A list exploring what value investing really means.
My investing philosophy is strongly anchored in the school of value. Classically, value investing is viewed as something like looking to buy a dollar for a quarter, and while I love that as much as anyone, I see it as something broader than a numbers game. I believe the classic elements or tenants of value investing can and should be expanded to encompass and address a larger universe of approaches. A non-exhaustive list follows.
- A focus on primary research. It is very much a hands-on approach, and while one can make use of all the latest tools and resources, the work needs to be yours. If you don’t own the work, the research process, the results, you cannot reasonably rely on them to make decisions. As a colleague of mine so wisely put it a few years ago, “our edge is that we do the work”. One needs to avoid phone-game or relying too much on what someone else told you that you cannot substantiate first hand. This need not be taken to extremes, but for instance, if you don’t read the publically available contract that someone tells you about, if the prices and volumes aren’t correct in the end, that’s on you.
- Widdle down the work. As you do your research, you should work to reduce the set of possible outcomes to a smaller set of probable outcomes. Dear reader...anything is possible, fewer outcomes are probable. A robust research and analysis process will leave you with unknowables. Those unknowables will be unique to you in the situation. At this stage, you need to determine if these unknowables are likely widely unknowable, or if they are unknowable to you and knowable to others. If you determine that said items are likely knowable to a reasonable number of other people by way of their experience, networks, domain expertise, or something else, this should give you pause. If you determine that said items are likely widely unknowable, then it’s more reasonable to move forward. Avoid taking a knife to a gun-fight as a wise man once said...
- Always look for a margin of safety. Traditionally this concept has been thought of in terms of intrinsic value versus the price the market is giving you. If the market price is below your view of intrinsic value by a wide enough margin, then you should buy; if the market price exceeds your intrinsic value by a wide enough margin, then you should consider shorting. In this sense, your margin of safety is higher the greater the disparity between intrinsic value and the market price. I believe this concept can also be applied away from price to things like domain expertise, position in a capital structure, or the structure of an investment.
- Work from a way of being that combines curiosity and rational optimism with a healthy dose of skepticism for anything that seems overly novel. Anything truly new requires more work, more primary research, and a larger margin of safety in my book.
- Borrowing from Howard Marks, “it’s never different this time.” This is especially true as it relates to management teams or financial sponsors with a history of not delivering. This is also true as it pertains to business cycles.
- First, don’t lose money. If you invest with the approach that your goal isn’t to lose, you are better positioned to win. Usually, this comes about because things that are washed out, unloved, uncovered, passed over have many ways and paths to produce positive outcomes (eg improved financial performance, multiple expansion, overlooked asset value) than ways and paths to produce negative outcomes (eg once you file bankruptcy the situation becomes more rules-based and uncertainty is reduced). This isn’t to say that you won’t lose money, but going into a situation with a firm view of the downside will leave you better prepared to make investment decisions. If you cannot quantify a reasonable downside, you should pause.
- Don’t feel forced to act. One of my professors at Columbia handed out punch cards to the students and said that if you fill the card (one punch per investment – 20 potential punches in total) during your career then you have said yes to too many ideas. Despite what the financial media suggests, not everything is a trade that you need to consider or have a view on. It’s ok to not have a view or to sit out when you feel that you would only be acting to act.
- Market inefficiencies and dislocations create opportunities. The marketplace today includes an increasing number of investment structures and parties that abide by a varying set of rules, rules that may include the need to sell things based on ratings agency views, industry concentration issues, price levels, price changes, dividend payments, defaults, etc. Backed by a view on intrinsic value, these “forced sellers” create potential opportunities.
- Risk is not the same as volatility. Something can be volatile (e.g. have a higher propensity to move), but in the right structure, investors may never be forced to crystalize a loss (that’s the risk). The reason you cannot truly invest like Warren B is that he has capital with a nearly endless investment horizon and a business that provides fresh capital every quarter to reinvest...and you do not.
- The terms of your capital should always drive your investing style and color your approach to risk and volatility. This mismatch has been the driver of the demise of many funds and even businesses. Do not invest in illiquid assets in a liquid investment structure unless you are certain that your investors will not call capital from you at the worst possible time (e.g. when your investments are most illiquid or at lows).
- The value of recognizing aligned and misaligned interests is often overlooked. It is important to understand who has skin in the game and who does not. Why someone is trying to sell you something or get you to invest in something may be just as important as what they are pitching.
- Surround yourself with smart people who don’t take themselves too seriously while realizing the seriousness of what they do for their constituents.
- Look for holes in any thesis. Ideally, find the smartest person you can access who has also done the work and has a differing opinion and hear them out.
- The harder it is for you to communicate a thesis or pitch an idea, the more likely it is that there is more work to do and / or that the idea is not a fit for you.
Dear reader...this is a non-exhaustive list. Please tell me your thoughts as comments to this entry on Linkedin and I look forward to learning more from you as part of the discussion!
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