The value imposers

I was riding on a ski lift with an apparently successful investor from New Zealand.  Each January he flew to Utah to ski for three weeks with his family.  I couldn't even imagine how much airfare and lodging must have cost.  Our conversation naturally drifted to investing.  He asked what type of investor I was to which I responded "a value investor."  He had a puzzled look and said "what does that mean?" I said "I look for undervalued stocks, companies trading for $,.50 that are worth $1."  The man laughed and said "Isn't that what all investors are doing? Looking for undervalued stocks?"

That ski lift ride was 10 minutes long, but the conversation has stuck with me the last three years.  It serves as a constant reminder to invest differently.

As Warren Buffett's investing style has shifted from small neglected companies to elephants the sentiment of value investing seems to have shifted with him.  Articles about value investors from the 1970s and 1980s are full of quotes about finding companies the market has left for dead yet full of value.  Companies where their real estate is worth more than their market cap alone, or companies where coffers stuffed with cash are disregarded because there is no growth.

Buffett is arguably one of the most successful investors of all time.  He might be outdone by Rockefeller or Carnegie, but until Buffett passes from this life into the History Channel no one's counting.  Buffett has matured from a small time investor at the fringe of the market to a star that the rest of the market orbits around.  If Buffett wants to speak anyone with a camera listens.  His quotes have found a home in almost any market situation.  Even a trader might be caught saying "Be fearful when others are greedy."  Buffett quotes are like horoscopes, ambiguous enough that they apply to any investor in any market situation.

As Buffett's company Berkshire Hathaway grew from cigar butt stocks (small neglected companies) to larger names his strategy shifted.  He started to buy larger companies whose growth wasn't appreciated.  After all with billions of dollars in capital he was effectively forced out of smaller names.  When Buffett bought undervalued growth the market purchased it too.  Then another shift happened, Buffett could no longer buy undervalued growth and simply had to look for wonderful companies selling at any price that wasn't outrageous.  If a large enough company comes calling and they aren't asking too much he'll probably buy.  Why?  He has to keep feeding the beast.  Berkshire Hathaway is a victim of compounding.  The company has grown so large and so successful they have an increasing amount of cash that needs to be put to work each year.  Buffett could hardly be criticized, he has built one of America's largest companies and made himself into one of America's richest men in the process.  So what if he has to lower his standards a bit?

Berkshire Hathaway's pool of potential investments is limited to maybe 100 public companies and a similar number of private companies.  But just because he's limited doesn't mean we should be limited.  Buffett will probably outperform the market over the next decade, but my guess is Berkshire's returns gently glide to be inline with the market.  Why?  Because at a certain size his company is a proxy for the market.  As the American economy goes so goes Berkshire Hathaway.

My point is that Buffett has become the market, and at this point mimicking what he does gives results no different than what the market generally does.  Why not buy an index fund?

If as an investor you want different results from the market you need to do something different than the market.  Everyone in the market wants growing companies.  How do I know this?  Browse the mutual fund selection at any discount brokerage.  What is the term that appears most? Growth.  I did a quick search and Fidelity offers me 374 growth funds verses 288 value funds.  But I'd say this number is skewed.  I read the summaries on a few of the value funds and they all mentioned they look for growing high quality companies in a value manner.  Even the value funds are growth funds.

Is growth bad?  Not at all, we all want things to grow.  If something isn't growing it's shrinking.  I want my portfolio to grow, my relationships to grow, my knowledge to grow, my kids to grow, everything to grow.  And so does everyone else.  We all want growth.  If most mutual funds are looking for the same thing is there any question as to why most slightly under-perform roughly by the amount of their fees?  Of course not, it's because they're all doing the same thing, looking in the same places for the same types of companies doing the same things.

When everyone is doing the same thing an industry becomes an arms race.  Who can find the growth the quickest, who has the better tools, who has the smartest analysts and who can get better information.  This is the efficient market, the knowledge arms race for growth.

This arms race extends beyond mutual funds to hedge funds.  Many hedge funds think differently together resulting in crowded trades.  Individual investors see these clusters of fund managers in the same names and naturally gravitate towards the same companies, like moths to a light.

There is an alternative.  For those of us without Wharton, Harvard, or Columbia analysts or those of us who aren't managing billions, or even for those of us who are.  The answer is to think and act differently.

One of the reasons value investing was so unique when Graham first wrote about it was because it was so different.  At the time investors wanted high yielding stocks.  A high yielding stock was desirable.  It didn't matter what assets or earnings the company had, only their dividend.  As time has progressed the metrics the market considers important have shifted.  Instead of dividends it's ROE, growth, moats and EV/EBITDA multiples.

