One thing that I think distinguishes value investors somewhat is that they pay a lot of attention to what could go wrong, what's the downside. And that's well captured in this quote from Ragen Steinke of Westwood Management. "The very first thing we do when we start to analyze a company is to ask ourselves how far the stock price would fall if we were wrong.
It's not some back of the envelope calculation, but a full assessment looking at liquidation asset values and stressing the business model and valuation levels under any number of bad scenarios." "If the downside is more than 30% from today's price, it's unlikely we'll invest, regardless of the upside potential. If we can't establish a concrete downside number, which probably means it isn't far from 100%, we absolutely won't buy the stock." "Going through this first sets the tone we want to set in our research. Rather than start looking to convince ourselves why we should buy something, we start out trying to prove why we shouldn't buy it. We try to keep that level of skepticism alive throughout the process." I think that's a hallmark of value investors, that kind of-- any investor has to have some optimism. You wouldn't invest if you weren't optimistic about a company's prospects https://www.casinoslots.co.nz/bonus-bets. But skepticism is kind of a hallmark I think of a good investor, and really thinking about what could go wrong. It's great if a stock could double, but if that stock could go to zero, you should think about that. So Whitney will speak in more detail about how smart investors go about determining what a stock is worth. But even if you're able to do that well, there are a lot of things that can trip you up as an investor. And a lot of that revolves around anything doing with money can set off all kinds of irrational responses on people's parts. It could be you're assuming that what just happened is what's going to happen forever. Or you're panicking because your stock went down and it feels really bad to have money evaporate like that. You could be that you're only looking for evidence that confirms what you already believe and you're really ignoring evidence that disconfirms what you already believe. So these are the types of things that can throw people off, and this is the reason why it is so hard to beat the market. People make a lot of behavioral and emotional mistakes. And I think one of the things that sets really good investors apart is they're able to deal with that pretty well, however they do it. Whether it's just innate wiring or it's they've learned it over time, you have to control your basest instincts somewhere. I have a couple quotes here from two very longtime, very successful investors, one of whom is Seth Klarman of the Baupost Group. "As Graham, Dodd and Buffett have all said, you should always remember that you don't have to swing at every pitch. You can wait for opportunities that fit your criteria, and if you don't find them, patiently wait. Deciding not to panic is still a decision." And that's just-- I mean everyone's probably felt it. Like if you were an investor and you lived through 2008, 2009, it feels really bad. Reading the paper was really hard, and it feels bad. And there was a really strong tendency in those cases to just want to get out. Make the pain go away. And that's perfectly natural. It's evolutionary in a lot of ways, but it's not the greatest thing to do as an investor. The person who panicked and sold in March of 2009 and then was so scared that they haven't gone in for the last five years, they've left a lot of money on the table and that's a big mistake. This is another quote from a guy who is a very longtime investor. He's in his 70s and he still really does well, and he just very matter of factly said, "I honestly don't feel any of the emotional ups and downs from the market's day to day activity.
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If you're right that something is mispriced it will eventually take care of itself. We think it matters because you can conceivably avoid a lot of pain waiting for truth to prevail if you have a good read on why it currently doesn't." So again, just to reiterate a little bit, just because a company is a good company doesn't mean it's a good stock investment. There has to be something about your perception of how the assets they have or how the future's going to play out that differs from what everybody else thinks and what's built into the stock price. So a logical question following that would be, so why do stocks get mispriced?
