down and valuation increases. If you believe the scandal won’t be detrimental to earnings power, than Wells Fargo might be worth a look too.
How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
It’s definitely not cheap. I don’t get too deep into the market valuation discussion. Luckily I can be patient and wait for any pullbacks or opportunities that turn up. Nobody knows what’s going to happen or when it’s going to happen. I just continue to invest, have cash available and not fixate on where the market is.
What are some books that you are reading now? What is the most important lesson learned from your favorite one?
I’m reading “Titan” by Chernow, which is great so far. I don’t know that I can pick a most important lesson or a favorite book, but Galbraith’s “The Great Crash, 1929” is a book I highly recommend. It’s amazing how similar everything was to the most recent financial crisis. It really crystallized for me how human nature never really changes.
Any advice to a new value investor? What should they know and what habits should they develop before they start?
I recommend opening a brokerage account and just get started investing. Don’t get carried away with huge amounts of money, but put some skin in the game. Nothing can replicate having actual money on the line. Once you have a stock drop 10%, 15%, 20% in a short period of time you’ll know whether you have the temperament for this.
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?
I’ve made plenty of mistakes. Some of the more recent ones that I can think of are Colfax (NYSE:CFX), JC Penney (NYSE:JCP), Weight Watchers (NYSE:WTW) and Iconix Brand Group (NASDAQ:ICON). I was lucky that in each case they were small investments as a percentage of my portfolio. Also I believe I actually made money on Weight Watchers and broke even with JC Penney. But that was total luck and I still consider them huge mistakes. In every case (except Colfax), the management teams were less than stellar and that is being kind. Two of them were turn-around situations. They each had large amounts of debt and all of them, except Colfax, were cheap on a “normalized” earnings basis. As for my mindset, I think I deviated from my usual framework and got enamored with the possibilities on the upside versus focusing on the downside. The upside led me to excuse certain things that I normally wouldn’t, especially in the case of Weight Watchers and Iconix. Those management teams had big red flags. When I did a postmortem of these investments, I noticed that all were small allocations of around 2-3% each. I rarely invest such a small allocation and should of listened to my gut when I wasn’t confident enough to make it a more significant position.
How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections, and fluctuations?
One of my biggest strengths is the ability to stay even keel while the market or stocks that I own fluctuate. I try to focus on the fundamentals and underlying drivers of each one of my investments. I ask myself if anything has changed. I look at what the fundamentals are over the course of time and that helps me focus on what matters. Of course that’s easy for me to say having started investing in 08/09 and seeing nothing but a rising market since. Generally though, I’m wired in a way that I get excited when the market is down and anxious when it goes up.
If you’d like to share, how have the last five to ten years been for you investing wise?
I started keeping detailed records of my returns over the last few years and have beaten the market by a decent margin. However, as I mentioned earlier I picked a great time to start investing and haven’t been through a full investment cycle. This year I’m trailing the S&P by quite a bit. I’m really looking forward to finishing school and focusing on my investments.