If you want different results from the market then you need to think and act differently.  There will always be a few managers who win the arms race, but silently mimicking them isn't helpful unless you want to join the race.  One needs to look at things differently.  If the market is looking for growth and high ROE then what are they glossing over that's important?  The key to success is finding what others have missed.

Being different is difficult, there are few friends and you need to pave your own path.  I have never marched with the crowd, for some reason I came out of my mother's womb wanting to go my own path.  To me marching in a different direction is natural, I'm curious, I follow seemingly endless hunches or attractions and hope to learn a little on the way.  This extends to my investing, I'm attracted to the nooks and crannies of the market simply because no one else is there.  If what I do is unnatural for you that's fine, don't mimic me, do your own thing.  To me the key to success is being different and thinking differently.

I find success fascinating.  There are plenty of high powered CEO's who grew up in the right suburbs, went to the right colleges and climbed the right ladders.  The financial media loves them, but to me they're boring.  I find the successful entrepreneurs fascinating.  People who never went to college and own multi-million dollar landscaping companies.  People who left high powered jobs to start something different like a cupcake business.  The ones who saw opportunity and acted on it.  The ones who risked failure, or the loss of their reputation to do something different.  People who are obsessed with something and won't give up until they are satisfied with a solution.  These are the success stories I love to hear about.

While I love success I am even more fascinated by failure.  There are common failure paths that most companies or individuals take.  These are well trod out paths that some can see coming.  Why do so many companies with well educated executives fail so miserably?  As an investor spotting failure and avoiding it can be extremely profitable.  Most companies that fail follow the crowd, they fail to take risks and do things differently.  Some industries fail together as each company marches in lock step toward imminent death.

Buffett's success came from being different.  He created a new type of investment company.  It's a shame that instead of learning that lesson from him investors have instead embraced trying to copy him.  If you want different investment results than the market you need to think and invest differently.  If you don't you might as well invest in an index fund and forget about the market.


  1. It's so nice being a not hugely wealthy individual investor. If there are no good stocks, you don't have to buy any stocks. You can focus your time on investing in local private businesses or even just investing the money in your own business by building one, like you have of course.

    1. There is an enormous advantage to having a relatively small pile of capital. When I say relatively small I'd say anything less than $40m is relatively small. There are plenty of startup funds that can still swim in the waters of this blog but choose to go for large caps, that's puzzling to me.

  2. I generally agree but I do think there is a place for just buying monopoly businesses at reasonable prices. The trick is of course to pick who will be exceptional over the next 20 years rather than the last 20 and that is where people get tripped up.

    I think it is the same thing with cigar butt investing. The trick there is to be able to avoid the really awful ones. So there is always a trick or an edge you need to have.

    I think the highest returns come from being a successful flipper of stocks and not from long term ownership of a great business. That is heresy in some circles but the simple fact is people can change their minds about business value faster than businesses can grow value.

    Graham covers this question in the appendix to the edition of the intelligent investor, whether it's better to buy quality or value. His advice is to pick the "middle course", stocks with decent quality that are conservatively valued. I think that is good advice for everyone who isn't Buffett/Fisher/Lynch type. Graham's way works for people who aren't even that smart which is why I'm using it :)

    1. I really like what Kraven once said to giofranchi once on CoBF about what Graham meant by being a "business-like" investor. It doesn't mean that one has to hold a business for a long time. It just means that one treats the buying and selling of stocks as a business-like endeavor, as if stocks were inventory in your store to be bought and sold intelligently.

      Somehow, the "business-like" investor line has been distorted by some to mean that you should never sell any stock.

    2. The problem with the monopolies is rarely do you know who will have an advantage by looking in the past. So many previous monopolies were disrupted by innovation or just market shifts. I own MA and I'm worried about this myself. Will they still dominate payments in 20 years? I don't know, maybe, but I need to be watchful.

      Innerscorecard is correct that being business-like means to execute on the process and investment plans in a businesslike manner. You look at a company if it's a good investment you buy and when it turns you sell, no emotion. A grocery store owner might appreciate a really high quality crop of tomatoes, but they don't decide to never sell them because they're so good.

  3. Nate,

    You wrote, "Many hedge funds think differently together resulting in crowded trades. Individual investors see these clusters of fund managers in the same names and naturally gravitate towards the same companies, like moths to a light."

    It must have occurred to you that your website and newsletter have this same effect, right? The people who are attracted to these are investors who want to "think differently together" along with you...

    - aagold

    1. To an extent I agree on the blog. There are a lot of readers here, but only a few share the same investment philosophy. On the newsletter that readership is obviously more interested in acting on the investments, but not everyone acts 100% of the time.