It's efficient market. A lot of academics will tell you that it's an extremely efficient market and you should not even try to beat the market. So what a fundamental value investor who is an active manager is trying to do is identify what's going on that could make this the stock cheap. And I thought that was summed up pretty well in this quote from Steve Morrow of New South Capital. "We believe the market often misprices stocks due to neglect, emotion, misinterpretation, or myopia. So our value add comes from bottom-up stock selection. We're trying to buy at low prices relative to our current estimate of intrinsic value, and we want to believe that intrinsic value will grow." So neglect, emotion, misinterpretation, or myopia. Those are the types of things that can lead a stock not to reflect accurately what's going on in the future. Howard Marks of Oaktree Capital who is a longtime very articulate investor puts it this way in a more general way. "Investment markets follow a pendulum-like swing between euphoria and depression, between celebrating positive developments and obsessing over negatives, and thus, between overpriced and underpriced." "There are few things of which we can be sure and this is one. Extreme market behavior will reverse. Those who believe the pendulum will move in one direction forever or reside in an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously." So what kind of situations can lead to neglect, emotion, misinterpretation, or myopia, and therefore, potentially inaccurate stock prices? A lot of things can make that happen, but there tends to be change. There tends to be uncertainty. And quite often there tends to be a problem or multiple problems. These are things that can throw off or cloud what the future may hold to a greater degree than if everything's kind of going OK. Again, I'm doing this because I think the people that we interviewed say it better than I would, so I'm going to quote John Jacobson from Highfields Capital where he talks about where he looks for opportunities. So what is the fertile ground for potential mispricing? "Two kinds of events create volatility, which creates opportunity. The first revolve around individual companies, such as earnings misses, unexpected news, M&A activity, restructurings, and legal issues-- things that can make prices and valuations change relatively quickly. We want to understand what made the price change and then figure out whether the facts have changed as much as the price. To the extent they haven't, that can be an opportunity." "The other major source of volatility is when a macro event or trend causes markets to move. The market reflects at any moment what investors think XYZ's business is worth. So if macroeconomic factors force people to buy and sell its securities, but we believe those factors have nothing to do with the underlying fundamentals of the company, or less to do with the fundamentals that is being reflected in the share price, that can also be an opportunity." You guys probably notice, even looking at Google stock, if you look at a Google stock chart over the last five years, you'll see it moves. It moves quite a bit. And it moves a lot more, one could argue, than the actual fundamental reality of what's going on at Google at any given time. And it's that if this is what's going on at Google at any time and this is the stock price, there can be opportunities to buy the stock when it's inefficiently priced. So while most discussions of stocks talk about what can go right about a stock-- everybody's talking about what's the upside, this is going to be great, it's going to double. That's not to say there aren't other reasons why people buy stocks. People buy stocks because my wife works at the company, I think it's a great company, or I love the product, or I heard at a cocktail party that it was going to go up. Lots of stocks get bought that way, but that's not what fundamental value investors do. So one of the first concepts we talk about is this notion of circle of competence. And that is what are the-- every investor should think about OK, what are the industries, what are the situations, what are the geographic areas, what are the size of companies that I'm going to look at and I'm going to become an expert in that will allow me to get an edge over what is a very efficient market?
And I think the basic concept is explained really well in this quote from Julian Robertson who's one of the best, most successful hedge fund managers of all time. "A baseball player never really gets paid, no matter how many home runs he hits or what his batting average is unless he gets to the big leagues. Then he's guaranteed to make a lot of money. But in the fund business, you can find a minor league where you can hit for a better average because that's what you're paid on." "I remember one of our guys taking us into Korea in the early 1990s and the market was so inefficient that it was a goldmine if you knew what you were doing. My point is that to be successful in this business, you don't have to be better than everybody everywhere, just better than everybody in the league in which you play. It's maybe today more difficult to find those inefficient areas, but it's not impossible." So the central conceit of any investor is that you figured something out that the market doesn't know or the market has just got wrong. If what's priced into the stock is just what everybody assumes and what the consensus is, it's very unlikely that that stock is going to be a successful investment. The price reflects the future, as the consensus sees it. And I think that's something I think people don't-- it's like, OK, Google is a great company, but that doesn't always mean that investing in Google stock is a great investment. It may be that the market is so enamored with Google's future that the price you'd have to pay it own a share of Google isn't a value, and it won't be a great investment. That doesn't mean it's not a great company and won't still perform extremely well, but it may not be a great investment. So I think one quote that captured that kind of notion really well, which is really important, was from a publisher of "The Daily Racing Forum," of all places. He said, "The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory. There's no such thing as liking a horse to win a race, only an attractive discrepancy between his chances and his price." OK, so that puts a premium on what successful investors often call the variant perception. Actually knowing what it is or identifying what you think are the reasons a stock is mispriced. A lot of investors may just imagine, OK, the stock is cheap and that's eventually going to work its way out. But I think what we found is that a lot of the best investors go beyond that, and they want to understand at least why it's cheap. Why would these be cheap? What's going on that could make this cheap? And that is the subject of this quote that I thought said it pretty well from Curtis Macnguyen who's at Ivory Capital. "Why something is mispriced is too often ignored by value investors. The general thinking is that it doesn't really matter. |
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