      I do have an impact (although limited) compared to a big name 'guru' who when they purchase shares of some company lines of investors follow.

  4. I agree that you have to be different and look in places others cannot or will not go. I see so many folks even on value boards attempt to find great companies at reasonable prices. There are alot of professionals and individuals playing this game thus it is like playing tennis with against John McEnroe. I think doing this is much more difficult than looking at the cheap stuff and being picky about what you buy. This is like playing tennis with your slightly overweight out of shape neighbor. The Credit Agricole regionals or Korean preferred stocks are examples of the cheap stuff out there that I could never see Buffett or those looking for great companies buying. You can use the characteristics of great businesses to select those in the bargain bin. This is inverting the normal process of finding great and waiting for the price to change. Just like in commodity businesses (which stock selection is) competition will remove excess return pretty quickly from great businesses once they appear.


    1. Packer,

      The great irony is I'm sure a time will come when we can pick up great companies at good prices, it's just that time isn't now.

      I really like your tennis analogy, it's spot on. I'd rather 'compete' against other investors who are at a similar skill level to myself. Or find investments that have some structural component like the CA banks or the Koreans that serve to keep other investors out.

      Great comment.


  5. Great post, I really agree with a lot of what you had to say. I think being a value investor involves going in a different direction than the crowd and a lot of the difficulty involves having the fortitude to keep it up when you are part of a very small minority buying when people are selling, or staying on the side when everyone else is making a killing.

    One thing I would point out that is important, especially concerning Graham's philosophy, was not only going your own way and seeing what other people don't, but correctly interpreting the available data using a scientific approach. Graham mentions a variety of scenarios like that in Security Analysis and his other publications where for instance a high yielding stock would be popular, but examining the financials made it clear they couldn't maintain the dividend and thus weren't suitable for investment.

    I think there is still fertile ground for that sort of analysis in the modern age. Similar to the focus on yield in Graham's day, I think the focus on EBITDA and the use of EV/EBITDA has the potential to distort valuation. Quite often I see articles making a case for a company that use EBITDA as a measure of their profitability and they seem to ignore that everything in the ITDA part actually is relevant. By the same token, I think Graham's characterization of the market as a voting machine in the short term and a weighing machine in the long term is still as true today as it was then.

    Again, really enjoyed the post and looking forward to hearing more.

    1. You can't eliminate the analysis, but looking at the market differently from The Market is valuable. It's as you say, if everyone is looking at EV/EBITDA then maybe there's a different angle. If everyone is looking at large caps then maybe small caps or mid caps hold some gems.

      What's tough for some I think is this criteria is always shifting. What is popular shifts from time to time. An investor needs to be flexible.

      I believe one mistake many take with Graham is they look at his approach as a formula. Just buy net-nets or low P/B stocks mechanically and call it a day. But he was discussing so much more, those were the common examples and they served to illustrate his purposes.

      If every company in an industry is trading at 10x EV/EBITDA and there's a company trading at 5x EV/EBITDA it might merit investigation. If you dig into the company and look at them from another angle maybe the market is missing something and they should be worth what their peers are worth. I don't think that's any less of a value investment than some low asset stock. Actually that's probably more of a value investment compared to some of the really crummy low P/B stocks that I've seen touted.

    2. I agree the flexibility to respond to changing conditions and the fortitude to keep doing something the market is against are the keys to value investing.

      It's funny because I think all the people looking for an easy formula are ignoring the actual easy formula right in front of them which is of course index investing. Very low amount of work required and you easily achieve market returns (or possibly better as you can diversify away certain market risk). Of course such a strategy would be anathema to me but for those who don't want to put the work in I can't see why they wouldn't choose that route.

      I think if Graham were rewriting Security Analysis and The Intelligent Investor today the major changes to Security Analysis would be discussion of the cash flow statement, funds, and some of the modern metrics and how to properly use them, but The Intelligent Investor would be completely rewritten to be a discussion of index investing.

  6. Nate,

    I would be interested in your views of an undervalued quoted company that is tightly held by one or a small group of owners/investors.

    If they have control over the company and don't want to sell their shares it may be of no concern to them what the share price is. With enough stock its possible they could de-list the company at any time.

    Once delisted there are no doubt many ways to extract the value from the company without benefit to the minority shareholder.

    Is this type of senario a concern to you? I myself have a couple of investments I am worried about. One company I think is undervalued is being delisted. The majority shareholder is offering to buy out the others for a low price. He has sent me a letter saying the loss I will make on the transaction maybe useful for capital gains tax purposes.

    Any thoughts.

    A concerned investor